The Investment Industry Regulatory Organization of Canada has issued a pair of guidance notices, spelling out sales practice obligations for dealers selling leveraged or inverse exchange-traded funds, and best practices for managing credit risk.

The IIROC notice dealing with leveraged and inverse ETFs is being issued concurrently with a notice from the Financial Industry Regulatory Authority on the same subject. It points out that these sorts of ETFs are increasingly popular, and while they may be useful in some sophisticated trading strategies, it cautions that they may not be appropriate for many retail investors.

“They are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, leveraged and inverse ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets,” it says.

The notice reminds dealers of their sales practice obligations in connection with these products. “In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and dealer members must have adequate supervisory procedures in place to ensure that these obligations are met,” it says.

The investor advocacy group, the Canadian Foundation for the Advancement of Investor Rights, recently issued an alert on these products and called for regulators to do a better job of warning investors about the possible pitfalls of these funds for retail investors.

In addition to the notice on ETFs, the IIROC also issued guidance setting out best practices for credit risk management. “This notice provides guidance for dealer members on the importance of being diligent in assessing and maintaining adequate credit risk policies and procedures given the recent credit and financial market crisis,” it explains, adding that it expects that all dealers to ensure that their credit risk management practices are adequate.

IE