Definition of the SRD
The Deferred Settlement Service (SRD) is a mechanism that allows investors to carry out transactions on financial markets without immediately paying the price of the securities bought or sold. It is a leveraged financial product, meaning it allows investors to take larger positions than their available capital by borrowing part of the funding from the investment services provider. In doing so, the investor can increase their potential gains, but also their potential losses.
In this article, we will explain how the SRD works, its advantages and disadvantages, as well as the legal obligations imposed on investment services providers and clients who use it.
How does the SRD work?
The SRD allows the purchase or sale of shares, bonds, or futures contracts over a one-month period, renewable up to five times, without paying the full amount of the transaction. The client pays an initial guarantee, called margin cover, which represents a fraction of the securities’ price (between 20% and 40% depending on the case). The balance is paid at the end of the trading month, upon settlement-delivery of the securities.
The client can choose between two types of transactions:
— Buying on margin: this involves purchasing securities in the hope that they will appreciate in value, then reselling them at the end of the trading month or before, realising a capital gain. The client borrows the balance of the purchase price from the investment services provider, which charges interest.
— Short selling: this involves selling securities that one does not own, in the hope that they will depreciate in value, then buying them back at the end of the trading month or before, realising a capital gain. The client borrows the securities from the investment services provider, which charges lending fees.
What are the advantages of the SRD?
The SRD offers several advantages for investors who wish to speculate on financial markets:
— It allows investors to benefit from leverage, i.e. to multiply potential gains by investing a sum greater than their available capital. For example, if a client purchases 100 shares at 10 euros with a 20% margin cover, they only pay 200 euros instead of 1,000 euros. If the shares rise to 11 euros, they realise a capital gain of 100 euros, representing a 50% return on their initial investment. Conversely, if the shares fall to 9 euros, they incur a loss of 100 euros, representing a 50% loss on their initial investment.
— It allows investors to take long or short positions on the markets, using margin buying or short selling. Thus, the client can profit from price fluctuations, whether the market is trending upward or downward.
— It provides increased liquidity, since the client can carry out transactions without tying up all their capital. They can thus diversify their portfolio and seize market opportunities.
What are the disadvantages of the SRD?
The SRD also entails significant risks for investors who use it:
— It involves a risk of capital loss, which may exceed the amount invested. Indeed, if prices move unfavourably, the client must pay the difference between the purchase price and the selling price of the securities, which may exceed the initial guarantee. For example, if a client short sells 100 shares at 10 euros with a 20% margin cover, they receive 1,000 euros and deposit 200 euros as a guarantee. If the shares rise to 12 euros, they must buy back the securities for 1,200 euros, resulting in a loss of 200 euros. But since they only deposited 200 euros as a guarantee, they must pay an additional 200 euros to the investment services provider, representing a total loss of 400 euros, exceeding their initial investment.
— It involves fees and commissions, which reduce the profitability of transactions. The client must pay interest on the borrowed balance in the case of margin buying, and lending fees on borrowed securities in the case of short selling. They must also pay commissions to the investment services provider, which are generally higher than for cash transactions.
— It involves a forced liquidation constraint, which may require the client to close their positions before the end of the trading month if they fail to meet margin calls. Indeed, if prices move unfavourably, the investment services provider may require the client to deposit additional collateral, called margin, to maintain their positions. If the client does not deposit the margin within the prescribed time period, the provider may proceed with the forced liquidation of positions, i.e. sell or buy the securities at market value, without the client’s consent. The client must then bear the loss resulting from the forced liquidation.
What are the legal obligations related to the SRD?
Investment services providers must also provide clients with clear and comprehensive information on the characteristics and consequences of the SRD, particularly regarding margin cover, fees and commissions, forced liquidation, settlement-delivery, and guarantees. This information must be communicated in writing or on a durable medium before the conclusion of the SRD contract. Furthermore, providers must periodically assess the suitability of the SRD for the client’s profile.
In addition, Article L. 533-13 II paragraph 3 of the French Monetary and Financial Code provides: « where providers consider, based on the information provided, that the service or instrument is not suitable, the providers shall warn such clients prior to the provision of the service in question. » A duty to warn is thus imposed on them if the SRD is not suitable for the client’s profile.
Investors who use the SRD may benefit from enhanced legal protection compared to cash transactions. Indeed, pursuant to Article L. 533-12 of the French Monetary and Financial Code, investment services providers must ensure that clients who wish to use the SRD have the knowledge and experience necessary to understand the risks inherent in this service.
Conclusion
The SRD is a leveraged financial product that allows investors to speculate on financial markets without immediately paying the price of the securities bought or sold. It offers advantages, but also disadvantages and significant risks, which should be carefully assessed before committing to it. Investment services providers and clients who use it are subject to strict legal obligations aimed at ensuring the transparency, security, and suitability of the service.
