This article, originally published at 10:49 a.m. on Friday, Dec. 11, 2015, has been updated with actions at the SEC's meeting.
Exchange-traded funds offering some of the juiciest returns -- such as one that promises triple the returns on emerging-market stocks -- are getting fresh scrutiny from U.S. regulators who are increasingly concerned over the risks to individual investors.
The Securities and Exchange Commission agreed today to issue a proposed rule governing ETFs' use of derivatives -- a type of unregulated trading contract that's used to bet on an underlying asset such as a stock index or commodity. Such products include so-called leveraged ETFs, which use derivatives to multiply returns. One example is the Direxion Daily Emerging Markets Bull 3x Shares, an ETF that employs derivative contracts with such Wall Street firms as Citigroup (C) , Deutsche Bank, and Bank of America Merrill Lynch (BAC) .
The rule would require the ETFs to "limit the amount of leverage the fund may obtain through derivatives," according to an SEC statement. They also would have to set aside cash or other assets to guarantee their trades and set up risk-management programs. The rule will be published on the agency's website and in the Federal Register, and the SEC will take feedback for 90 days afterward.
The proposal threatens to slow a fast-growing corner of the booming industry for ETFs, which have proliferated as a vehicle for investors to bet on everything from share prices to bonds -- including high-yield securities that rarely trade. Assets in U.S. ETFs have more than doubled in the past five years to $2.15 trillion, according to ETF.com.
That's despite warnings from the Financial Industry Regulatory Authority and International Monetary Fund that they pose risks not just to investors but to global financial stability.
"Today's proposal is designed to modernize the regulation of funds' use of derivatives and safeguard both investors and our financial system," said SEC Chair Mary Jo White.
Leveraged ETFs have grown by about 30% this year through November, triple the rate for the broader industry. The instruments are rebalanced daily, meaning they're designed to be traded one day at a time; because of that structure, they've led to unexpected losses for some investors who failed to understand they weren't suitable for longer-term bets.
In 2012, regulators sanctioned Citigroup, Morgan Stanley, UBS and Wells Fargo a combined $9.1 million for flawed practices involving the sale of leveraged funds for long periods during the volatile markets from January 2008 to June 2009.