It’s Time For An ETF Gate

March 29, 2012

The structure didn’t fail Eric here. Eric failed Eric.

You see, I’m going to guess that Eric never read the pricing supplement for TVIX. I’m going to go so far as to say he probably didn’t understand that with VIX futures in crazy contango throughout the last month, his expected return was quite negative.

But the solution isn’t to ban ETNs, as the most hyperbolic CNBC commentators would suggest.

The solution is also not labeling—where only certain structures could call themselves “ETFs”—as BlackRock would suggest.

The solution is gating.


If Eric wanted to open a futures account and trade VIX futures, he’d need to clear an hour off his schedule.

He’d have to read and sign a piece of paper saying he’d read and understood a rather lengthy set of risk disclosures from the Commodity Futures Trading Commission. So why should he be able to invest through a backdoor in those exact same futures through TVIX or another volatility product like the iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX)?

He shouldn’t be.

If Eric wanted to make a huge leverage bet on the S&P 500, he’d have to open a margin account, which comes with another pile of paperwork explaining the risks and limits of leverage. Why should he be able to make the exact same leveraged bet through a backdoor?

He shouldn’t be.

Instead, ETFs should go through a review process that actually categorizes them based on their risks, exposures and complexity. Products that cross certain lines—leverage, derivatives use, path-dependent fees—should be put behind a separate set of disclosures.

To be clear, I’m not crying foul on plain-vanilla ’40 Act funds like the Vanguard Total Bond Market ETF (NYSEArca: BND) or the SPDR S&P 500 ETF (NYSEArca: SPY), because disclosure on relatively straightforward funds is perfectly adequate.

But there should be disclosure on more complicated securities, whether they’re structured as:

  • '40 Act funds like the ProShares Ultrashort S&P 500 ETF (NYSEArca: SDS)
  • commodities pools like UVXY or the United States Oil Fund (NYSEArca: USO)
  • or as ETNs, like TVIX


These disclosures could either be implemented as interstitials to trading—pop-up screens, required live-broker scripts—which would be tremendously unpopular.

Or they could simply be implemented at the account level, like access to shorting or access to options or access to margin.

Frankly, I think they could be implemented with a fairly simple set of rules from the Financial Industry Regulatory Authority. Again, FINRA members—the brokerage firms—would hate it, but I think it would work.


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