) -- While President Obama and the Commodities Futures Trading Commission push for greater regulation of the financial instruments at the heart of exchange-traded funds like
United States Natural Gas
, investors are suffering the
In his address on Wall Street yesterday, Obama highlighted the problems with current regulation, saying, "We've seen the development of financial instruments, like derivatives and credit default swaps, without anyone examining the risks or regulating all of the players."
Over the past few months, the Commodities Futures Trading Commission has been examining the role that derivatives-based commodity ETFs, like UNG and
United States Oil
, have had on the markets they are designed to track.
Managers of these derivatives-based funds are anticipating that position limits may be placed on the number of contracts that each fund owns. This move would effectively limit the growth of the funds, or disable the creation and redemption mechanism that keeps funds like UNG and USO in-line with their underlying value.
In response to the regulatory uncertainty and potential changes, a number of commodities funds have halted creation of new shares. In addition to a voluntary halt by UNG in August,
iShares S&P GSCI Commodity Indexed Trust
iPath Natural Gas
have also halted creation of new shares. Due to regulatory pressure,
recently announced the closing and redemption of its
PowerShares DB Crude Oil Double Long ETN
If Obama's financial regulation touches upon derivatives-based ETFs, the effects will be felt beyond the realm of commodities funds. Leveraged ETFs like Direxion's
Daily Financial Bull 3X
and currency ETFs like
PowerShares DB Bearish
also use derivatives to achieve their strategies.
In his speech, Obama noted that, "under existing rules, some companies can actually shop for the regulator of their choice." While ETF issuers do not actively shop for regulators, the gaps and overlaps in regulatory authorities are evident in the ETF landscape. As derivative-based ETFs have come under scrutiny, different regulators have emerged to comment on different types of funds.
Both the CFTC and
have been involved in the regulation of futures-based commodity funds, impacting the funds in different ways. In a conference earlier this month, these two regulatory agencies resolved to put their heads together when it comes to discussing and regulating ETF products.
Leveraged ETF funds, on the other hand, have been the focus of a series of warnings and regulations from FINRA.
A positive result of Obama's proposals would be coordination between these agencies, especially when it comes to the regulation of similar products. Re-categorization and increased disclosure for derivatives-based ETFs would help investors determine suitability.
It is the current uncertainty, not the threat of regulation, that is hurting ETF issuers and consumers most. As issuers guess at what type of regulation is in the pipeline, they are adapting their strategies on the fly and making moves to protect their funds, even if it results in premiums or discounts for the customer. (See
Clear-cut regulation would help issuers to develop solid tracking strategies and consumers to pick the right funds for their portfolios.
-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion Money Management owned UDN.
Don Dion is president and founder of
, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.
Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.