The Securities and Exchange Commission revealed this afternoon that it has begun an investigation into the use of derivatives in exchange-traded funds (ETFs) and traditional mutual funds.

In a statement Thursday, the SEC said it will review investments to determine if "additional protections are necessary for those funds under the Investment Company act of 1940."

The commission notes that the review will not affect any current ETFs, yet the results could affect new and pending actively-managed and leveraged ETFs that use swaps and other derivative investments.

"It's appropriate to engage in a more thorough review of the use of derivatives by ETFs and mutual funds given the questions surrounding the risks associated with the derivative instruments underlying many funds," stated SEC chairman Mary Shapiro.

The SEC will explore the derivatives issue from a variety of angles, ensuring that:

current market practices involving derivatives are consistent with the leverage, concentration and diversification provisions of the Investment Company Act

funds that rely on derivatives maintain and implement adequate risk management

fund boards of directors are providing appropriate oversight of the use of derivatives

existing rules sufficiently address matters such as the proper procedure for a fund's pricing and liquidity determinations

existing prospectus disclosures adequately address the particular risks created by derivatives

there are regular reporting requirements.

Citing data from Morningstar, MarketWatch reports that there were 70 leveraged bullish ETFs with $11.2 billion in assets under management at the end of February, and 76 leveraged bearish ETFs with $16.6 billion. 

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