Huge ETN Euthanized

Editor's note: This article was corrected after its initial publication. Please see Corrections and Clarifications.

NEW YORK ( TheStreet) -- In the past, ETF issuers killed off their weakest funds, stragglers that could not garner enough investor interest to be viable.

Wednesday, however, was a landmark moment for the ETF industry, as Deutsche Bank ( DB) euthanized the wildly popular PowerShares DB Crude Oil Double Long ETN ( DXO).

This leveraged, futures-based commodity ETN has not had trouble attracting trading volume. As of Sept. 3, the three-month average daily trading volume for the fund was 12,775,600 shares. Currently, DXO has $407 million in outstanding notes that will have to be redeemed to investors on Sept 9.

As both a leveraged fund and a futures-based commodity fund, DXO has been caught in a double regulatory crossfire this summer as the Commodity Futures Trading Commission targets "speculators" in the commodities markets and Financial Industry Regulatory Authority scrutinizes leveraged ETF products.

Regulation on both fronts seems imminent , and funds like United States Natural Gas ( UNG) and DXO have tried to protect their funds from restrictions.

DXO's biggest crime, however, is its popularity. CFTC regulators will likely slap position limits on future-based commodity ETFs in the near future, making it difficult for funds to grow and track their underlying value. Larger funds, like DXO and UNG, may have reached these levels already, or are close to doing so.

One of the measures that these funds are taking to stay within limits is to halt creation. Both DXO and UNG recently halted creation, along with funds like iShares S&P GSCI Commodity Indexed Trust ( GSC) and iPath Natural Gas ( GAZ), to stem the need for the contracts in question.

The ETF industry has historically been Darwinian in nature. Small, unsuccessful funds are picked off from the pack and shuttered by their issuers. This is the natural course for an increasingly large industry with exotic ideas and duplicate products. In 2008, nearly 50 funds were shut down due to lack of investor interest. Zombie ETFs , with low liquidity and high spreads, wander the market until they are stopped.

The threat of regulation, however, has turned the tables. In its press release announcing DXO's demise, Deutsche Bank noted that the fund would be closing due to "limitations imposed by the exchange on which Deutsche Bank manages the exposure of the Notes have resulted in a "regulatory event" as defined in the terms of the Notes, which has caused Deutsche Bank to redeem the Notes." In the same release, DB noted that DXO is the only fund currently affected.

This statement should raise eyebrows in the ETF community. The same structural factors that crippled DXO are inherent to additional DB products like PowerShares DB Crude Oil Double Short ETN ( DTO). Why shut down DXO and not DTO? Size matters. DXO has $407 million in assets while DTO has just $183 million. Since DXO is larger, it is likely much closer to the proposed position limits than DXO.

It's not the only time that size has meant problems for commodities ETFs. While UNG has been in the headlines in recent months, United States Oil ( USO) battled many of the same problems months before. It is the growing size of UNG that has drawn the regulatory spotlight, and underscored problems inherent in the fund's strategy.

Stop Trading UNG

Increased regulatory attention has prevented fund like DXO and UNG from operating as designed.

Issuers like DB are taking pre-emptive measures before these funds are altogether disabled. Leveraged, futures-based commodity and currency funds will likely continue to come under attack.

Investors need to watch out for the zombies as well as ETFs that are too big for their britches. Until the regulators get it straight, the fate of these funds is uncertain. Regulation is replacing natural selection in the ETF industry. Buyer beware.

-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion does not own any of the funds mentioned in the story.

Don Dion is president and founder of Dion Money Management, 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.

If you liked this article you might like

Deutsche Bank Job Cuts Could Mean Fatter Paychecks for Survivors

Deutsche Bank Job Cuts Could Mean Fatter Paychecks for Survivors

Deutsche Bank Tops DAX Amid Asset Management IPO Speculation, Rare Upgrade

Deutsche Bank Tops DAX Amid Asset Management IPO Speculation, Rare Upgrade

Broadcom and Qualcomm, Comcast and Fox - 5 Things You Must Know

Broadcom and Qualcomm, Comcast and Fox - 5 Things You Must Know

Deutsche Bank Slumps After China's HNA Trims Stake in German Lender

Deutsche Bank Slumps After China's HNA Trims Stake in German Lender

Deutsche Bank Shares Hit 3-Month Low After Third-Straight Annual Loss

Deutsche Bank Shares Hit 3-Month Low After Third-Straight Annual Loss