Four trends and developments set to shape the financial services industry in Switzerland
Sandro Fehlmann and Valérie Bayard of Advestra examine the likely impact of increasing demand for sustainable investments, the implementation of the regulatory framework for financial services and financial institutions that entered into force in 2020, the merger of Credit Suisse and UBS, and the introduction of L-QIFs.
As a global centre for private wealth management, Switzerland plays an important role in the financial services industry. The trends and developments in the financial services field in Switzerland broadly follow global trends but with a Swiss touch.
This article will consider the following four trends and developments that are likely to shape the industry in the coming years:
The demand for sustainable investments has triggered closer scrutiny by the government; the regulator, the Swiss Financial Market Supervisory Authority (FINMA); and the industry itself;
The roll-out of the Federal Act on Financial Services of June 15 2018 (FinSA) and the Federal Act on Financial Institutions of June 15 2018 (FinIA), which entered into force on January 1 2020, is reaching its conclusion and the laws are increasingly affecting the market, including through relaxed rules on offerings of foreign investment schemes to qualified investors and the new licensing requirements applicable to portfolio managers and managers of collective assets;
In connection with the merger between Credit Suisse and UBS announced on March 19 2023 and the measures taken by the Swiss government and the Swiss National Bank (SNB) to ensure financial stability during the takeover and in future, FINMA has instructed Credit Suisse to completely write down its additional tier 1 instruments (AT1 bonds); and
The market is expecting a new structure for alternative investments: the limited qualified investor fund (L-QIF), which will be limited to qualified investors but will also not be subject to licensing requirements.
ESG and greenwashing
A constant area of growth in recent years has been the market for sustainable financial products. As part of this development, the number of ESG or other sustainability-related financial products has grown significantly.
In December 2020, the Swiss Federal Council adopted concrete measures to make Switzerland more sustainable as a financial centre, with the stated goal of consolidating Switzerland’s position as a leading location for sustainable financial services, but this project has not yet led to specific legislative changes.
Therefore, the current focus on ESG and sustainability is of interest for products that take such factors into account, but also a concern for clients and investors who may be misled about the sustainable characteristics of financial products and services (‘greenwashing’).
Under Swiss law, there are no specific rules – for example, under the FinSA or the Federal Act on Collective Investment Schemes of June 23 2006 (CISA) – against greenwashing. In particular, FinSA does not include any specific duties that indicate how a client’s sustainability-specific preferences should be taken into account at the point of sale. Moreover, Switzerland has not followed the EU taxonomy system.
In response to the demand for ESG products and the risk of greenwashing, FINMA announced in its FINMA Guidance 05/2021 that it would focus its regulatory and enforcement policy on preventing greenwashing and deploy all instruments from its regulatory and supervisory toolbox to address this issue. For example, FINMA clarified the information that must be included in the documentation if Swiss funds are labelled as being sustainable.
Regarding financial service providers and foreign funds, FINMA took the view that its powers are more limited, as Swiss law does not provide for transparency requirements on sustainability at the point of sale, and that it would not act until expressly mandated by law to do so. This is a conservative position, as FINMA could have attempted to rely on the catch-all requirement of ‘fit and proper’ to address potential shortcomings by banks, insurance companies, and other supervised financial institutions.
In June 2022, the Swiss Bankers Association issued its Guidelines for the financial service providers on the integration of ESG-preferences and ESG-risks into investment advice and portfolio management, requiring all member banks to determine, as part of their suitability test, the preferences of their clients in terms of sustainability and, in an advisory relationship, offer them products that meet their expectations.
The new guidelines entered into force on January 1 2023. This instrument is binding on members of the Swiss Bankers Association but does not provide for an enforcement mechanism going beyond mandating an audit. Hence, non-compliance will not be specifically sanctioned, unless FINMA considers it as a minimum standard of self-regulation that needs to be complied with as part of the fit and proper requirement or if civil courts rely on this instrument to construe the requirements of the duty of care owed by an investment adviser or a portfolio manager under a contract of mandate.
Nevertheless, this suitability requirement, which applies only to financial service providers at the point of sale, may indirectly trigger additional demand for sustainable investments to allow financial service providers to meet the expectations of their clients.
Ongoing roll-out of the FinSA and the FinIA
The Swiss financial sector will continue to be affected by the implementation of the FinSA and the FinIA, which replaced the previous sector-specific regulations with a comprehensive framework governing financial services, regardless of the provider, and all financial institutions, with the notable exceptions of banks and insurance companies.
In this context, the new regulatory framework focuses on ‘offerings’ of financial instruments (Article 3 (g), FinSA), including collective investment schemes, rather than the broader concept of ‘distribution’ used until then, although the practical impact of this change will be limited, because Article 127a of the Ordinance on Collective Investment Schemes of November 22 2006 considers that the requirements applicable in connection with an offering are triggered by any form of advertisement for a fund.
At the same time, the new rules relax the offering of collective investment schemes by repealing the requirement to appoint a Swiss representative and payment agent for collective investment schemes that are only offered to qualified investors, with the exception of schemes offered to high-net-worth individuals who have elected to be treated as professional investors, who continue to be subject to this requirement.
Hence, fund managers and other financial service providers can forgo appointing a Swiss representative and a Swiss paying agent if they do not offer their funds to elective professionals and private clients (other than qualified investors, because they rely on the services of a portfolio manager or an investment adviser).
Similarly, the enactment of the FinIA carried an amendment to the CISA repealing a licensing requirement for distributors of collective investment schemes. In practice, this was very light once it was secured, as it did not entail any ongoing supervision by FINMA and was consequently deemed superfluous and even potentially misleading.
Instead, the new law relies on the rules of conduct under the FinSA, as well as the requirement to register client advisers and, depending on to whom financial services are provided, join an ombuds-organisation to ensure sufficient compliance by financial service providers that are not subject to supervision as financial institutions.
As a practical matter, the burden of this new rule will be carried mainly by Swiss and foreign sponsors that seek to market their funds to Swiss elective professionals or to private clients. By contrast, financial service providers focusing exclusively on per se professional clients will not be subject to the requirement to join an ombuds-organisation and may benefit from several reliefs from, and presumptions under, the rules of conduct.
Finally, the transition period for portfolio managers and trustees, who were previously only regulated for anti-money laundering purposes – including asset managers who acted on a de minimis exemption from the requirement to be licensed as a manager of collective investment schemes – to seek a licence from FINMA ended on December 31 2022. Hence, institutions which neither applied for the licence nor ceased their regulated activity are exposing themselves to administrative or criminal enforcement action.
Write-off of Credit Suisse’s AT1 bonds in connection with the merger with UBS
On March 19 2023, the Swiss government, the SNB and FINMA orchestrated, together with UBS and Credit Suisse, the emergency merger upon which UBS will absorb Credit Suisse by paying CHF 3 billion (approximately $3.3 billion) in UBS shares. Among other measures, FINMA ordered the complete write-off of Credit Suisse’s AT1 bonds in the total amount of approximately CHF 16 billion.
AT1 instruments in Switzerland are designed in such a way that they are written down or converted into equity capital before the equity capital of the bank is completely used up or written down. The conditions of the AT1 bonds at issue provide that they will be completely written down in the case of a so-called viability event; in particular, if extraordinary government support is granted.
In connection with the merger, the Federal Council agreed on liquidity measures to ensure business continuity at Credit Suisse until the takeover is complete, by enabling the SNB to provide additional liquidity assistance, which will benefit from bankruptcy privilege rights and a default guarantee by the Swiss government. The measures were adopted by way of an emergency ordinance.
In addition, the government issued a guarantee to assume potential losses arising from certain assets taken over by UBS as part of the transaction. Hence, FINMA took the position that the conditions for a write-off of the AT1 bonds have been met and, hence, ordered the full write-off of all AT1 bonds. This decision shook the AT1 investor universe – mainly institutional investors – and some have recently filed lawsuits against FINMA to challenge the write-off. It remains to be seen whether, and under which contractual basis, such claims might be successful.
The L-QIF: a new structure for investment funds
Until very recently, Switzerland had been poorly suited to setting up investment funds and, consequently, asset managers tended to prefer other jurisdictions, such as the Cayman Islands or Luxembourg, to set up funds, even if the investments were primarily designed for the Swiss market. In response to this phenomenon, the Swiss government proposed the creation of a new type of fund to reverse the trend and encourage the use of Swiss structures for domestic investors.
After a smooth parliamentary process, a bill amending the CISA to create L-QIFs passed into law on December 17 2021 and is expected to enter into force in the second half of 2023, once the implementing ordinances are finalised. The act aims to create a flexible form of collective investment scheme under Swiss law, based on the model of Luxembourg’s reserved alternative investment fund.
The L-QIF regime will allow Swiss fund management companies and, for limited partnerships for collective investments, Swiss managers of collective assets (but not self-managed investment companies with variable capital, or SICAVs) to set up a contractual fund, a SICAV or a limited partnership for collective investments, without seeking the prior approval or authorisation of FINMA, shortening the time to market, and reducing compliance costs.
As a matter of principle, investments in L-QIFs will be reserved to qualified investors, such as institutional and professional investors, as well as private clients who have entered into a long-term portfolio management or investment advisory relationship with a regulated financial institution under the FinIA or an equivalent foreign legislation. L-QIFs investing in real estate will, however, be subject to stricter requirements and will be reserved to per se professional investors under the FinSA to the exclusion of structures for high-net-worth individuals with a professional treasury.
As a further precaution to ensure appropriate supervision, L-QIFs can delegate (or sub-delegate) asset management to:
A Swiss manager of collective assets under the FinIA – portfolio managers benefiting from the de minimis exemption under Article 24 (2) of the FinIA will not be permitted; or
Foreign asset managers subject to appropriate supervision and regulated by a foreign supervisory authority which has entered into a co-operation agreement, if so required by foreign applicable law.
Consequently, FINMA will be able to supervise the L-QIF indirectly and ensure that the fund management company and the asset manager have the requisite knowledge and experience.
L-QIFs will not be required to follow specific investment guidelines or be subject to risk diversification requirements, but will be required to be transparent regarding these issues in the fund documentation (Articles 118n and 118o, CISA as amended). Accordingly, L-QIFs are not subject to restrictions for permissible investments and, therefore, allow investments in traditional asset classes such as securities, money market instruments and real estate, as well as in more exotic asset classes, such as commodities, crypto-assets and art.
Furthermore, since no risk diversification rules apply, an L-QIF may invest all its funds in a single asset or a single type of asset – provided they can be readily valued and there is sufficient liquidity for redemption.
Accordingly, the L-QIF structure will be suitable for investment funds using non-traditional investment strategies or investing in non-traditional asset classes such as real estate, private equity and private debt. It is also an appropriate structure for feeder funds investing in foreign investment schemes.
However, L-QIFs will be subject to the same limitations that are generally applicable to real estate funds; in particular, the restrictions on related-party transactions, which may make the L-QIF difficult to use for sponsors seeking to restructure a real estate portfolio.
L-QIFs are subject to the same tax treatment as other Swiss funds and, accordingly, the L-QIF will be primarily suitable for investors in Switzerland or in jurisdictions with a tax treaty. This makes them primarily of interest to Swiss institutional investors, as well as Swiss-domiciled high-net-worth individuals and clients of portfolio managers.
As a practical matter, the authors expect pension funds to be the primary investors in this asset class.