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FINRA Gives Warning on Oil-Linked ETPs

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The Financial Industry Regulatory Authority put the business of selling oil-linked Exchange-Traded Products, or ETPs, on notice Friday that these products should not be sold to the average investor, at least not without full disclosure and understanding of what risks these products hold. Further, as of June 30, 2020, these products, like other securities, will be governed under the Regulation Best Interest rule.

As the FINRA notice states, the June 2020 WTI futures contract price fell 43% to close at $11.57 a barrel only a day after the May 2020 futures contract dove into negative territory, settling at minus $37.63 per barrel.

“This plunge in market value has significantly impacted ETPs trading WTI futures,” the release states.

FINRA outlined examples of ETPs that caused investors harm. On April 22, FINRA states, the “largest oil-related ETP lost 41% of its value in one week. This ETP also subsequently adjusted to its investment focus from near-dated futures to longer-dated contracts.”

(The United States Oil Fund, which was the largest and most heavily traded ETP, plunged more than 40% that week, and in fact changed its structure to include more contracts aside from the front month.)

FINRA says it’s been suggested that retail investors were getting into this product, and in fact, surging demand “led to a dramatic increase in new share issuance, which ultimately exhausted the number of available shares permitted to be issued under the ETP’s existing registration statement,” FINRA states.

In another case, an ETN tracking WTI oil futures “announced an early liquidation.”

FINRA states that retail investors and those selling these oil-based ETP products may have thought they were a proxy for the spot price of oil instead of tracking oil futures contracts or indexes. Many factors come into play, such as rolling over to the next month, which may have a higher price or “contango,” or a lower prices or “backwardation.” These could lead to gains or losses separate from the price of oil.

The complexity of these ETP products, states FINRA, is that they “may not be suitable for some investors, such as retail investors with conservative investment objectives and long-time horizons.”

Suitability and Regulation Best Interest rules come into play and requires a firm or its reps to have to have a “reasonable basis” to believe these products are suitable for the client, and that they understand the strategy and potential risks involved. Also, the associated person has to be capable of explaining “at minimum, the products main features and associated risks” as well as differences in ETP products.

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