Ripple is moving deeper into Wall Street’s leveraged ETF business, with its prime brokerage arm providing swap financing to funds that use derivatives to amplify bets on stocks and indexes.
A recent Wall Street Journal report shows how the crypto company is entering a fee-heavy part of traditional finance where banks have long dominated, while tighter capital rules are creating room for nonbank firms.
Ripple Takes Aim at Leveraged ETF Financing
Ripple entered the business last year through its $1.25 billion acquisition of Hidden Road, now known as Ripple Prime. The platform is already working with ETF providers and is seeking business from other investment managers, including hedge funds.
Additionally, on October 6, Ripple Prime announced its prime brokerage and clearing and financing service for Brevan Howard, which adds yet another hedge fund to the list of clients.
Leveraged ETFs use total return swaps and other derivative instruments in order to amplify the daily changes in individual stocks or indexes. The swap is provided by a bank or broker at a cost, and the risk is then hedged by purchasing the underlying security.
Morningstar Direct data quoted by the WSJ put the number of US leveraged ETFs at 593, with more than $256 billion in assets. Single-stock leveraged funds account for 426 of them, a category regulators first approved in 2022.
Noel Kimmel, president of Ripple Prime, described swap financing as a “growing and meaningful part” of the business. Nonbank firms such as Jane Street and Clear Street are also gaining ground as banks face tighter limits on the amount of risk they can take.
One example shows why the business can generate substantial fees. The Tradr 2X Long SDNK Daily ETF pays Ripple a fee tied to the overnight bank funding rate plus four percentage points. As of October 7, that worked out to roughly 8% of the fund’s assets on an annualized basis.
The Cost Falls on Leveraged ETF Investors
These financing charges are different from management fees and are captured in the net asset value of the fund. In a situation where leveraged ETFs are held by investors over long periods of time, the swaps costs will come together with daily compounding, and market movements will be very expensive for returns.
Swap financing also carries risk for providers. A sufficiently large one-day decline in an underlying stock could wipe out a leveraged ETF’s equity and leave its counterparty facing losses. Providers therefore hedge that exposure through other asset managers or market makers.
As CryptoPotato reported yesterday, Ripple Prime had expanded its relationship with Brevan Howard to include multi-asset prime brokerage, clearing and financing. The move follows Hidden Road’s earlier expansion into US institutional crypto OTC swaps, cross-margining and financing after Ripple acquired the brokerage.
Ripple’s latest push therefore reaches beyond crypto trading and payments, putting its prime brokerage operation into a financing business that has traditionally generated fees for Wall Street firms.
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