While I understand that this RFC is for members to provide feedback, I would like to provide some general comments as an individual investor who makes extensive use of geared ETFs. Accordingly, most of my comments are "geared" towards them (sorry, had to!). For your consideration:
1. There is no relationship or similarity between the various products outlined in this RFC. Defined outcome ETFs and Interval funds are nothing like geared ETFs or cryptocurrency futures ETFs, and certainly nothing like options. It seems extremely odd and dangerous to lump these disparate types of products together, as guidelines/practices/regulations appropriate for one type are unlikely to be relevant to another.
2. "Risk" is a term that carries a lot of baggage, and which also depends on one's perspective and situation. In the case of geared ETFs, for instance: while it is true that an investor may be more likely to suffer some losses relative to the unlevered underlying fund or constant levered underlying due to compounding (or "volatility decay"), this same function actually limits losses during extended drawdowns. Compare the performance of a simulated 2x or 3x daily reset SPY fund during the 2008 market crash and you will see that the daily reset funds retained significantly more capital than an equivalent 2 or 3x leveraged position utilizing futures or margin, because the fund deleverages as the underlying loses value. It is therefore over simplistic to look at these as “risky" because of this one aspect.
Moreover, in terms of loss potential, buying long (bull) geared ETFs is far less risky than utilizing futures, certain options strategies, buying on margin, and buying individual equities - which can and do go to $0.
Similarly, buying inverse (bear) geared ETFs is far less risky than shorting a stock index utilizing futures, selling call options, short-selling ETFs, and short-selling individual equities - which can and do make massive up moves regularly (e.g., Game Stop, AMC), exposing investors to nearly unlimited losses.
Rather than focus on the relatively small risk of losses due to compounding/"vol decay", I think the more important factor to consider is that these products give retail investors a method to enhance returns or hedge their portfolios using modest leverage without exposing them to unlimited losses, which is a very desirable feature and one which actually reduces investor risk in many scenarios. It is worth mentioning that 2x-3x is much less leverage than that afford by futures or most options strategies and is still less than even reg-T Margin allows for 1x funds. And it should go without saying that individual equities are far riskier - on both the long and short side - than even a modestly levered broad equity index fund. If people are allowed to speculate on individual stocks that could just as easily triple or go to zero in a single day, there is no reason why they shouldn't be allowed to similarly invest in a 2x or 3x leveraged equity index fund that has less overall risks in terms of loss or volatility, without an undue burden placed on them.
3. Regarding geared ETFs, the current disclosures about their idiosyncratic risks seem more than sufficient. It is almost impossible to encounter someone who trades/invests in geared or inverse ETFs and who is unaware of the risks of daily volatility on long term returns of these products. If anything, in my experience trading these for over a decade, I’ve found that people *over* state that risk and think the impact is worse than it actually is (at least historically) so it appears that the current efforts of education and notification are quite sufficient.
4. Every time an RFC or NOPR on these products comes out, it causes great consternation among the investors who utilize these products their options, which have long-dated expiries. Parties to these options contracts made those trades expecting the products would be trading through the duration of the contract, and not be arbitrarily shut down, altered, or limited such that liquidity disappears. The products terminating due liquidation clauses or large events can be accounted for and hedged against, but regulatory risk is the greatest threat facing investors and traders of these products.
This request for information and comments itself is very disruptive to these markets. FINRA (and regulators) should be aware that even asking comments or publishing NOPRs sows doubt about the long-term viability of these products and harms the market for them, which itself is dangerous. For many investors who utilize these products, the scariest prospect of all - and that with the greatest financial consequences - would be a delisting, deleveraging, or disallowing/restriction of these products. The risk inherent to the products is very well understood - it is the regulatory risk that concerns us, as you have no doubt seen in the deluge of comments that have been sent in. It would be helpful if FINRA and other bodies would make it clear that these products are not in danger of being restricted.
The most harmful thing that an organization such as FINRA - or a regulatory body such as the SEC - could do to individual investors regarding geared ETFs would be to limit access to them through undue restrictions, force them to close, or force them to reduce leverage - whether directly or through onerous requirements for individual investors or FINRA members that would ultimately lead to them not being available in practice. Such actions would have extremely harmful consequences for individual investors who utilize these funds responsibly as part of a balanced long-term portfolio and who could incur devastating tax consequences or losses on options contracts should the funds be eliminated, altered, disallowed, or subject to loss of liquidity due to fewer market participants. I urge you to consider *these* risks when evaluating the supposed riskiness of these funds and what that means for individual investors, instead of focusing on the perceived – but limited and manageable – risks of the funds themselves.
K Comment On Regulatory Notice 22-08
While I understand that this RFC is for members to provide feedback, I would like to provide some general comments as an individual investor who makes extensive use of geared ETFs. Accordingly, most of my comments are "geared" towards them (sorry, had to!). For your consideration:
1. There is no relationship or similarity between the various products outlined in this RFC. Defined outcome ETFs and Interval funds are nothing like geared ETFs or cryptocurrency futures ETFs, and certainly nothing like options. It seems extremely odd and dangerous to lump these disparate types of products together, as guidelines/practices/regulations appropriate for one type are unlikely to be relevant to another.
2. "Risk" is a term that carries a lot of baggage, and which also depends on one's perspective and situation. In the case of geared ETFs, for instance: while it is true that an investor may be more likely to suffer some losses relative to the unlevered underlying fund or constant levered underlying due to compounding (or "volatility decay"), this same function actually limits losses during extended drawdowns. Compare the performance of a simulated 2x or 3x daily reset SPY fund during the 2008 market crash and you will see that the daily reset funds retained significantly more capital than an equivalent 2 or 3x leveraged position utilizing futures or margin, because the fund deleverages as the underlying loses value. It is therefore over simplistic to look at these as “risky" because of this one aspect.
Moreover, in terms of loss potential, buying long (bull) geared ETFs is far less risky than utilizing futures, certain options strategies, buying on margin, and buying individual equities - which can and do go to $0.
Similarly, buying inverse (bear) geared ETFs is far less risky than shorting a stock index utilizing futures, selling call options, short-selling ETFs, and short-selling individual equities - which can and do make massive up moves regularly (e.g., Game Stop, AMC), exposing investors to nearly unlimited losses.
Rather than focus on the relatively small risk of losses due to compounding/"vol decay", I think the more important factor to consider is that these products give retail investors a method to enhance returns or hedge their portfolios using modest leverage without exposing them to unlimited losses, which is a very desirable feature and one which actually reduces investor risk in many scenarios. It is worth mentioning that 2x-3x is much less leverage than that afford by futures or most options strategies and is still less than even reg-T Margin allows for 1x funds. And it should go without saying that individual equities are far riskier - on both the long and short side - than even a modestly levered broad equity index fund. If people are allowed to speculate on individual stocks that could just as easily triple or go to zero in a single day, there is no reason why they shouldn't be allowed to similarly invest in a 2x or 3x leveraged equity index fund that has less overall risks in terms of loss or volatility, without an undue burden placed on them.
3. Regarding geared ETFs, the current disclosures about their idiosyncratic risks seem more than sufficient. It is almost impossible to encounter someone who trades/invests in geared or inverse ETFs and who is unaware of the risks of daily volatility on long term returns of these products. If anything, in my experience trading these for over a decade, I’ve found that people *over* state that risk and think the impact is worse than it actually is (at least historically) so it appears that the current efforts of education and notification are quite sufficient.
4. Every time an RFC or NOPR on these products comes out, it causes great consternation among the investors who utilize these products their options, which have long-dated expiries. Parties to these options contracts made those trades expecting the products would be trading through the duration of the contract, and not be arbitrarily shut down, altered, or limited such that liquidity disappears. The products terminating due liquidation clauses or large events can be accounted for and hedged against, but regulatory risk is the greatest threat facing investors and traders of these products.
This request for information and comments itself is very disruptive to these markets. FINRA (and regulators) should be aware that even asking comments or publishing NOPRs sows doubt about the long-term viability of these products and harms the market for them, which itself is dangerous. For many investors who utilize these products, the scariest prospect of all - and that with the greatest financial consequences - would be a delisting, deleveraging, or disallowing/restriction of these products. The risk inherent to the products is very well understood - it is the regulatory risk that concerns us, as you have no doubt seen in the deluge of comments that have been sent in. It would be helpful if FINRA and other bodies would make it clear that these products are not in danger of being restricted.
The most harmful thing that an organization such as FINRA - or a regulatory body such as the SEC - could do to individual investors regarding geared ETFs would be to limit access to them through undue restrictions, force them to close, or force them to reduce leverage - whether directly or through onerous requirements for individual investors or FINRA members that would ultimately lead to them not being available in practice. Such actions would have extremely harmful consequences for individual investors who utilize these funds responsibly as part of a balanced long-term portfolio and who could incur devastating tax consequences or losses on options contracts should the funds be eliminated, altered, disallowed, or subject to loss of liquidity due to fewer market participants. I urge you to consider *these* risks when evaluating the supposed riskiness of these funds and what that means for individual investors, instead of focusing on the perceived – but limited and manageable – risks of the funds themselves.