Alert in the event of a 10% fall in the value of a leveraged financial instrument: an obligation for the intermediary

The facts

Mr X is a holder of leverage certificates[1] and states that he has incurred a capital loss resulting from early redemption of the product.

He blames the investment firm keeping his account for not having informed him of the fall in the price of the security and of its early maturity date.

He claims that these failings prevented him from selling the certificate at a better valuation and especially before its redemption so as to benefit from a more favourable tax regime (tax offsetting of his capital loss).

The investigation

I questioned the account-keeper involved in this case. When investigating this case, other more conventional issues appeared and were taken into consideration in the mediation (appropriateness of the certificate with regard to the client's profile [2] and information concerning the early redemption of the product on the issuer's decision), [3] but it seemed more interesting and instructive in this case of the month to deal only with the issue of alerts concerning the fluctuation in the price of a leverage certificate, which was arising for the first time.

Among the arguments raised by the account-keeper concerning information relating to the certificate's fall in value, it is true, as the investment firm asserted, that the information provided in the Key Information Document (KID) urged the investor to keep a regular watch on the price of the certificate in order to determine the right time to sell it. The KID alerted to the fact that the product's price amplifies the smallest variations in the price of the underlying, which results in losses or profits being generated within a time that proves unpredictable.

Mr X therefore knew that he should be attentive to fluctuations in the price of the product.

The investment firm also stressed that the client was accustomed to arbitrage transactions implying fairly regular monitoring of quoted prices, monitoring that he was also free to perform in the case of the certificate in the case at hand, because he had access to the quoted prices via his application on computer and smartphone. The record of transactions listed buying and selling transactions on short-dated certificates, transactions requiring regular monitoring with which Mr X was therefore familiar.

The account-keeper therefore maintained initially that it had no obligation to alert Mr X of fluctuations in the price of a security subscribed to via the service of reception and transmission of orders (RTO).

However, in accordance with Article 62.2 of Delegated Regulation (EU) 2017/565, "Investment firms that hold a retail client account that includes positions in leveraged financial instruments or contingent liability transactions [4] shall inform the client, where the initial value of each instrument depreciates by 10% and thereafter at multiples of 10%. Reporting under this paragraph should be on an instrument-by-instrument basis, unless otherwise agreed with the client, and shall take place no later than the end of the business day in which the threshold is exceeded or, in a case where the threshold is exceeded on a non-business day, the close of the next business day."

To determine whether this obligation applied to the case in point, it was necessary to:

• clarify what the text means by "inform the retail client"; and
• verify the nature of the service provided by the investment firm, the type of financial instrument, the variation in the instrument's valuation, and the existence of an agreement with the client regarding information procedures.

Recommendation

Having completed the investigation, I reached the following conclusion:

- Article 62.2 of Delegated Regulation (EU) 2017/565 is adopted pursuant to Article 25.6 of Directive 2014/65/EU (MiFID II). The latter stipulates that the investment firm shall provide the client with adequate reports on the service provided in a durable medium. Now, in its Q&A 35-43-349 on investor protection in MiFID II, the European Securities and Markets Authority (ESMA) specifies that provision in a durable medium as stipulated in Article 25.6 of MiFID II implies that the report can be made available to the client in a secured area of the firm’s website, specifically dedicated to that client, with the client receiving a notification (via e-mail or through any other means of communication) of the availability of the document on the website.[5]

• Moreover, in the case in question I noted that:
• since the investment firm was acting in its capacity as custody account-keeper providing an RTO service, it appeared to me that the requirement of an "investment firm that holds a retail client account" was met;
• furthermore, the product concerned was indeed a leveraged product;
• the trading data indeed showed a 10% fall in the value of the instrument relative to its initial value and for each successive multiple of 10%, because the certificate continued to fall;
• lastly, the account-keeper confirmed to me that there was no explicit agreement with the client providing for an aggregate valuation of several instruments or of the total portfolio value. The information was therefore to be provided instrument by instrument.[6]

I was therefore of the opinion that the account-keeper could not claim that it was not bound in this case by any obligation of alerting its client regarding the fluctuations in the price of the certificate subscribed to via the RTO service. It was subject to an obligation to send a personal alert concerning price fluctuations to the client and could not merely provide access to the price quotes for the certificate.

I went back to the investment firm involved to ask it to take measures in-house and carefully check whether information had been provided as quickly as possible or not.

After searching, the latter finally confirmed that the product held by Mr X was a leveraged instrument, and it found the alerts sent concerning the fall in value of the certificate. These alerts, called "Leverage effect -10%", had been generated in the information system of the firm called into question and then transferred to the IT teams in charge of sending them to the clients concerned.

I checked, in this case, that the email address of the recipient of the alerts corresponded to that used by Mr X in his communications with the AMF Ombudsman’s Office and I noted that the "Sent" status appeared on each of the messages.

I therefore concluded from this that Mr X had indeed received the alerts concerning the fall in value of the certificate, and that it was incumbent on him to check his emails. Given the information he was provided with, Mr X would have been able to sell his certificates when he considered it advisable. In light of these facts, I told him that I could not give a favourable decision to his request.

Lesson to be learned

An account-keeper providing the RTO service is required to inform its client when the value of a leveraged instrument held by that client has fallen 10% relative to its initial value, and for each subsequent multiple of 10%.

This reporting obligation is based on Article 62 of Delegated Regulation (EU) 2017 2017/656 supplementing the MiFID directive. Under this directive, not only investment firms providing portfolio management services, but also investment firms holding the account of a retail client containing positions in leveraged financial instruments (as in our case in point) or transactions involving contingent liabilities, are required to establish a client alert system.

It is important to note that in the case of a portfolio management service, the client must be alerted when the total value of the portfolio, as valued at the start of each reporting period, has fallen 10%, and for each subsequent multiple of 10%, whereas in the case of a custody-account keeping service, the rule is that the alert must be given when the value of each instrument, particularly leveraged instruments, has fallen 10% relative to its initial value, and for each subsequent multiple of 10%, unless agreed otherwise with the client.

The account-keeper can therefore depart from this rule of valuation instrument by instrument if the client explicitly consents to an aggregate valuation of the 10% fall. This aggregate valuation may, for example, concern the total value of the portfolio (as in the case of a portfolio management service), but also the value of all the leveraged instruments or transactions involving contingent liabilities included in the client's portfolio. The client must necessarily be notified personally of this information, and this cannot be substituted for by making the alert available on the website or else by merely providing access to the price quotes for the product.

Therefore, investors subscribing to leveraged products are invited not only to keep a watch on the prices of those products, but also to check the alerts sent by their account-keeper in the event of a 10% fall in their value, notably so as to anticipate any loss on the investment and, if they so wish, take a divestment decision as quickly as possible.