Risk Notice Lombard Loans

This Notice explains the risks involved when financial instruments are acquired using credit funding under a Lombard loan. If financial instruments are partly or wholly financed by a loan, it is important to be aware of the following risks:

Obligation to commit more capital or sell

If the value of the financial instruments pledged as collateral falls or there is insufficient liquidity, there may be an obligation to commit more capital (additional collateral) or sell the collateral provided to partially repay the loan. The Bank may also reduce the loan-to-value ratio for some financial instruments, or cut it to zero, which may likewise result in an obligation to commit more capital or sell. In order to minimise risk, therefore, additional cash or collateral that can be used to repay the loan immediately and is not already pledged for another loan in the event of an obligation to commit more capital (margin call) should always be held. 

Leverage

If the market performs positively, a higher return on equity can be achieved by using debt (leverage) from the Lombard loan. The expected return on the portfolio may be increased, but if performance is negative then leverage results in disproportionate risk, as the costs of the loan (interest, repayment, etc.) remain fixed. In the worst case scenario, this may lead to a total loss of the capital invested and the obligation to repay the full amount of the loan plus interest. It is therefore important to pay special attention to leverage, as any enforced sales of securities pledged generally have to be made at an unfavourable time.

Minimum cover and liquidity shortages

If market performance is negative, the value of the collateral may fall below a certain level or mean there is insufficient liquidity to meet the interest due or repay the loan. Unless the client has further unpledged cash or collateral to meet the obligation to commit more capital at the agreed time, the Bank may liquidate some or all of the collateral pledged. 

Market risk

If a portfolio is financed with a Lombard loan, market fluctuations can trigger an obligation to commit more capital. Depending on the move in the market, the debt interest may be greater than the income, resulting in a negative leverage effect.

Currency and interest rate risk

Movements in currencies and interest rates also affect portfolio return. In particular, a currency mismatch between the loan and the investments pledged can have a negative effect on the investment strategy or minimum cover requirements as a result of exchange rate fluctuations.

Change in risk profile

Taking out a Lombard loan changes the risk profile of a portfolio without changing the composition of the portfolio pledged, which can lead to a change in the original investment strategy.

Tax effects

In addition, taking out a Lombard loan for private asset management purposes may be regarded by the tax authorities in Switzerland as an indication of operating as a professional securities dealer. The effect of being classified as a professional securities dealer is that capital gains which would otherwise be tax-free have to be taxed as income. For clients who are residents abroad, the tax consequences are determined by the applicable foreign tax law.

Do you have any questions or would you like an advisory meeting? Your relationship manager will be happy to assist you.