Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Wednesday, September 2, 2009

FINRA Increases Margin Requirements for Leveraged ETFs

Effective December 1, 2009, FINRA is implementing increased customer margin requirements for leveraged ETFs and uncovered options overlying leveraged ETFs, in accordance with NASD Rule 2520 and incorporated NYSE Rule 431.

ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index.  However, some ETFs that invest in commodities, currencies, or commodity—or currency—based instruments are not registered as investment companies. Unlike traditional UITs or mutual funds, shares of ETFs typically trade throughout the day on an exchange at prices established by the market.  Leveraged ETFs are a subset of ETFs that are designed to generate multiples (e.g., 200%, 300% or greater) of the performance of the underlying index or benchmark they track.  Some leveraged ETFs are “inverse” or “short” funds,meaning they seek to deliver the opposite of the performance of the index or benchmark they track. FINRA recently reminded firms of their sales practice obligations with respect to leveraged and inverse ETFs, including the risks caused by the fact that most of these funds are designed to achieve their stated performance on a daily basis.  Leveraged ETFsmay include among their holdings derivative instruments such as options, futures or swaps. Leveraged ETFs are inherently more volatile than their underlying benchmark or index.  NASD Rule 2520(f)(8)(A) and Incorporated NYSE Rule 431(f)(8)(A) permit FINRA—in response tomarket conditions—to prescribe higher initial and maintenance margin requirements. In view of the increased volatility of leveraged ETFs compared to their non-leveraged counterparts, FINRA believes higher margin levels are necessary.

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