The Risks and Regulatory Scrutiny of Complex ETPs for Retail Investors

The UK's Financial Conduct Authority (FCA) has intensified its focus on complex exchange-traded products (ETPs), particularly leveraged and inverse instruments, as retail investor participation in these high-risk vehicles surges. Between July 2024 and July 2025, the number of retail investors trading such products rose by 23%, a trend the FCA warns could lead to poor financial outcomes if firms fail to uphold robust risk-assessment protocols. This article examines the regulatory landscape post-FCA warnings, the structural risks inherent in leveraged/inverse ETPs, and the urgent need for investor education and systemic safeguards.

Regulatory Scrutiny: A Wake-Up Call for the Industry

The FCA's recent review of complex ETPs revealed a troubling disconnect between product design and investor understanding. While some firms demonstrated good practice-such as product-specific risk assessments and educational materials- many relied on generic tests that inadequately evaluated comprehension of ETP-specific risks. For instance, pass rates on these tests sometimes reached 100%, raising questions about their efficacy in identifying unsuitable investors. The regulator emphasized that firms must adopt plain-language communication, in-app alerts, and dynamic monitoring to align with the Consumer Duty framework.

A critical concern highlighted by the FCA is the lack of clarity around holding periods. Leveraged and inverse ETPs are designed to track daily returns, not long-term performance, yet few firms explicitly warn investors about the risks of extended holding. This oversight can lead to tracking errors and volatility decay, as daily rebalancing amplifies compounding effects in volatile markets. The FCA also expressed alarm over the influence of "finfluencers," who often promote these products without disclosing their risks, further exacerbating the potential for retail investor harm.

Structural Risks: Why Leveraged/Inverse ETPs Fail Retail Investors

Leveraged and inverse ETPs are mathematically complex instruments that amplify both gains and losses. A 2025 study by Srinidhi Kanuri and James Malm analyzed 114 U.S.-based leveraged and inverse ETFs, concluding that these products are "extremely high-risk investments and not at all suitable for retail investors." Key risks include:
1. Volatility Drag: Daily compounding erodes returns in choppy or sideways markets. For example, an inverse U.S. mid-cap growth ETP saw a $100 investment grow to $340 during the 2008 financial crisis but plummet to $7.61 by 2015 due to prolonged volatility.
2. Path Dependency: Performance diverges from expected outcomes in non-linear market environments. Tiffany Zhang of National Bank Financial notes that these products are "path dependent, subject to volatility drag and compounding risks."
3. High Costs: Elevated expense ratios and frequent rebalancing increase drag, further diminishing risk-adjusted returns compared to traditional ETFs.

The 2020 pandemic exemplified these risks, with 90 leveraged/inverse ETPs liquidated amid extreme volatility, compared to just one in 2021 when markets stabilized. Such patterns underscore the instability of these instruments when held beyond their intended timeframes.

Investor Protection: A Call for Systemic Reforms

The FCA's recommendations stress the need for firms to strengthen fair value assessments by incorporating all product costs-not just service fees-and to restrict access for unsuitable customers. However, regulatory action alone is insufficient. Retail investors must engage in rigorous due diligence, including:
- Understanding Holding Periods: Leveraged ETPs are best suited for short-term, directional bets. Holding them longer increases exposure to compounding decay.
- Assessing Risk Tolerance: These products are incompatible with conservative or long-term investment strategies.
- Demanding Transparency: Investors should scrutinize prospectuses for details on rebalancing mechanics, expense ratios, and redemption policies.

The FCA's Discussion Paper 25/3 on expanding consumer access to investments also invites industry feedback on balancing innovation with protection. For now, the onus remains on investors to navigate a landscape where complexity and volatility collide.

Conclusion

The FCA's warnings serve as a critical reminder that complex ETPs are not democratized tools for the average investor. While these products offer amplified returns in ideal conditions, their structural flaws and behavioral risks make them prone to misuse. As retail participation grows, regulators, firms, and investors must collaborate to ensure that innovation does not outpace understanding. In a post-FCA warning landscape, the mantra is clear: due diligence is not optional-it is a lifeline.