Key Highlights
- The SEC established a regulatory wall against ETFs exceeding 300% leverage by pausing Roundhill’s latest high-volatility filings.
- Regulators dismissed alternative risk benchmarks, mandating that leveraged funds must be measured against standard unleveraged counterparts.
- This enforcement of Rule 18f-4 signals an end to the “leverage arms race” by making 4x exposure incompatible with federal safety standards.
The U.S. Securities and Exchange Commission (SEC) has stopped Roundhill ETF Trust from launching its proposed 4x leveraged exchange-traded funds.
The SEC’s Division of Investment Management sent a formal letter to the firm’s counsel, Morrison Warren, regarding the Roundhill 4X SPY ETF and Roundhill 4X QQQQ ETF filings.
The financial and crypto-asset sectors are closely watching this situation, as it reinforces the agency’s plan to impose a strict leverage cap across all open-end fund structures.
Under Rule 18f-4, all open-end funds, including those holding crypto-linked derivatives, must keep their Value-at-Risk (VaR) within 200% of a reference portfolio. This means that 2x leveraged crypto ETFs sit at the absolute regulatory limit, leaving little room for tracking error, volatility spikes, or structural complexity.
Violating rule 18f-4 leverage limits
The main concern is related to Rule 18f-4 of the Investment Company Act of 1940, which tries to ensure that the risk level associated with leverage in funds remains under control. According to this rule, the Value-at-Risk (VaR) of an open-end fund cannot exceed 200% of the VaR of a reference portfolio.
Since the proposed ETFs from Roundhill are focused on offering 4x leverage, meaning 400% of the daily return, the SEC believes that this is not possible while remaining within the permissible leverage ratios.
Administrative rejection and fiduciary concerns
The SEC’s intervention came after Roundhill filed post-effective amendments on January 23, seeking to offer 400% daily exposure to major indices. The regulator stated it will not review these filings in detail until the issues in the letter are addressed, and it asked the firm to voluntarily delay the effectiveness of its filings.
This administrative hurdle serves as a clear rejection, as the SEC questioned how the trust’s directors could fulfill their fiduciary duties while pursuing a strategy that appears to go against federal risk management standards.
Risk baseline calculations
Roundhill reportedly tried to use a different baseline to assess its risk profile in its filings. The agency clarified that if a fund’s goal is to track the performance of an unleveraged index such as the S&P 500, it must use that specific index as its reference portfolio.
The SEC noted that the fund’s reference assets accurately represent the fund’s unleveraged portfolio and are the only proper baseline for calculating leverage risk. While 2x and 3x leveraged ETFs have become common for short-term traders, the SEC has typically been cautious about “super-leveraged” options.
SEC emphasizes rules for issuers
The reaffirmation of Rule 18f-4 in recent years aimed to establish a clear framework for derivatives use. However, this exchange suggests some issuers thought there might be loopholes for products exceeding the 3x limit. The SEC’s current concerns emphasize that the 200% VaR limit is an unmovable barrier for now.
The SEC has made it clear that “more than 200% (2x) leveraged exposure to underlying indices or securities” is facing challenges under current rules. By refusing to review the Roundhill filings until they align with Rule 18f-4, the commission has effectively limited the leverage available in the ETF wrapper.
Issuers must now choose between withdrawing their filings or fundamentally changing their strategies to comply with the 200% risk limit.
