How can you keep trading when your money is tied up in settlement periods? Day traders come up against the dilemma as soon as they begin trading more than once or twice per week. Because Swiss stock markets follow a T+2 settlement cycle, it takes two days in addition to the day on which the transaction was made for you to actually get the money for the securities which you sell.
If you make a lot of trades every day, your margin can very quickly run out long before your transactions are settled. You would then have to either transfer more money to your brokerage account to replenish your margin, or wait until your payments clear before you can keep trading. This situation can throw a sizeable monkey wrench into the day trading ambitions of many investors.
What is a lombard loan?
In Switzerland, some banks and brokers offer a secured line of credit in the form of a “lombard loan”. This type of loan is secured using the securities in your portfolio as collateral. Most stock brokers will only provide lombard loans when the assets which form the collateral are held in custody accounts at the same broker.
Example: Your portfolio at a certain broker holds 50,000 francs worth of securities. The broker grants you a lombard loan worth 80% of your portfolio (40,000 francs). If you sold 38,000 francs worth of securities one day – bringing your margin down to 12,000 francs – you could use up to 38,000 francs of the lombard loan to raise your margin to 50,000 francs again, allowing you to buy new securities on the same day. The new securities which you purchase maintain the collateral which secures the loan.
As long as you maintain sufficent securities in your custody account to secure a line of credit, you can continually borrow against that line of credit as necessary. This makes lombard loans a very flexible tool for financial liquidity.
Variable or fixed loans?
Both variable and fixed-term lombard credits are offered in Switzerland, although not every broker will provide both. Loans with variable terms have no fixed maturity date, and can usually be used indefinitely. You are generally free to terminate a variable loan at any time (a notice period may apply). Most brokers charge a quarterly loan commission for variable loans.
A fixed-term lombard loan has a predefined term and a fixed maturity date. Interest rates are fixed over the life of the loan, so you know exactly what you can expect to pay. Fixed loans usually work out cheaper, with many brokers not charging a loan commission. However, minimum loan amounts are typically much higher than those required for variable loans, with some banks only providing fixed loans of 100,000 francs or more. Another disadvantage is that you will not be able to terminate the loan until the end of the fixed term.
While fixed-rate lombard loans are offered by some banks, many brokers only provide variable lombard loans which come with variable interest rates that are subject to change. In Switzerland, interest rates generally follow market conditions. In the current low-interest environment, most brokers are offering very favorable rates. If overall interest rates sink further, your interest rate may go down, and if overall rates go up, the interest rate on your lombard loan may go up as well.
Before you use lombard loans, take time to calculate how interest rates will affect your overall trading costs. Most brokers only charge you interest on the portion of available credit which you actually use. The loan-term consists of the time it takes you to repay the loan (the 2-day settlement period, for example).
So the amount of interest you pay will depend on how frequently you trade, how much of the credit you actually use, and how long you carry balances for. If you borrow the full amount available on a near permanent basis, which is possible if you trade on a daily basis, the annual interest charges can add up to a significant extra cost.
The risks of lombard loans
Lombard loans aren’t all peaches and cream. Like all loans, lombard loans come with interest, fees and charges. Another hazard of securities-backed credit is that if your securities lose in monetary value, your collateral will shrink and your broker will adjust your line of credit to match. If your balance is higher than the new, lower line of credit, you will have to make up the difference out of your own pocket.
If the value of the securities free-falls, you could end up owing the broker a lot of money above what they can glean off your portfolio. Example: A broker holds the 50,000 francs worth of securities in your custody account as collateral against your lombard loan. You use the loan to purchase 30,000-francs worth of securities. The value of the securities you provided as collateral then falls from 50,000 francs to just 20,000 francs. You now owe the bank the 10,000 francs which are no longer covered by your collateral.
In most cases your broker will force you to sell your securities before serious losses are incurred, assuming that securities are liquid enough to sell quickly. For this reason, most brokers accept only highly liquid securities as collateral against a lombard loan, and generally require that your positions are well diversified. As long as high-liquidity assets are used and you do not use large leverage ratios in trading, potential losses normally will not be devastating.
A more real risk is presented by taxes. Applying for a lombard loan from a broker can make you look like a career trader to Swiss tax authorities. If you are categorized as a career trader by your local tax office, you will have to pay taxes on capital gains earned on investments, which will take a bite out of yields. However, you can also earn the tax designation of “career trader” by trading on a frequent basis (more than once every 6 months, for example), even if you do not get a lombard loan.
Lombard loans from Swiss brokers compared
Most Swiss banks which offer brokerage services also provide lombard loans. However, not all online brokers provide this service and interest rates vary between those that do. Here, we look at the interest rates charged by some of the most affordable brokers in Switzerland.
Swissquote makes lombard loans available to its customers in CHF, EUR, and USD via a current account. You can use this loan to buy securities via Swissquote, with securities held in your Swissquote custody account providing the collateral. The variable interest rate for a lombard loan in Swiss francs or euros is currently 3% per annum (as of October 2016), and applies to the portion of available credit which you actually use. Loans in U.S. dollars are subject to a 3.51% annual interest rate. In order to qualify for a Swissquote lombard loan, your portfolio must have at least 3 diversified positions. Swissquote occasionally runs special lombard loan promotions and these can be very attractive. For example, between May 3, 2016 and September 30, 2016, Swissquote charged a 0% annual interest rate on lombard loans.
Strateo offers lombard loans at an interest rate of 3% per annum (as per October 2016). Interest is charged on a quarterly basis and you only pay interest on the actual amount which you borrow during each quarter, and not on the full line of credit. Loan terms are variable, with no fixed maturity date, so you can continue to make use of this line of revolving credit for as long as it makes sense to do so. Loans can be provided in several different currencies. This lombard loan could work well for smaller scale traders because loans as low as 10,000 francs are available. However, your loan cannot exceed 50% of the market value of your securities. That is somewhat conservative, but also provides you with a safety net against falling into debt if your securities lose value.
Saxo Bank does not offer clients access to lombard loans at this time. The bank’s online trading service is currently one of the most affordable in Switzerland, as shown by the moneyland.ch online broker comparison. The PostFinance e-trading service is another popular online broker which does not currently grant lombard loans.
Cornèr Bank, which provides the Cornèrtrader brokerage service, offers lombard loans via a current account. The line of credit and interest rate you get depend on the amount and type of securities which you provide as collateral. It also offers fixed lombard loans with terms of 1 to 12 months and fixed interest rates – but the minimum loan size is 250,000 Swiss francs or the equivalent in foreign currency.
Large established banks, in some cases, may provide more options or lower rates on lombard loans than online brokers. Credit Suisse offers both variable and fixed lombard loans to its clients. The Liechtensteiner Landesbank provides both fixed and variable lombard loans at a rate of 2.75% interest per annum for loans in Swiss francs and U.S. dollars, 2.25% for euro loans and just 2% for lombard loans in Japanese yen (as of October 2016).
However, the brokerage fees and charges at many major banks are substantially higher than those charged by the most affordable online brokers. At many large banks, the minimum credit lines available are high, and therefore are not suitable for small-time traders. At Credit Suisse, for example, the minimum lombard loan size is 30,000 francs for variable loans, and 100,000 francs for fixed loans. The Liechtensteiner Landesbank is flexible with regards to variable loan amounts, but only offers fixed loans starting at 150,000 francs.
Some banks make lombard loans available, but reserve this service for certain types of customers. For example, major Swiss bank UBS primarily provides lombard loans as part of its wealth management services. These loans are aimed at helping customers to achieve their investment goals or to finance investments, including stock market trades. The cost of lombard loans from UBS varies, as costs are tailored to fit individual banking relationships. As with most lombard loans, lines of credit for UBS lombard loans are based on the amount of securities deposited.
A lombard loan is a useful (albeit risky) tool for traders looking for greater financial liquidity. If you find that tying-up your capital in settlement cycles is inhibiting you from taking advantage of profitable trade opportunities, then applying for a lombard loan could provide a solution.
But because nobody can accurately predict whether the value of stocks and other market-based securities will rise or fall, using securities as collateral against a loan has a very real element of risk. If you are an experienced trader, you are probably familiar with the risks associated with the stock market.
As a new trader, on the other hand, you will want to avoid taking on lombard loans above what you can easily repay out of your own pocket without seriously impacting your finances.