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Providers promise better protection for investors in high-risk leveraged products

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Certain investment products with a high leverage do not offer investors any added value, because they offer an undesirably small chance of a positive return. In addition, leveraged investment products, such as turbos, speeders and sprinters, are not suitable for building up capital in the long term. The explanation provided by providers about the leverage and the consequences for the possible return does not offer investors sufficient certainty. This is evident from the investigation into the operation of leveraged products with an in-built stop-loss that was performed by the Netherlands Authority for the Financial Markets (AFM).

The AFM has presented the findings of this investigation to the providers of turbos, and has asked them to present solutions for the shortcomings that were identified.

Measures

Following constructive consultation, the providers proposed several measures to improve the protection of investors. They intend to implement these on 1 October of this year.

The providers will set up a website on which they provide independent and non-commercial information concerning the operation of these products, especially about the leverage.

  • The providers will devote more – and explicit - attention to risk warnings on their own websites.
  • The providers will form an association of issuers that will simplify the initiation, implementation and further development of market standards.
  • The providers will adjust their range of products, whereby the products with an extremely high leverage are no longer possible upon issue. Furthermore, products whereby the leverage becomes too high during the day trade will be removed from the market at the end of the day.

The AFM is positive about these measures and sees them as a step in the right direction. The AFM does note that, in particular, the latter measure has to be evaluated in order to establish whether it offers consumers sufficient protection. The AFM will continue to pay attention to leveraged products.

Findings of the investigation

The AFM has assessed leveraged products that are offered in the Netherlands, basing this assessment on a qualitative and quantitative analysis of such products. First of all, the analysis revealed the main risks of such products. This concerns, inter alia, the risks involved in the price development of the underlying value, the gap risk premium with respect to certain variants of the turbos, the process of reaching the stop-loss level outside trading times, and the influence of the leverage on potential return on the investment. The AFM is of the opinion that providers should, in particular, inform investors more clearly about the leverage.

The investigation focused to a significant extent on a quantitative assessment of the products. The AFM modelled the probability distribution of the anticipated return of an investment directly in the underlying value, and an investment in the same underlying value via a leveraged product. Naturally, an analysis on the basis of historical data does not offer watertight results. However, the results of the analysis show that the chance of a positive return becomes smaller as the leverage increases, and also show the extent to which this occurs.

Insufficient knowledge among investors

Market research also shows that many investors in leveraged products (as per the end of 2012) have insufficient knowledge of the operation of such products. Only one out of ten of all investors in leveraged products is able to indicate which of eight characteristics do apply to their product(s), and which do not apply. For example, one out of three investors erroneously thinks that a leveraged product can never exceed the stop-loss level outside trading hours.

In addition, investors overestimate their return when investing in leveraged products. For the coming years, they expect to realise an average gross return of 21% a year, while in the past year they realised a gross return of only 5%. Four out of ten investors do not know either what return they realised during the previous year on their investment in leveraged products.

Products with a leverage that is too high offer consumers too little chance of a positive return. The manner in which these products are structured turns out in practice to mean that the downside is enlarged to such a strong degree that it is highly doubtful as to whether this product offers any added value for consumers. The AFM’s opinion is that such products should not be offered to investors, and it also believes that providers of other, similar products should continue to guarantee the added value for the investors.

The AFM is committed to promoting fair and transparent financial markets.

As an independent market conduct authority, we contribute to a sustainable financial system and prosperity in the Netherlands.

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