Swiss ESG regulation for funds
Switzerland is facing a choice of whether to maintain its policy of self-regulation regarding sustainable finance or formulate legislation that applies across all financial industry sectors, say Jürg Frick and Alexander Cochardt of Homburger
Over recent years, the EU has pursued its sustainable finance ambitions through a multitude of new regulations and standards, the effects of which stretch far beyond the EU’s borders. In Switzerland, there is still no overarching legislative framework on sustainable finance. However, in November 2021, the Swiss Federal Council adopted various measures to promote sustainable finance.
For example, it has instructed the Federal Department of Finance, in cooperation with the Swiss Financial Market Supervisory Authority (FINMA), to propose by the end of 2022 how financial market legislation could be amended – particularly with regard to transparency – to avoid greenwashing.
Despite limited powers and pending the finalisation of the government’s intended environmental, social, and governance (ESG) framework, FINMA has also taken certain measures related to ESG on its own initiative (see section 2 below).
Before deciding whether a legislative revision or the adoption of mandatory regulation is needed, the Swiss Federal Council gave an opportunity to the financial industry to implement self-regulation by the end of 2022. This approach is in line with Switzerland's historical reliance on self-regulation in the financial sector.
Self-regulation can be enforceable through the organisation performing the self-regulation itself (given that the rules are binding on its members) or a minimum standard being declared by the regulator (resulting in delegation of legislative powers to the private sector, with enforcement through ordinary regulatory measures by the state regulator).
Accordingly, the financial industry agreed to implement voluntary self-regulation that has been prepared and published independently by the Swiss Bankers Association (SBA) and the Swiss Asset Management Association Switzerland (AMAS) (see section 3 below).
Other associations are expected to publish similar self-regulation for their specific industry shortly, including the Swiss Association of Pensions Funds (ASIP) and the Swiss Structured Products Association. By the end of 2022, the Swiss Federal Council is expected to express whether the implemented self-regulation is viewed as a sufficient measure to meet its objectives.
Due to their central position among sustainability-related financial products, collective investments or, for these purposes, funds represent a main object of ESG regulation. By volume, sustainable funds correspond to about 53% of the entire Swiss funds market and about 40% of all sustainable investments in Switzerland (see the Swiss Sustainable Investment Market Study 2022, Swiss Sustainable Finance/Center for Sustainable Finance & Private Wealth, University of Zurich, page 6).
This article provides an overview of ESG regulation in the area of funds in Switzerland.
2 FINMA actions
In its strategic goals for 2021 to 2024, FINMA committed to contributing to the sustainable development of the Swiss financial centre, derived from its primary mandate according to Article 4 of the Financial Market Supervision Act. According to the FINMA Risk Monitor 2021, FINMA continues to scrutinise climate-related financial risks closely.
FINMA has so far focused intensively on the topic of consumer protection by examining measures to combat greenwashing. Importantly, where investor protection provisions apply, greenwashing practices may be addressed by many articles of the present regulatory regime. For example, Article 12 of the Collective Investment Schemes Act (CISA) explicitly sets forth that “the designation ’collective investment schemes’ must not provide any grounds for confusion or deception”.
As FINMA approves products offered by collective investment schemes and grants authorisation to any party that establishes or operates a collective scheme or is responsible for the safekeeping of the assets held, FINMA has required, since January 2021, more accurate and detailed information for so-called green, ESG, or sustainable funds in the product approval process, as well as in the fund documents (for example, the prospectus, and fund and investment contracts).
In addition, FINMA published its Guidance 05/2021 on preventing and combating greenwashing in the fund segment on November 3 2021, in which it sets out its expectations and present practice regarding the management of sustainability-related collective investment schemes at the fund level (transparency and reporting) and institutional level (organisational requirements), as detailed below.
2.1 Fund-level transparency
Fund documents must, notably:
Avoid references to sustainability where no sustainable investment strategy/policy is pursued;
Provide information about the sustainability approach and its implementation;
Ensure consistency between the sustainability approach pursued and the investment policy;
Avoid references to sustainability where the investment strategy/policy does not go beyond widespread exclusion criteria (which would not be sufficient as such);
Include reference to ‘impact‘ or ‘zero carbon‘ only where the stated impact or carbon reductions can be measured and verified; and
Provide details about the investment strategy/policy, the selection of permitted investments, along with how sustainability considerations are integrated into the investment decision process; in such context, general information is not sufficient.
2.2 Fund-level reporting
Retrospective sustainability reports are required, setting out to what extent a sustainability-related fund has achieved its sustainability goals. The regulator does not mention a reporting standard to be followed but recommends a "high degree of transparency". Based on FINMA's developing practice, this ex post sustainability reporting should be:
Consistent (in terms of form and content);
Highly transparent; and
Avoid extensive disclaimers (for example, regarding ESG ratings).
2.3 Institutional-level organisational requirements
In detailing the requirements according to Article 9 of the Financial Institutions Act (FinIA) and Articles 14 (1) (c) and 20 (1) CISA, institutions based in Switzerland managing sustainability-related Swiss or foreign collective investment schemes must be suitably organised:
The investment decision process must consider sustainability factors, which shall be reviewed as part of independent monitoring of risks;
Sustainability-related expertise and knowledge must be present within the governance, supervision, and control function, as well as at the operational level;
The body for governance, supervision, and control (i.e., the board of directors in a corporation) shall specify the sustainability strategy; and
Information provided by external data providers (data, analyses, tools, and ratings) must be adequately assessed, monitored, and validated.
FINMA did not establish binding rules at the point-of-sale level, pointing to a lack of legal basis for doing so. It takes the view that the advisory process (at the point of sale) can also pose greenwashing risks and that financial service providers are expected to manage them accordingly.
As FINMA's regulatory activity regarding collective investments has been limited to the above-mentioned actions, critical voices speak of a regulatory gap between Switzerland and the EU. In essence, this can be explained by the fact that the EU and Switzerland have pursued fundamentally different approaches to regulation in the area of sustainable finance from the outset.
The Swiss Federal Council was guided by the principle of subsidiarity of government action and thus wanted to leave the greatest possible scope for self-regulation, and regulatory measures going beyond this were to be taken only "in the event of a lack of effect of existing framework conditions or in the event of market imperfections or market failures".
3 Industry initiatives
3.1 SBA ESG Guidelines
On June 16 2022, the SBA issued its "Guidelines for the financial service providers on the integration of ESG-preferences and ESG-risks into investment advice and portfolio management" (the ‘SBA ESG Guidelines’). The SBA ESG Guidelines mainly govern the point-of-sale level and partially the institutional level, and will enter into effect on January 1 2023.
The purpose of the SBA ESG Guidelines is to implement a minimum standard for the consideration of ESG preferences and risks in investment advice and portfolio management, and to prevent greenwashing (Article 1).
Pursuant to the principles-based provisions of the SBA ESG Guidelines, financial service providers shall enquire about the clients' ESG preferences and take these into consideration when providing investment advice and portfolio management. In addition, it shall be ensured that the investment solution and recommended financial instruments are aligned with the clients' ESG preferences (Articles 11 and 12).
Financial service providers shall provide information, documentation, and render of account (Articles 10, 13, and 14) in relation to ESG preferences, ESG investment solutions, and ESG risks and ESG characteristics of financial instruments or financial services.
Client advisers shall obtain appropriate training concerning sustainability, ESG investment solutions, and applicable ESG approaches (Article 15). The SBA ESG Guidelines do not contain obligations regarding the incorporation of ESG into product information documents such as prospectuses, key information documents, or marketing materials (Article 16).
Importantly, none of the self-regulation obligations apply to the financial service of ‘acquisition or disposal of financial instruments’ under the Financial Services Act (FinSA), as opposed to investment advice or portfolio management services. The distribution of Swiss or foreign funds does therefore not trigger any rules of conduct with respect to ESG aspects (for example, information obligations) under the FinSA, the SBA ESG Guidelines, or the AMAS ESG Guidelines, unless the distributor is subject to the SBA ESG Guidelines and provides ‘point of sale’ investment advice or portfolio management services under the FinSA. Introducing such obligations for the acquisition or disposal of financial instruments would require an amendment to the FinSA.
3.2 AMAS ESG Guidelines
On September 26 2022, AMAS introduced an ESG self-regulation framework for asset managers and producers of sustainability-related collective investments. The AMAS ESG Guidelines intend to govern the institutional level and fund level exclusively, excluding point-of-sale requirements, and lay out guidelines for reporting, management processes, and advertising based on a principle-based approach. The AMAS ESG Guidelines will largely enter into effect on September 30 2023.
The AMAS ESG Guidelines apply to fund management companies, sociétés d'investissement à capital variable (SICAVs), Swiss limited partnerships, sociétés d'Investissement à capital fixe (SICAFs), asset managers (de minimis or not), and other financial institutions, such as banks or securities firms, that manage collective investment vehicles defined as sustainability-related ‘collective assets’ (for example, funds and pension funds) in Switzerland.
Given that the portfolio management of collective assets constitutes a regulated activity in Switzerland, requiring a licence as an asset manager of collective assets, the AMAS ESG Guidelines de facto apply only to institutions already prudentially regulated in Switzerland under the Swiss financial markets legislation. They also apply to producers of Swiss sustainability-related collective assets narrowly defined as fund management companies, SICAVs, Swiss limited partnerships, and SICAFs (Article 4).
A collective asset is deemed to be sustainability-related if it is managed, designated, or positioned with reference to ESG aspects. The sustainability-related concept might also include funds not designated or positioned by the issuer as sustainable but advertised as such, for example, by distributors. Interestingly, in line with the Swiss government’s stated policy, following an ESG approach by a simple exclusion only of certain assets is, as such, not sufficient to classify the approach as ‘sustainability-related’ or the product to be in line with the AMAS ESG Guidelines (Article 17, paragraph 4).
The AMAS ESG Guidelines apply exclusively to administration (i.e., management), investment management, and production with respect to collective assets (Article 5). They do not cover other financial services or the offer of financial instruments as defined under FinSA. Therefore, investment advice mandates, custody, or other types of mandates do not fall within the scope of the AMAS ESG Guidelines.
3.2.2 Substituted compliance
The AMAS ESG Guidelines provide that the application of comparable foreign standards will be sufficient to comply with the AMAS ESG Guidelines (Article 9). The EU regulations for the purpose of such substituted compliance are expressly recognised, without excluding the recognition of other foreign regulations, a number of which AMAS is expected to recognise as comparable to the AMAS ESG Guidelines within the coming months.
The recognition of the possibility to apply foreign standards is of high importance given the rather comprehensive European sustainability framework that may apply to Swiss asset managers, at least indirectly, and to Swiss products that could be marketed in the EU (subject to the rules of each member state). It is also possible to apply the principles set forth in the AMAS ESG Guidelines to a certain portion of the collective assets while applying foreign comparable standards to another portion of the assets.
In addition to substituted compliance, the AMAS ESG Guidelines also allow financial institutions to comply with other relevant Swiss self-regulation standards (such as the standards for the pension funds industry that are soon to be published by ASIP) in lieu of the AMAS ESG Guidelines. This ‘alternative compliance’ allows asset managers to comply in a commercially flexible manner with the standard chosen by their clients. If the client does not select any other standard, the AMAS ESG Guidelines apply by default.
3.3.3 Key obligations
22.214.171.124 Principles applicable to asset managers
Asset managers must ensure that they have the necessary infrastructure, sufficiently qualified resources (for example, expertise in sustainability at board, executive management, and operational levels), and organisational capabilities to implement the sustainability requirements set out in the investment policy or strategy. Processes relating to governance, reporting, investment, and risk management must be duly formalised (Articles 11 to 13).
In the case of delegation or sub-delegation of investment management, the asset manager must ensure that the respective delegation agreement considers the sustainability requirements (Article 14). The rules on delegation in the AMAS ESG Guidelines and the content of the relevant delegation agreements (for example, allocation of competences, reporting, and control rights) are aligned with the delegation requirements under FinIA.
The AMAS ESG Guidelines contain specific rules regarding the design of the investment policy and the use of sustainability data and metrics. In particular, the minimum proportion of investments that must meet the stated sustainability requirements is to be determined in the investment management agreement (or in another document referred to in such agreement). The sustainability metrics relevant to the implementation of the investment strategy must be comprehensible and recorded in a verifiable manner (Article 15).
If sustainability research, data, or analysis tools from third-party providers are used, the asset manager shall review the third-party provider’s organisation, the scope of data, and other key aspects that are decisive for the investment process. The identity of the third-party providers must only be disclosed in the investment management agreement (or in another document referred to in such agreement), but not necessarily in documents available to end-investors or the public, unless the product is a sustainability-related Swiss fund, in which case the fund management company must disclose the data sources in the prospectus or other fund documents (Article 16).
When advertising sustainability-related funds, the asset manager must ensure that the advertising is consistent with the fund’s legal documents (Article 20).
The AMAS ESG Guidelines also set out reporting requirements. Asset managers (or a third party) must inform investors annually by means of a sustainability report (for example, as part of the regular reporting or by publication on the homepage). The report shall include the relevant sustainability approaches used, describe the approaches, and compare the most important ratings, metrics, or other benchmarks. In the case of impact strategies, the report shall indicate the extent to which the fund has achieved the stated sustainability objectives (Article 21).
126.96.36.199 Principles applicable to producers of collective investments
The management of the producers of collective investments (‘Producers’) must have basic knowledge of sustainability as well as expertise regarding the main features of the sustainability strategy applicable to their collective investment schemes. Producers must ensure that the responsible employees have sufficient expertise so that they are able to fulfil the requirements for sustainability-related collective investments. In the case of external asset management, lower expertise requirements may apply (Article 23).
Regarding the delegation or sub-delegation of investment management (Article 24), the design of the investment policy and the use of sustainability data and metrics (Article 25), and advertising (Article 28), the above remarks on asset managers apply mutatis mutandis. Producers are generally subject to the above-mentioned reporting requirements but may obtain periodic confirmation from the external asset manager that the investors are provided with reporting that complies with these requirements (Article 29).
So far, the path chosen by the Swiss regulator to promote sustainable finance has clearly been one of self-regulation. The SBA and AMAS ESG Guidelines reflect the Swiss financial industry's commitment to meet the highest international standards on ESG.
In the present regulatory environment, FINMA cannot recognise the SBA and AMAS ESG Guidelines as a minimum standard due to a lack of legal basis.
It remains to be seen whether these initiatives will eventually become a minimum standard for the industry, recognised by FINMA, or whether Swiss authorities will choose the legislative path. Recent statements by FINMA's CEO, Urban Angehrn, suggest the latter, as he mentioned that a legal framework is needed that applies to all sectors of the financial industry and is enforceable under supervisory law.