Late trading and market timing

Since its press release of 17 February 2004, the CSSF has continued its inquiries with the aim of getting an overall view of the possible propagation of Late Trading and Market Timing practices within Luxembourg collective investment schemes.

In November 2003, the CSSF launched a large-scale investigation encompassing 425 entities, mainly Luxembourg registrar and transfer agents, central administrations, distributors of units of investment funds, depository banks and asset management companies, requesting them to respond to some detailed questions relating to Late Trading and Market Timing.

The CSSF then launched a second investigation by selecting about a hundred compartments of funds investing their assets mainly in securities from the Asian or American markets.

In this regard, the CSSF has also required those Luxembourg entities belonging to a financial group mentioned in the international press for having perpetrated or letting perpetrate Late Trading or Market Timing operations, to take a position on the alleged facts and to make a statement on the possible impact of these operations on the Luxembourg collective investment schemes.

The CSSF then sought out those Luxembourg collective investment schemes which had delegated tasks to one of the managers accused of having promoted or practised Late Trading or Market Timing activities. It has asked these investment funds to comment on these accusations and to make a statement on the possible impact of the controversial practices on the Luxembourg collective investment schemes.

The CSSF has noticed that the vast majority of the entities questioned had for some time already been alerted of the inherent problems of Late Trading and Market Timing and had taken or were in the process of taking the necessary protective measures. In this sense, the investigation has allowed the CSSF to get a concrete idea of the procedures and controls already set up by the various service providers of Luxembourg collective investment schemes.

The investigations have revealed two cases where orders have been placed after the cutoff time set in the prospectus of the investment fund concerned.

In the first case, a technical malfunction generated during the installation of the facility to subscribe via Internet had resulted in the extension of the cut-off time for orders placed by electronic means. The entity concerned has submitted a detailed report to the CSSF in which it concludes that the investors, who had placed “late” orders did not take advantage of this situation and did not exploit any arbitrage opportunity, given the duration of the average holding of their units and the absence of correlation between the size of the orders given after the cut-off time and the scale of the market fluctuations.

In the second case, a prior agreement made with an investor was at the origin of an approximate two and half hour delay on the official cut-off time outlined in the
prospectus in force. However, the investor did not benefit from this delay as he used to transmit his orders before the financial markets opened.

The CSSF notes that in the aforementioned two cases, corrective measures have been taken by the entities concerned, who confirm moreover that these transactions had no impact on the investment funds.

In addition, several entities questioned have informed the CSSF about their suspicions on possible Market Timing practices within some investment funds. The CSSF has requested explicit information.

Indeed, opportunities arise to the market timer, if the NAV is calculated on the basis of stale prices or if the investment fund has already started with the calculation of its NAV while it is still possible to place orders.

The CSSF considers that the practice of Market Timing cannot be allowed, insofar as it either diminishes the performance of the investment fund through an increase in fees, or brings about a dilution of the profit.

The CSSF’s attention was drawn to about twenty investors who had started to adopt atypical investment behaviour by subscribing and redeeming in a relatively short period of time, without however being able to prove that they were actually market timers.

The documents provided showed that these investors have been unable to develop their activities in Luxembourg, while the investment fund has promptly terminated its relationship or imposed restrictions on them.

In all the cases cited, the impact of these short term transactions on the investment fund has been considered insignificant.

In addition, the CSSF has not detected any elements which could prove that the Luxembourg financial centre lends itself to suspicious dealings by people who, with the
help of a professional of the financial centre, are in pursuit of a fast profit at the expense of others.

The CSSF concludes that the investigations not only alerted potential market timers, but also showed that those responsible in the investment fund field are conscious of their professional duties and have done the necessary research. Where problems have occurred, solutions have been put in place.

The CSSF will continue to make sure that the protection and the equal treatment of investors is not disturbed by Late Trading or Market Timing practices and will carry out controls in this regard.

Finally, a circular concerning Late Trading and Market Timing is about to be finalised.