Cross-Border Financing Report 2017: Switzerland
Daniel Hayek and Alexander Flink, Prager Dreifuss
SECTION 1: Market overview
1.1 Please provide an overview of the cross-border financing market in your jurisdiction.
Switzerland is home to more than 260 banks, with an aggregate balance sheet total of approximately CHF3.1 trillion. Consequently, the Swiss cross-border market is mature and well-developed. Major local banks such as Credit Suisse, UBS and Zurich Cantonal Bank (ZKB) are the dominant lenders when it comes to cross-border financing but international banks are quite active in the Swiss market as well. This is because headquarters of large international groups are located in Switzerland and also because borrowers frequently have Swiss affiliates which grant security. The Swiss jurisdiction provides the necessary legal certainty for large scale financial transactions to resolve resulting disputes. However, borrowers and lenders usually tend to find an amicable solution in disputes, rather than resorting to litigation.
1.2 What have been the key trends or developments in cross-border financing in your jurisdiction over the past 12 months?
The ongoing Brexit negotiations may have had a slightly negative impact on cross-border financing, but the market has been rather steady over the last twelve months.
1.3 Have there been interesting changes in the structure of the banking sector in your jurisdiction?
It appears that Chinese banks are increasingly active as lenders in the Swiss market in connection with the acquisition of Swiss targets.
SECTION 2: Financing structures
2.1 Briefly outline some recent notable transactions involving your jurisdiction, highlighting any interesting aspects in their structures and what they might mean for the market.
We have seen a multi-billion euro transaction in order to finance a large-scale infrastructure project. The most interesting aspect of the transaction was that the current lenders are European energy companies that do not have a banking licence. At present, there are no bank lenders involved, even though they may provide financing at a later stage of the project. This raised some difficult questions in relation to the so-called 10/20 Non-Bank Rule, which limits the number of potential non-bank lenders (for further details see section 3.3 below). Consequently, finding a solution for the allocation of "slots" for lenders without a banking licence providing mezzanine, bridge or funding gap capital, as well as the transfer of loan shares to non-banks, proved to be challenging. The composition of the lenders made this transaction quite unique. Therefore, we do not expect that its structure will influence the Swiss market standard.
2.2 Have there been any significant developments in the way cross-border financing transactions are structured or in the way borrowers and/or lenders are participating in the market?
Syndicated secured loan facilities are probably the most frequent type of cross-border financing transactions and it appears that this will not change in the near future.
SECTION 3: Legislation and policy
3.1 Describe the key legislation and regulatory bodies that govern cross-border financing in your jurisdiction.
There is no specific legislation or regulatory body that exclusively or predominantly governs cross-border financing in Switzerland. However, it goes without saying that the Swiss Financial Market Supervisory Authority (Finma) is relevant when it comes to the regulation of domestic (bank) lenders and that the Swiss Federal Tax Administration is relevant in relation to ancillary tax issues.
3.2 Have there been any recent changes to regulations or regulators that may impact the cross-border financing market and what impact do you expect them to have?
There have been no changes to regulations or regulators which would have had a significant impact on the cross-border market.
3.3 Are there any rules, legislation or policy frameworks under discussion that may impact lenders or borrowers involved in cross-border financing in your jurisdiction?
The abolition of the 10/20 Non-Bank Rule has been widely discussed, because it could considerably improve the appeal of lending directly to Swiss borrowers. In a nutshell, this rule states that interest payments are subject to the 35% Swiss Withholding Tax, if the number of lenders without a banking licence exceeds 10 (under a single debt instrument) or 20 (under all debt instruments of the Swiss borrower taken together), respectively. Under certain circumstances, interest payments guaranteed by a Swiss guarantor may be subject to the Swiss Withholding Tax as well. The limitation of syndication to non-bank lenders due to the 10/20 Non-Bank Rule is a viable solution to avoid or mitigate the consequences of this rule.
However, such an approach may not be satisfying to larger syndicated finance transactions or if the involvement of lenders without a banking licence is a necessity. In this case, the funds are often raised by a foreign parent company and the Swiss entity solely acts as guarantor and security provider. If this structure is properly planned and implemented, the applicable upstream and cross-stream limitations (see section 5.1) can be reduced to a minimum, but it would be preferable if the lenders had unlimited claims against the Swiss entity and the transfer of loan shares to non-banks was not restricted. Therefore, the abolition of the 10/20 Non-Bank Rule would be most welcome to borrowers and lenders. As a positive side effect, the volume of loans made available to Swiss borrowers could increase substantially.
SECTION 4: Market idiosyncrasies
4.1 Please describe any common mistakes or misconceptions that exist about the financing market in your jurisdiction.
The 10/20 Non-Bank Rule (see section 3.3) and the applicable up- and cross-stream limitations on guarantees (see section 5.1) may have a significant impact on the structuring of a deal. This is frequently underestimated by foreign lenders who are not familiar with the Swiss market.
4.2 Are there frequently asked questions or often overlooked areas from parties involved in cross-border financings in your jurisdiction?
Most questions concern the potential structure of a transaction in the light of the 10/20 Non-Bank Rule, the applicable up- and cross-stream limitations (see section 5.1) and the resulting tax consequences. Not all foreign lenders are aware of the significance of these issues. To a lesser extent, lenders want also to know which asset classes can be taken as security and what documentation or formalities are required to create, perfect and maintain such security.
4.3 Are there any classes of assets over which security cannot be taken or regulations specific to your jurisdiction governing the taking of security over certain classes of assets that lenders should be aware of?
Security can be taken over all classes of assets a lender would usually expect, such as shares, bank accounts, receivables, insurance policies, real property and intellectual property.
In order to perfect and maintain a pledge over shares (or other movable objects), the security trustee needs to be in physical possession of the pledged movable objects during the security period (Faustpfandprinzip). As a consequence of this requirement, security over plants, machinery, equipment or inventory is possible, but is usually not taken.
There are some limitations to security taken over real estate that serves primarily as living accommodation and there are certain formalities which must be observed. However, the quality and value of the security is usually worth the extra effort.
In principle, floating charges are not available in Switzerland. However, there is the option to grant security over a value quota of an intermediated securities account. Therefore, it is possible to create a Swiss security over intermediated securities that is, to a certain extent, similar to a floating charge. It should be noted that there are several ways to create security interest over intermediated securities.
4.4 What measures should be taken to best prepare for your market idiosyncrasies?
Solutions exist for most of the Swiss market idiosyncrasies to avoid or at least mitigate the resulting impact for the lenders and the borrowers. The best approach for a lender that is not familiar with the Swiss market is to contact a specialised Swiss law firm before the parties have agreed to a financing structure that is difficult or impossible to implement in Switzerland.
SECTION 5: Practical considerations
5.1 Briefly explain the downstream, upstream and cross-stream guarantees available in your jurisdiction, with reference to any specific restrictions or limitations.
Downstream guarantees are not subject to restrictions or limitations, but upstream and cross-stream guarantee payments are considered constructive dividends and are, hence, limited to the profits and reserves freely available for distribution in the guarantor's balance sheet. Consequently, the respective rules for distribution of dividends must be observed. This includes the preparation of an up-to-date balance sheet by the guarantor and the approval of the resulting distribution by the shareholders' meeting. In order to maximise the available assets for distribution, the finance documents should contain Swiss guarantor limitation language to that effect and it is standard to combine a guarantee with a pledge over the shares in the Swiss guarantor.
It should also be noted that the proceeds from upstream and cross-stream guarantees are subject to 35% withholding tax and, in recent years, it has become common for the Swiss Federal Tax Authority to request that the Swiss company providing a guarantee to its parent company receives an appropriate remuneration for the guarantee (guarantee fee).
5.2 Are there any specific issues creditors should be mindful of regarding a bankruptcy and restructuring situation?
The enforceability of any contract may be limited under the rules of the Swiss Debt Enforcement and Bankruptcy Act. In particular, the following transactions may be fully or partially voidable:
transactions carried out during the year prior to the bankruptcy or insolvency decree, in which the Swiss security grantor accepted to receive no consideration at all or a consideration out of proportion to its own performance;
certain financially inadequate transactions, if carried out during the year prior to the bankruptcy or insolvency decree and if the Swiss security grantor was at the time of the transaction already over-indebted; however, the transaction is not voided if the recipient proves to have been unaware of the security grantor's over-indebtedness; and,
all transactions which the Swiss security grantor carried out during the five years prior to the bankruptcy or insolvency decree with the apparent intention of disadvantaging its creditors or of favouring certain creditors to the disadvantage of others.
Another major insolvency related issue that should be addressed in the finance documents is the allocation of proceeds between the different classes of lenders. Frequently, there is a UK or US law governed intercreditor agreement that provides for a certain waterfall that does not necessarily take into account Swiss insolvency law. In particular, the subordination of claims can lead to issues and delays in relation to the enforcement of security in Swiss insolvency proceedings if not properly addressed in the intercreditor agreement, the security documents and other ancillary documentation.
5.3 Do foreign debt quotas apply in your jurisdiction and is offshore financing to domestic entities monitored?
In connection with cross-border financing there are no foreign debt quotas which would have to be observed. In addition, there are no rules which would require to specifically monitor offshore financing to domestic entities, subject to the applicable money laundering legislation and sanction regimes.
5.4 Describe your jurisdiction's relationship with non-performing loans (NPLs), including volume of outstanding NPLs and techniques/challenges in managing them.
Over the last decade, the ratio of Swiss bank nonperforming loans to total gross loans has continuously fallen from 1.3% in 2005 to 0.755% in 2015, which is low in comparison to other jurisdictions. Consequently, NPLs are not as relevant in Switzerland as in other jurisdictions. A reason for this low ratio may be that non-performing loans suggest that the obligor is facing liquidity problems. This is a major issue for Swiss directors. The board of a Swiss obligor will have to convene an extraordinary shareholder's meeting and to propose restructuring measures if half of the company's share capital and legal reserves are no longer covered by its assets. In the event that the balance sheet of a Swiss obligor shows negative equity, the board of directors must notify the court. This usually leads to bankruptcy. If the board fails to observe its obligations, the individual directors may incur personal liability. It goes without saying that the board will try to find a commercial solution with the existing lenders or try to raise additional capital from alternative sources to avoid such a situation.
SECTION 6: Outlook
6.1 What are your predictions for the next 12 months for cross-border financing in your jurisdiction? How do you expect legal practice to respond?
The so called 10/20 Non-Bank Rule has been identified as an obstacle for cross-border financing connected to Switzerland and it has been debated to abolish this rule or at least to replace it with a more market friendly rule. However, this will take more than 12 months.
About the author
Partner, Prager Dreifuss
T: +41 44 254 55 55
F: +41 44 254 55 99
Daniel Hayek is a member of the management committee and head of Prager Dreifuss' corporate and M&A team. He specialises in mergers and acquisitions (mainly strategic buyers), corporate finance, takeovers, banking and finance and corporate matters. He advises business clients in all types of domestic and cross-border transactions, including finance and real estate transactions. He has also advised major US and German banks in acquisition finance transactions and in the recovery of distressed debt. In these fields he is also representing clients in court and before arbitration tribunals. Lately, his practice has involved acquisitions of Swiss targets for major strategic buyers from a variety of industries (chemical, automotive, transport), as well as debt restructuring and insolvency law.
About the author
Associate, Prager Dreifuss
T: +41 44 254 55 55
F: +41 44 254 55 99
Alexander Flink is a member of the corporate and M&A and banking & finance teams of Prager Dreifuss. He focuses mainly on restructuring transactions and financing. He has also significant experience in presenting lenders as well as borrowers in the negotiation of credit facilities regarding leveraged finance and project finance, as well as in acquisition finance for private equity companies and providers of senior and mezzanine debt. His recent practice has involved the representation of major banks in domestic and cross-border transactions, including corporate finance, real estate and IP transactions. He further advises clients in connection with insolvency laws and the recovery of distressed debt.