Arbitrage in employee savings schemes: when the execution time varies depending on whether or not the fund investment management company belongs to the same group as the account keeper

Facts

As the holder of an employee savings scheme, Mr E placed two arbitrage requests with his account keeper on the same day:

• two orders to sell units from two different "source UCITS";
• in order to invest the sums obtained in a single "target UCITS".

However, the processing times for the two arbitrage requests were different. This had an impact on the retail investor’s investments, which suffered a drop in value.

Mr E considered that the account keeper was responsible for extending the delay due to poor execution of one of his arbitrage requests.

Mr E asked me to intervene in order to obtain compensation from his account keeper for the prejudice suffered as a result of the fall in value. 

Investigation

As part of the investigation into this case, I contacted the institution in question to ask for its observations.

The account-keeping institution told me that, according to an established procedure, any arbitrage request entered online before midnight or received by post by its employees is indeed recorded at an unknown value, but at the first net asset value (NAV) following the entry, which depends on when the fund is valued.

The account keeper explained that arbitrage takes place in two stages:

• the units in the source fund are redeemed in order to obtain the amount to be invested in the target fund;
• the account keeper invests in the target fund when the amount obtained from the redemption is known.

The amount to be reinvested can only be obtained once the net asset value of the fund(s) in question is known. 

However, when an arbitrage transaction involves two investment management companies from different groups, the institution must wait until it knows the net asset value of the fund that belongs to an investment management company from a different group.

The institution stressed that it is therefore dependent on investment management companies outside its group for knowledge of the net asset value of units in the source fund (or the target fund, or both, depending on the case) to determine the amount to invest in the target fund (or to disinvest from the source fund, for example).

In the case in question, the account keeper gave me the following details:

• for the first arbitrage: the source fund and the target fund were managed by an investment management company from the same group as the account keeper. The arbitrage request was made online at an unknown value on date D. The amount of the sale was therefore calculated at the first known net asset value following the entry of the transaction, i.e. the net asset value on D+1, in accordance with the institution's procedure. Once this value was known and the amount of the sale calculated, the account keeper was able to buy the units of the target fund on the same day, i.e. D+1;
• the second arbitrage was carried out online, at an unknown value, on the same day as the first arbitrage. However, the source fund belonged to a investment management company outside the institution's group. The external investment management company did not communicate the value of the fund and the amount of the sale until D+2. Since the target fund was managed by an investment management company from the same group as the account keeper, the amount of the sale was reinvested in the target fund at the first known net asset value following the entry of the transaction, i.e. D+3.

Recommendation

I reminded the retail investor of the two stages involved in an arbitrage transaction:

- redemption of the units in the source fund to obtain a sale amount (the number of units multiplied by the net asset value);

- then the investment of this amount in the target fund to obtain the number of units in this target fund (redemption amount divided by net asset value).

Additionally, the French Labour Code provides a strict framework for employee savings schemes, particularly as regards the way in which beneficiaries can allocate their savings.

Articles R.3332-1 and R.3332-2 of the Labour Code stipulate that:

"The rules of the employee savings plan shall include, in an annex, the selection criteria and a list of the investment instruments, as well as the notices of the variable-capital investment companies (SICAVs) and unit trusts offered to members.”

"If the plan offers several investment vehicles, its rules shall specify the terms and conditions under which members can change how their savings are allocated between these vehicles.

However, the plan rules may restrict the power to change the initial investment choice in instances that it shall define. The investment of sums which have benefited from the additional employer’s contribution under the conditions provided for in the second paragraph of Article L. 3332-11 may not be changed.”

I confirmed to Mr E that the first arbitrage involved a source fund and a target fund belonging to an investment management company that was part of the same group as the account keeper. The amount of the sale was therefore calculated on the basis of the first known net asset value following the entry of the transaction, which was D+1 in this case. Once the amount of the sale was known, the account keeper was able to buy immediately, on the same day, units of the target fund managed by an investment management company that was also part of the same group.

As regards the second arbitrage, I noted that the order to sell the source fund had been placed on the same day as the first arbitrage, at an unknown value. However, as I was able to verify, the investment management company of the source fund, which was not part of the account keeper's group, did not communicate the net asset value of the source fund and the amount of the sale until two days later. The account keeper was indeed dependent on the external investment management company in order to know the amount of the sale to be reinvested. The account keeper was then able to immediately reinvest the sum to buy units in the target fund, at the first known net asset value of the units of the target fund, a fund that was held by an investment management company in the same group as the account keeper.

Thus, for the second arbitrage request, the retail investor having chosen a "source UCITS" managed by an investment management company outside the account keeper’s group resulted in a de facto delay beyond the institution's control in obtaining the net asset value of the fund concerned and the amount to be reinvested.

I therefore informed the retail investor that, in view of all these factors, I could not respond favourably to his request for compensation, in the absence of any evidence of a regulatory breach on the part of the institution when executing his two arbitrage requests.

Lessons to be learned

This dossier highlights the key steps to be taken when making an arbitrage request, and not just in the area of employee savings schemes, which should help retail investors understand and anticipate the execution of their request:

• before making an arbitrage request, a retail investor must read the plan rules to find out:
  • the selection criteria, list of investment instruments and the notices of the available SICAVs and FCPs;
  • how savings are allocated between the available instruments;
  • and in particular the restrictions on changing the initial investment choice.
• when selecting the source and target funds, retail investors must identify the investment management company of the source and target funds by checking the regulatory documentation of the funds in question;
• when referring to the regulatory documentation of the fund in question, retail investors should pay attention to the frequency with which the net asset value of each fund is calculated, which may be daily, weekly, monthly or more. Note that redemptions or subscriptions are always executed at an unknown price (Ombudsman online diary- July 2017: Why requests to redeem units in collective investment undertakings “at a known price” have no merit);
• next, retail investors should refer to their account keeper's order execution procedure. This explains:
  • how orders are received ;
  • how a buy or sell order is processed for a fund held by an investment management company within the same group, including:
    • the date of the net asset value taken into account;
    • the execution time for the buy or sell order;
  • how a buy or sell order is processed for funds held by an investment management company outside the Group:
    • the unspecified time taken by the external investment management company to communicate the fund's net asset value;
    • the time taken to execute a buy or sell order once the net asset value has been obtained.

This information will enable retail investors to take into account the impact of the choice of source and target funds on the execution time for their arbitrage request. This delay, which may differ, can have an affect on the retail investor's investment, depending on the liquidity of the funds in question.