Homburger partner Jürg Frick explains how Swiss regulators are working to strengthen the country’s competitiveness as a fund centre
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|To strengthen its competitiveness as a fund centre, Switzerland intends to create a new, unregulated fund category reserved exclusively for qualified investors, the so-called Limited Qualified Investor Fund (L-QIF). Consultation of the draft bill has been initiated and the fund category may be enacted as early as 2021. The benefit of the L-QIF is that it does not need to be approved by the Swiss regulator and, therefore, can be established and offered on the market in a much swifter and cheaper way.|
On June 26 2019, the Swiss Federal Council initiated the consultation on an amendment of the Swiss Federal Collective Investment Schemes Act (CISA). The initiative is intended to create a new, unregulated fund category reserved exclusively for qualified investors. The consultation of the draft bill will last until October 17 2019.
The new fund category, a so-called Limited Qualified Investor Fund (L-QIF), is neither authorised nor approved nor supervised by the Swiss Financial Market Supervisory Authority (FINMA). The Swiss Federal Council is responding to a long-standing concern of the Swiss financial sector, which is that setting up a Swiss fund for alternative investments, exclusively open to qualified or sophisticated investors, is cumbersome and takes too long. .
The fact that an L-QIF is reserved for qualified investors, such as regulated financial intermediaries or pension funds, sufficiently recognises investor protection. Moreover, such investors can already invest in unsupervised foreign fund structures. An L-QIF must be managed by an institution supervised by FINMA. This institution risks supervisory measures or sanctions if it seriously breaches its obligations.
Since an L-QIF requires neither authorisation nor approval, it can be established and offered on the market more swiftly and cheaply than other funds. Liberal yet transparent investment rules also promote innovative and flexible products. The new fund category will offer a Swiss alternative to similar foreign fund products and ensure that more collective investment schemes are launched in Switzerland in the future.
The Swiss market for collective investment schemes or funds is an important element of the country's financial industry, however, it is primarily used for asset management and fund distribution. Switzerland is, however, less important as home jurisdiction for funds or collective investment schemes. Most of the funds managed out of Switzerland, or distributed to investors in the country, are those established externally, be it in Luxembourg or off-shore jurisdictions such as Jersey or Guernsey. Assets under management of Swiss funds total around €900 billion, whereas assets under management of Luxembourg funds stand at some €4 trillion. This is mainly due to both the restricted, limited access of Swiss funds to the European market and the Swiss withholding tax regime.
In combination with the very liberal investment regulation...a new category of funds can be established in Switzerland
Furthermore, the legal and regulatory framework, particularly in the area of alternative or innovative fund products is often more attractive in foreign jurisdictions than in Switzerland. For instance in recent years many jurisdictions outside Switzerland introduced fund structures which do not need to be approved by a regulator. These fund products include, for instance, the Reserved Alternative Investment Fund (RAIF) in Luxembourg, or the Notified Alternative Investment Fund (AIF) in Malta.
Since these structures do not need regulatory approval, they can be set up quickly and marketed to potential investors without undue delay. Furthermore, they are far more flexible in terms of investment products and techniques, strategies or risk diversification and so are particularly suitable and appropriate for alternative investments and innovative strategies.
In accordance with fund regulation in Switzerland, all Swiss collective investment schemes structures must be approved by FINMA or, with regard to contractual fund structures, the fund management company (Fondsleitungsgesellschaft) at least needs a FINMA license. Furthermore, asset managers of collective investment schemes, both depositories and fund distributors, also require a FINMA license. Swiss fund regulation does not foresee any exemptions from these approval or licensing requirements.
By introducing the L-QIF in Switzerland, this strict regime will be alleviated, improving the competitiveness of the Swiss fund market. The goal is that a more substantial portion of the fund value chain can be both kept and maintained in Switzerland. However, it is important to remember that a new Swiss fund structure does not solve the remaining Swiss tax impediments.
Key elements of L-QIF
Legal entity forms
The L-QIF, strictly speaking, will not be a new type of legal entity. An L-QIF can be established in one of the following legal structure forms already provided for by CISA: (i) contractual fund (vertraglicher Anlagefonds), (ii) SICAV, (iii) limited liability partnership (Kommanditgesellschaft für kollektive Kapitalanlagen, KmGK), or (iv) SICAF. If one of these collective investment scheme forms is established as an L-QIF then, firstly, it would only be allowed to accept qualified investors and, secondly, it would have to be run by a fund management company or a fund asset management company licensed by FINMA. If this is the case, then the fund as such could be qualified as L-QIF and would not need FINMA approval.
The CISA provision that applies to one of the four collective investment schemes structures will coremain in force, with a few exemptions,, such as the investment regulations being more liberal. There will still be restrictions on possible investments and risk diversification.
For transparency reasons, the company or fund name of an L-QIF needs to contain the addition 'Limited Qualified Investor Fund'.
Investor protection is maintained by restricting access to L-QIF to qualified investors only. These should be either sufficiently sophisticated themselves or, if not, then at least be professionally advised and, furthermore, their financial situation should be such that they could sustain a possible loss. Furthermore, in practice, it is expected that those investing in an L-QIF carry out a due diligence first before investing in a fund, that they may be involved in the negotiation or determination of the fund terms, and that they monitor and supervise the fund and its performance thoroughly.
In the following paragraphs, we will briefly discuss the term "qualified investor" in the sense of CISA. Since the L-QIF will not be through the legislative process in Switzerland before the new Swiss Federal Financial Services Act (FINSA) is in force we will review the term against the background of this new law, expected to be in place January 1, 2020.
FINSA will introduce a new client categorisation, including three different categories: retail, professional and institutional. CISA, however, will not incorporate this client segmentation and instead will keep its own terminology, with a dichotomy between "qualified investors" as defined in article 10 CISA and "non-qualified investors". That said, the client segmentation pursuant to FINSA nevertheless plays a role for CISA because as of January 1 2020 CISA will no longer contain its own list of qualified investors but instead, in article 10, paragraph 3, CISA will state that "qualified investors" are professional clients as defined by FINSA.
An L-QIF that needs neither approval nor licensing by FINMA can be launched directly and swiftly
Professional clients pursuant to FINSA include:
(i) Swiss financial intermediaries as defined in the Swiss Federal Banking Act, in the Swiss Federal Financial Institutions Act (FINIA), also supposed to enter into force on January 1 2020, and by CISA, banks, securities dealers, fund management companies or asset managers of collective investment schemes;
(ii) Swiss insurance companies pursuant to the Swiss Federal Insurance Act (ISA);
(iii) foreign institutions that are subject to a prudential supervision in their home jurisdiction, which is equivalent to the one applied by FINMA to Swiss financial intermediaries and Swiss insurance companies mentioned before;
(iv) central banks,
(v) public entities,
(vi) pension funds and other institutions whose purpose is to serve occupational pensions;
(vii) companies with their own professional treasury operations (professional treasury services are given when at least one competent person with experience in the financial sector is mainly responsible to manage on a regular basis the financial assets of the relevant entity);
(viii) large companies: those that exceed at least two of the following parameters, first, a total balance sheet of CHF 20 million, second, turnover of CHF 40 million, and, third, equity of CHF 2 million; and
(ix) private investment structures with professional treasury operations set up for high-net worth individuals.
Furthermore, high-net worth individuals themselves and private investment structures set up for them (but which do not have professional treasury operations) may declare in writing that they wish to be treated as professional clients within the meaning of FINSA, so-called "opting-out".
Finally, retail clients, under certain conditions, may also be considered to be qualified investors in the sense of CISA. This is on the condition that they have appointed a financial intermediary, such as asset manager pursuant to FINIA, or a foreign financial intermediary subject to equivalent prudential supervision that provides portfolio management or investment advice services to such retail clients within the scope of permanent portfolio management or investment advice relationship. Another condition is that a retail client has not declared in writing that they do not wish to be treated as qualified investors, so-called "opting-in". Any other investors is deemed to be a non-qualified investor in the sense of CISA.
It is envisaged that the L-QIF can be set up as single-investor fund; however, the delegation of investment decision back to the investor will be excluded, except in cases where the single investor itself is licensed by FINMA as a fund management company.
Management of L-QIF
The lack of approval or licensing requirement will be compensated for by restrictions applicable to the management of L-QIF, which needs to be undertaken specifically by FINMA-licensed financial institutions. FINMA ensures that these institutions dispose over an adequate organisation and have the knowledge and experience required to manage an L-QIF. This means, for instance, that if in future a contractual fund is established as an L-QIF, then it would not need to be approved by FINMA. However, the respective fund management company would still need to be FINMA-licensed.
With regard to SICAV, limited liability partnerships and SICAF, the regime is different. Here the requirement is that investment management shall be delegated to a FINMA-licensed fund management company. An exception is for limited liability partnership, provided the general partner is a FINMA-licensed bank or insurance company.
In effect this means that an L-QIF is not subject to direct FINMA supervision, however, the company managing the L-QIF will continue to be subject to FINMA supervision.
If the management of the L-QIF is not assumed by licensed institutions to be in accordance with the new law, criminal sanctions, among others, could be imposed.
If an L-QIF established as contractual funds, SICAF or SICAV still need to appoint a depositary bank. This bank will also be subject to FINMA supervision and such a bank will assume important control functions.
The investment guidelines or regulations are more liberal. The funds can either be open-end funds or closed-end funds. There are also no regulatory requirements as to investment possibilities or risk diversification. In particular, an L-QIF can invest in traditional asset classes such as securities, fund units, or money market instruments as alternative or more exotic investment classes, such as commodities, infrastructure projects, real estate, luxury goods, wine, art, classic cars, etc.
Alternative investments include those in any assets that are illiquid, for which no regular market demand exists, which are volatile or hardly diversifiable, and their value is difficult to determine. In any case, the respective investment strategy must be disclosed in the fund documents.
Even though the investment guidelines are liberal, the L-QIF or the respective fund management company is required to ensure sufficient liquidity in line with risk diversification principles, investor expectations as well as redemption rights. This requirement is explicitly stated in the new law, however, this only reproduces established practice and is based on international standards such as the Policy Recommendations to Address Structural Vulnerabilities form Asset Management Activities of the Financial Stability Board (FSB) or the Recommendations for Liquidity Risk Management for Collective Investment Schemes of Iosco. To achieve these liquidity goals different means may be used: if an L-QIF primarily invests in long-term and illiquid assets then the liquidity concern can be addressed by restricting redemption rights, only allowing them in certain intervals or up to certain threshold amounts.
There is no need to comply with risk diversification obligations, which means that an L-QIF could invest up to 100% of its funds in one single issuer or company.
The financial indebtedness of an L-QIF incurred to achieve a certain leverage on the return on investment will be regulated. The Federal Council will be entitled to issue an ordinance further outlining certain permissible investment techniques and investment restrictions.
Documentation and prospectus
Corporate documents, marketing material related to the L-QIF or other documents necessary for the establishment or the L-QIF do not need to be reviewed or approved by FINMA. Furthermore, for the distribution or offering of an L-QIF no prospectus needs to be prepared. However, on the first page of any marketing material and in connection with each marketing activity the fund needs to be clearly labelled as "L-QIF" and it needs to be clearly stated that the L-QIF is neither licensed or approved nor supervised by FINMA.
Notification to Federal Department of Finance
The institution responsible for the management of an L-QIF needs to notify the Federal Department of Finance (Eidgenössisches Finanzdepartement, EFD) of the establishment and termination of an L-QIF. The notification of a termination needs to be made within two weeks of it being ended. The EFD keeps a publicly available register of all L-QIF and their management companies.
Anti-money laundering regulation
L-QIF are exempt from the scope of application of Swiss anti-money laundering regulation, provided the entity managing the L-QIF itself qualifies as a financial intermediary in the sense of these regulations and, therefore, has become a member of a Swiss self-regulatory organisation and complies with applicable anti-money laundering duties of care.
The consultation period for the draft bill ends on October 17 2019. The revised draft and the related dispatch (Botschaft) of the Swiss Federal Council is expected to be published in Q1, 2020, with the earliest date for enactment of the new law on June 1 2021.
An L-QIF that needs neither approval nor licensing by FINMA can be launched directly and swiftly. For the sake of investor protection, it remains a prerequisite that the L-QIF is properly labelled and the related risks are adequately disclosed, that investors in an L-QIF are exclusively qualified investors and that the company managing the fund is licensed by and subject to FINMA supervision. In combination with the very liberal investment regulation, which allows investments in different kinds of alternative asset classes or undiversified investments, a new category of funds can be established in Switzerland, which was not possible earlier.
This initiative by the Swiss Federal Council is welcome because it strengthens the attractiveness of the Swiss financial market and, in particular, its fund market. It also reduces entry barriers and improves competition.
If it is possible later to remedy certain Swiss withholding tax issues – and if the EU grants Swiss funds liberal access to the European market, then the potential of the L-QIF could be significant.
|About the author|
Jürg Frick is a partner in Homburger's Zurich office. He specialises in banking and finance, fund regulation, restructuring and real estate. His clients include Swiss and foreign banks, securities dealers, asset managers and listed companies, as well as private equity and hedge funds. He regularly advises on syndicated bank financings, bond offerings, fund structuring and fund distributions, venture capital investments, leveraged buyout transactions, restructurings and insolvency proceedings.