Regulator has signaled it will allow only unleveraged funds tied to the cryptocurrency, at least for now
The Securities and Exchange Commission asked at least one asset manager not to proceed with plans for a leveraged bitcoin exchange-traded fund, according to a person familiar with the matter.
The SEC indicated it wants to limit new bitcoin-related products to those that provide unleveraged exposure to bitcoin futures contracts, such as the ProShares Bitcoin Strategy ETF, which was launched last week, the person said.
The decision is the latest challenge to the asset-management industry’s efforts to cash in on the investor interest in cryptocurrencies by launching new products. Regulators have been curtailing product launches in a bid to limit investor exposure to offerings that they deem vulnerable to fraud, manipulation and other risks.
Valkyrie Investments on Tuesday proposed to launch a fund that sought to amplify the daily returns of a portfolio of bitcoin derivatives, including futures contracts and options, by using 1.25 times leverage, or borrowed money. Valkyrie was asked to pull its proposal, added the person familiar with the discussions. As of Wednesday afternoon, Valkyrie’s filing remained effective.
Later the same day, Direxion filed plans for an ETF that aimed to allow investors to effectively bet against the bitcoin futures contracts used by the ProShares ETF. Direxion declined to comment.
Under rules governing ETF proposals, the SEC has 75 days to review fund applications. Assuming there are no objections from the regulator, fund offering papers are considered effective at the end of that period. The SEC can ask fund managers to withdraw filings in certain instances, but the managers aren’t obligated to do so.
Such requests by the SEC are considered a courtesy, securities attorneys said. But firms can press on if they want to force the regulator to make a decision.
The firms have sought to launch funds that could serve the significant investor interest in an asset class that has appreciated strongly in recent years and is notoriously volatile. Many analysts have warned that these sorts of products aren’t suitable for inexperienced investors, pointing to a series of meltdowns over the years involving exchange-traded products tied to volatility and commodities.
“This is a product the SEC has long had a case of approver’s remorse around,” said Ben Johnson, an analyst at Morningstar, pointing to the SEC’s on-again, off-again problems with leveraged ETFs. “These products tend to get quite a lot of attention for all the wrong reasons.”
Several volatility-linked leveraged ETFs suffered significant losses in 2018 when trading suddenly turned violent, wiping out billions of dollars in investor assets. Leveraged products also were hit hard last year when Covid-19 put energy markets into a tailspin. The SEC responded last year by imposing restrictions on how much leverage these products can use, and SEC Chairman Gary Gensler has indicated those concerns remain at the forefront of the agency’s thinking.
These ETFs “can pose risks even to sophisticated investors, and can potentially create systemwide risks by operating in unanticipated ways when markets experience volatility or stress conditions,” Mr. Gensler said earlier this month.
At the same time, the agency opened the door to more firms marketing such funds. More recently, the SEC earlier this month greenlighted two new ETFs that let investors make leveraged or inverse bets on futures contracts on the Cboe Volatility Index, or VIX.
There appears to be room for firms to apply leverage to bitcoin futures funds at least for some time. VanEck’s most recent regulatory filing for its Bitcoin Strategy ETF says it has the option to boost exposure to bitcoin futures to as much as 125% of the fund’s assets, effectively leveraging the fund, which could launch as soon as this week. That differs from Valkyrie’s fund, which proposed maintaining constant leverage on its bitcoin derivatives holdings.
Asset managers are trying to capitalize further on investors’ thirst for crypto in the wake of ProShares launching the ProShares Bitcoin Strategy ETF two weeks earlier. That fund raised $1 billion in just two days, faster than any ETF before.
The fund’s gains have raised questions as to whether the bitcoin futures market is big enough to sustain all of these funds. Already, ProShares owns about one-fifth of all October bitcoin futures contracts and one-third of November’s, making the fund an easy target for traders who seek to exploit the fund’s need to take large positions in near-term futures and frequently roll them into the following month to maintain ongoing exposure.
Concerns around market capacity led Invesco Ltd., one of the biggest issuers of ETFs in the country, to delay the launch of its bitcoin futures ETF, people familiar with the matter previously told The Wall Street Journal.
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