Authors: Nicolas Bracher, Meltem Cetinkaya
Subject Area: Banking Law
Lombard loans in the Corona crisis – legal issues under Swiss law
The global corona crisis has also affected the financial markets. Due to the fall in prices on the stock markets, many customers who finance their investments with Lombard loans have recently been asked by their banks to make additional contributions by means of margin calls. Against this background, this blog post discusses some of the relevant legal issues under Swiss law.
Functioning and risks of Lombard loans
Lombard loans are frequently used as means of obtaining liquidity. The customer receives a loan from the bank to conclude financial transactions. As collateral, he pledges assets to the bank for this purpose, be they financial instruments held in custody or other easily saleable assets. The loan agreements used in the banking industry often stipulate that the bank can demand additional payments if the pledged assets lose value. In this case, the customer is requested by means of a margin call to make additional contributions in the form of cash or other assets within a certain short period of time.
The risks of Lombard loans lie in particular in the leverage effect, as a result of which not only the opportunities for returns but also the risk of losses is higher. If the customer is unable to fulfil his obligation to make additional contributions, the pledged assets are sold, regardless of an unfavourable stock market situation. The customer has no right to wait for a recovery of the share price. If the pledged assets are realised during a fall in prices, this can lead to high losses for the customer. The increased risks of Lombard loans come along with special obligations on the part of financial service providers, which are briefly described below.
Information duties of financial service providers
According to Swiss case law, financial service providers have an increased duty of disclosure with regard to the risks of investments if the customer speculates not only with his own assets but also with loans granted by a bank. In particular, this applies with regard to Lombard credits. The extent of the duty of disclosure has not yet been clearly defined by the Swiss Federal Supreme Court, however.
Pursuant to general principles, the content of the duty of disclosure depends primarily on the customer's understanding of risk and his risk profile. Thus, the financial service provider must explore both aspects (suitability test). In particular, the financial services provider must ensure that the customer understands the functionality and risks of the Lombard loan and, if necessary, provide the customer with the appropriate information. Moreover, the financial services provider must also inquire whether the customer is willing and able to bear these risks. Otherwise, it may be necessary to adjust the recommended investment strategy.
Right of exploitation of the Financial Service Provider
Although not explicitly provided for by law, the pledgee and the pledger can agree that the pledgee is entitled to realise the pledge. According to the Swiss Federal Supreme Court, the pledgee must inform the pledger of the date of the private realisation beforehand and compensate him for any damage resulting from insufficient proceeds through the pledgee's fault.
These principles also apply in connection with Lombard loans. Accordingly, the loan agreements used in the banking industry regularly stipulate explicitly that the bank may realise the pledged assets if the customer does not meet his obligation to make additional contributions. In general, the announcement of the realisation of the assets is made together with the margin call, i.e. with the request to make additional contributions. Whether a margin call must be made even if this is not contractually agreed, has not definitively been decided by the Swiss Federal Supreme Court.
Despite the statutory right of exploitation, the liability risks for financial service providers are elevated. First, the financial services provider may be liable for breaches of his information duties. For example, if he fails to inform the customer of the increased risks involved in financing investment transactions by means of Lombard loans, or if he fails to take the increased risk of loss into account in the course of the suitability test. In several cases, the Swiss Federal Supreme Court has also affirmed the liability of banks for realising the pledged assets without a valid margin call. Finally, liability is also conceivable in cases in which the assets were realised below their market or stock exchange price.
Disclaimer: The information contained in this document is intended for general information purposes only and does not constitute legal or tax advice. This content is not meant to replace individual advice from competent professionals in a specific case.