When the new Swiss Federal Act on Collective Investment Schemes (CISA) came into force on January 1 2007, the Swiss market for collective investment schemes and structured products had seen years of unprecedented growth. With Switzerland being one of the world's most important places for the distribution of investment products, it was one of the CISA's aims to improve the regulatory environment for the domiciliation of collective investment schemes in Switzerland. To date, this aim has only partially been achieved. In addition, the ongoing financial crisis, and especially the Lehman Brothers collapse and the Madoff scandal, has a major impact on the Swiss market for both collective investment schemes and structured products, and has lead to a decrease of funds under management by the end of 2008. It is, therefore, a positive sign that authorities and industry organisations launched different initiatives to further improve the general regulatory environment for producing and distributing collective investment schemes in Switzerland.
Swiss market
On May 3 2009, 1317 Swiss and 5083 foreign collective investment schemes (including sub-funds of umbrella funds) were approved for distribution by the Financial Market Supervisory Authority (FINMA), the competent supervisory authority in Switzerland, showing a total net increase of 605 since the end of 2007. Most of the foreign vehicles approved in Switzerland are domiciled in Luxembourg and have indeed Swiss banks or financial groups as promoters. Furthermore, there is a number of statistically unevaluated foreign collective investment schemes which are only offered to qualified investors in Switzerland and which require no FINMA-authorisation. However, the volume of funds under management – to the extent they feature in the relevant Swiss statistics – decreased from CHF 600.5 billion to CHF 452.0 billion during 2008. This decrease is primarily due to an utterly adverse market environment, and only to a limited degree to redemptions. While equity funds suffered heavily in the financial crisis, money-market funds logically experienced a substantial growth. Equally, exchange-traded funds (ETFs) continue to be successful in Switzerland, with more than 150 listed at the SIX Swiss Exchange (SIX) by the end of 2008.
Although a large number of Swiss banks' and asset managers' clients have been hit by the Madoff fraud, no Swiss collective investment schemes were directly impacted. Most feeder funds that invested in Madoff were located either in offshore jurisdictions such as the Cayman Islands, Bahamas or the British Virgin Islands or in Luxembourg and Dublin. It is, nevertheless, expected that this major fraud will generally lead to thorough reflection on the effective separation of duties between the different fund actors (custodian bank, administrator and asset manager), on the role and responsibilities of the custodian banks, particularly in case of delegation of their duties, and on the scope and extent of the due diligence that banks and asset managers need to carry out while selecting and monitoring third-party vehicles or products.
The market for structured products (which are partially subject to the CISA in case of public distribution in Switzerland) saw an equally enormous growth over the past years. In 2008, this boom, however, discontinued against the background of many (barrier) reverse convertibles suffering knock-in events due to the poor performance of their underlyings, and the collapse of Lehman Brothers who was a frequent issuer on the Swiss market and had a programme for structured products registered with the SIX. It appears that, in order to avoid the issuer risk which materialised in Lehman Brothers' collapse, investors are presently turning their focus towards direct investments or collective investment schemes whose assets are segregated from the fund (management) company's bankruptcy estate in case of insolvency.
Collective investment schemes
Legal forms
The vast majority of Swiss collective investment schemes is set up in open-ended contractual form which was, prior to the enactment of the CISA, the only admitted legal form. They can be established for portfolios comprising securities, real estate, other traditional investments and alternative investments. The alternative open-ended legal form created by the CISA, the société d'investissement à capital variable (SICAV), was treated rather with reserve in practice. Through May 3 2009, the FINMA authorised one single-portfolio SICAV and a total of 18 sub-funds of three more SICAVs.
The CISA provides two new legal forms for closed-ended collective investment schemes, i.e., the société d'investissement à capital fixe (SICAF) and the limited partnership (LP).
Mainly for tax reasons, the introduction of the SICAF was not a success, and not a single SICAF was licensed by the FINMA on May 3 2009. However, the industry now faces some practical problems regarding the differentiation between FINMA-regulated SICAFs and certain types of non-regulated real estate companies and other operating companies. The FINMA published a decision ordering the liquidation of a non-regulated company which it qualified as SICAF in March 2008, however, general distinction criteria have yet to be developed. In our opinion, the practice should be geared to the primary aim of the CISA, investor protection. A company should not qualify as a SICAF if it primarily runs an entrepreneurial business operation and if investors finance such business operation with a primary focus on the company's financial needs.
The LP is intended for investments in risk capital (private equity) and is reserved for qualified investors. The FINMA granted six LP-licenses through May 3 2009. A reason for the hesitation in establishing Swiss LPs is that the tax treatment of the performance-related components of the fund managers' fees (carried interest) is unclear and – depending upon the structuring – can fully or partially be treated as taxable income in Switzerland. This issue is currently the object of further reflection and discussions both at cantonal and federal levels.
Hedge funds
In September 2007, the FINMA published a position paper concerning the market development, risks and regulation of hedge funds (Hedge Fund-Report) in which it concludes that Switzerland plays a marginal role as a location for hedge fund managers and as a domicile for hedge funds. Switzerland is, however, recognised as an important market for the placement of hedge funds units. Against this background, the FINMA advocated an improvement of the regulatory and fiscal framework for hedge funds and hedge fund managers domiciled in Switzerland. As regards the debate about a potential increase of the direct regulatory oversight of hedge funds, the Swiss regulator took the view that Swiss hedge funds and hedge fund managers were sufficiently regulated and supervised in Switzerland (with the exception of Swiss asset managers of offshore funds) and that the indirect supervision of (offshore) hedge funds via their banking counterparties (custodian and prime brokers) offered sufficient protection to investors and markets (under a systemic risk perspective).
It remains to be seen how the consequences of the financial crisis, including initiatives such as the International Organisation of Securities Commissions (IOSCO) task force on unregulated financial entities following the Washington G 20 summit, will affect this analysis and its chances of implementation in Switzerland. In this respect, one should note that IOSCO concludes in its report of March 2009 that hedge funds play generally speaking a positive role for the world markets and have been victims rather than cause of the recent global crisis. It also highlights the fact that hedge funds are, contrary to a wide-spread popular idea, generally much less leveraged than investment banks, for instance. Better application and enforcement of existing regulation would be more appropriate than new and costly politically justified over-regulation.
Regulation of asset managers
The CISA also applies to asset managers of collective investment schemes. However, only asset managers of Swiss collective investment schemes are mandatorily subject to FINMA-authorisation. Swiss asset managers of foreign collective investment schemes may voluntarily subject themselves to FINMA-supervision if certain conditions are fulfilled.
Until May 3 2009, the FINMA granted a CISA-asset manager license to 52 asset managers. Almost half of them manage exclusively foreign collective investment schemes.
Prudential rules
The FINMA may prescribe, as a licensing condition, that asset managers comply with a code of conduct established by an industry organisation. The Swiss Funds Association (SFA) published a draft Code of Conduct for Asset Managers of Collective Investment Schemes dated February 28 2009 which it submitted to the FINMA for recognition in accordance with the applicable FINMA Circular 2009/1 on Benchmarks for Asset Management, effective as of January 1 2009. On April 27 2009, the FINMA recognised the SFA Code of Conduct as minimum standard which shall be binding – in addition to the general CISA regulations – for all licensed asset managers of collective investment schemes. Compliance with the SFA rules shall be examined by the auditors of the asset managers.
Swiss asset managers of foreign schemes
Swiss asset managers of foreign collective investment schemes may apply for FINMA-authorisation if this is required under foreign legislation, and if the foreign vehicles which they manage are subject to adequate supervision abroad. This right primarily aims at allowing Swiss asset managers to manage undertakings for collective investment in transferable securities (Ucits)-funds. Conversely, Swiss asset managers of (hedge) funds which are domiciled on places like the Cayman Islands or in Bermuda are excluded from voluntary supervision. While certain asset managers view this as a regulatory advantage compared to other jurisdictions, the FINMA, in its Hedge Fund-Report, takes the view that this situation can also lead to competitive disadvantages for Swiss asset managers (of offshore funds). This is even more true in light of the European Commission's proposed directive on alternative investment fund managers, which is likely to have a major impact on asset managers domiciled in Switzerland. An extension of the voluntary supervision would, however, require an amendment of the CISA which is presently under discussion in the context of the „master-plan for the financial centre Switzerland" (see Outlook, below). It is to be noted that the FINMA has in its practice required that Swiss managers of foreign (appropriately regulated) collective investment schemes be subject to the FINMA oversight even if the foreign legislation does not require such managers to be regulated (e.g., Luxembourg "Part II funds") as soon as the FINMA approval for the distribution of such funds in or from Switzerland has been applied for.
Foreign asset managers of Swiss schemes
The fund administration may delegate investment management decisions if and to the extent this is in the interest of an appropriate administration. A delegation to an asset manager incorporated abroad is only permissible if the foreign asset manager is subject to adequate supervision and is qualified to conduct the asset management properly. In autumn 2007, the FINMA informed that asset managers with the regulatory status of a bank domiciled in the OECD, Hong Kong and Singapore meet this standard, so no further proof has to be provided in connection with their regulatory status in the FINMA-authorisation proceedings for the relevant Swiss investment funds or SICAVs. For other foreign asset managers, the applicant has to actually prove that the foreign asset manager is adequately supervised.
Foreign collective schemes
Public advertising
Foreign collective investment schemes may not be publicly advertised, in or from Switzerland, unless they have been formally approved by the FINMA. Public advertising means advertising addressed to the public and is interpreted by the FINMA as the use of means of advertising of any type whose contents serve the purpose of offering or distributing specific collective investment schemes. Such advertising is deemed public regardless of the number of potential investors to whom the advertising is directed.
Under the CISA regime, there is no public advertising, however – and hence no FINMA-authorisation requirement – if collective investment schemes are exclusively offered to qualified investors by methods that are customary for this market (such as personal contacts or road shows). In its Circular 2008/8, the FINMA laid down its current practice regarding the concept of public advertising and the available qualified investor exemptions. The circular applies to both foreign collective investment schemes and (Swiss and foreign) structured products.
Qualified investors include, among others, regulated financial intermediaries and insurance institutions, public entities and pension funds with professional treasury operations, high net worth individuals with bankable assets of at least CHF 2 million, and investors having concluded a written asset management agreement with a regulated financial intermediary. Independent asset managers and investors who concluded a written asset management agreement are also deemed „qualified" if certain conditions are fulfilled.
Abolition of the Swiss Finish
In the past, FINMA-authorisation proceedings for foreign Ucits-III funds were often delayed because Swiss law and the FINMA practice provided for more stringent requirements than EU law. The relevant requirements were referred to as Swiss Finish. The fund industry, therefore, welcomed the abolition of the Swiss Finish with effect as of March 1 2009.
Beside the abandonment of certain formal conditions, this abolition means, in particular, that the quantitative rules concerning the name of collective investment schemes have been given up. The FINMA will merely examine if the name of the collective investment scheme might be misleading and interfere in case of abuse. Further, the prohibition of the double-dip has been aligned with the European standard. In order to further simplify the FINMA-authorisation proceedings for Ucits-III funds, the SFA published standard forms setting forth the specific information that needs to be provided to investors in Switzerland.
It remains to be seen whether the authorisation proceedings will be substituted by mere notification proceedings at least for certain standard types of foreign investment funds, in accordance with requests from the fund industry.
Structured products
As already mentioned, the CISA also applies to structured products if they are publicly offered in or from Switzerland. There is no statutory definition of structured products. However, the CISA provides for a non-exhaustive list of examples, such as capital protected products, capped return products, and certificates.
The Swiss Bankers Association (SBA) issued Investor Information Guidelines in July 2007 describing structured products as investment instruments with redemption values linked to the performance of one or more underlying values. Conversely, financial products which serve primarily a financing purpose or a risk transfer do not qualify as structured products pursuant to the CISA. Hence, the CISA rules described below do not apply to bonds, convertibles, collateralised debt obligations, credit-linked notes and asset-backed securities. Moreover, forward and option transactions are expressly not within the scope of the CISA.
Issuer, guarantor and distributor requirements
If structured products are offered by means of public advertising, their issuer, guarantor or distributor needs to be subject to the supervision of the FINMA as a bank, securities dealer or insurance company, or, alternatively, to the supervision of an equivalent foreign supervisory authority. If the issuer, guarantor and distributor is unsupervised by the FINMA, there needs to be at least a FINMA-supervised affiliate office in Switzerland, unless the structured product is listed at a Swiss stock exchange. In its paper on Frequently Asked Questions/FAQ – Structured Products of 2007, the FINMA specifies that, as a minimum requirement, the simplified prospectus with the disclosure as set out in the Investor Information Guidelines of the SBA must be available at this Swiss office. A further involvement of the office in the distribution process is, however, not required.
Collective investment schemes
It is sometimes difficult to distinguish between structured products and collective investments schemes. The distinction is fundamental since, unlike in case of collective investment schemes, the FINMA does not perform a product supervision over structured products. Generally speaking, a structured product (only) grants its investor a claim for redemption against the respective issuer (and guarantor, if any) in accordance with the terms of the product. Investors are thus exposed to the issuer's insolvency risk. By contrast, in case of a collective investment scheme, the investor has the right to require the segregation of the respective fund's assets upon the fund (management) company's insolvency.
Especially in case of products issued by special purpose vehicles (SPVs), these criteria can be difficult to apply. According to the FINMA's practice as set forth in its FAQ-Structured Products, in order to prevent a re-characterisation of a financial product as a collective investment scheme, the SPV must not qualify as a collective investment scheme under the laws of its country of domicile or pursuant to the practice of the competent foreign supervisory authority. In addition, the issuer must not be a single-issuance SPV nor a multi-issuance SPV with segregated products.
Similar problems may arise in respect to structured products that – in the aftermath of the Lehman Brothers collapse – provide investors with a collateral in order to minimise the risk of substantial financial loss in case of their issuer's insolvency.
Fund-linked notes and indirect fund distribution
Special rules apply to fund-linked notes if their offering qualifies as indirect fund distribution. The latter expression describes the distribution of structured products with one or more collective investment schemes as underlying(s). In this case, the public distribution of the structured products is problematic, from a Swiss regulatory perspective, if the underlying collective investment scheme(s) is/are not authorised for public distribution in Switzerland. In order to exclude an (illicit) indirect fund distribution, according to the FINMA's current practice, at least three underlying funds are basically needed, none of which may constitute, at the time of issuance, more than 33.3% of the value of the product. Unlike passive products, actively managed products have to comply with this limit until maturity each time an investment decision is taken. For the above purposes, a fund of funds is considered as one underlying instrument.
According to a notification of May 2008, the SIX equally adopted this one-third-rule in connection with the listing of derivative instruments which have, as their underlying, collective investment schemes which are not authorised by the FINMA for public distribution in Switzerland.
Outlook
The SFA, the SBA, the Swiss Insurance Association and the financial centre infrastructure worked out a master plan for the financial centre of Switzerland (Master Plan) during 2007. It is the first time that an industry-overlapping strategy for the future has been developed which, under the term Vision 2015, aims at making the Swiss financial centre one of the top three places for global business. In order to intensify the dialogue about the Master Plan together with political authorities, a Financial Centre Dialogue Steering Committee (FCDSC) was established. In September 2008, the FCDSC published a report with various proposals to strengthen Switzerland as a financial centre, such as, in the context of the CISA, the competitive tax treatment of hedge funds and private equity and the extension of voluntary supervision of asset managers. In addition, the discussion of several measures like the adoption of a selective notification procedure for certain collective investment schemes (as an alternative to the authorisation procedure under the CISA), the possibility of international pass-porting of Swiss collective investment schemes and the improvement of the general requirements for real estate funds, shall be continued or newly brought in.
Due to numerous national and international regulatory initiatives for a domestic and global re-design of the financial markets, and especially the European Commission's proposed directive on alternative investment fund managers, the Master Plan will certainly have to be reviewed and, if necessary, adjusted to a financial world which has dramatically changed its face since September 2008. Many proposals of the Master Plan, in particular in respect of the CISA, are certainly worthwhile pursuing.
| Author biographies |
Lionel Aeschlimann
Schellenberg Wittmer
Lionel Aeschlimann heads Schellenberg Wittmer's banking and finance team in Geneva. His practice focuses on banking law and financial services, regulatory, investment funds and structured products, capital markets and stock exchange law.
Aeschlimann is a contributor at the Centre de droit bancaire et financier at the University of Geneva. He is an authorised representative at the SIX Swiss Exchange for listing purposes. He is the author of various publications and articles on investment funds, structured and derivative products, financial services, corporate governance and regulatory issues. He has been ranked as one of Switzerland's leading lawyers in his field by several professional registries.
Aeschlimann graduated from Berne University and holds a postgraduate diploma in European Law from the University of Sevilla in Spain as well as an Law masters from the College of Europe in Bruges, Belgium. He was admitted to the Berne Bar in 1992 and the Geneva Bar in 1994. He has been a partner with Schellenberg Wittmer since 2000.
Anita Schläpfer
Schellenberg Wittmer
Anita Schläpfer is a partner in Schellenberg Wittmer's banking and finance practice group in Zurich. Her main areas of practice are banking, finance and capital markets law, collective investment schemes, structured and derivative financial products and financial services regulation. In particular, Schläpfer advises Swiss and international financial institutions and other clients on the structuring, negotiation and documentation of domestic and cross-border acquisition finance and syndicated lending transactions. She also advises on restructurings, securitisations and other finance transactions as well as on all questions arising in connection with collective investment schemes, including licensing, distribution and asset management.
Schläpfer was born in 1971 and graduated in law at the University of St Gallen. She was admitted to the Swiss Bar in 2000 and earned a Master of Laws from Columbia University in 2002. She joined Schellenberg Wittmer in 2007, after working for a large business law firm in Zurich, and became a partner in January 2009. She is fluent in German and English.
Philippe Borens
Schellenberg Wittmer
Philippe Borens is a partner in Schellenberg Wittmer's banking and finance team in Zurich. His main areas of practice are banking and finance law, capital markets and stock exchange law, structured products and investment funds, as well as financial services regulation. Borens advises clients in all types of finance transactions, including syndicated loans, acquisition finance, domestic and international equity and debt capital market transactions, investment funds and investment companies, derivatives and structured products, securitisations, as well as securities listings on Swiss stock exchanges and regulatory issues. He is an authorised representative at the SIX Swiss Exchange and author of publications in the field of Swiss financial markets and securities law. He is also a lecturer at the law faculty of the Universities of Zurich and Liechtenstein.
Borens was admitted to the bar in Switzerland in 1997. After his graduation from the University of Basle, he completed a masters program in European economic law at the College of Europe in Bruges, Belgium and obtained a doctorate in law in 1999. Borens joined Schellenberg Wittmer in 1999 and became a partner in 2004. |