Cross-border distribution of funds to investors in Switzerland continues to be subject to debate and, unfortunately, uncertainty. Even though for the time being, it remains unclear whether every fund offering automatically qualifies as a financial service under Swiss law or not, the latest decision of the Swiss Parliament to introduce alleviations to the strict requirement for financial service providers to be affiliated with an ombudsman (the Ombudsman) shows a tendency into the right direction, which is to avoid unnecessary overregulation.
The aim of this article is to address the following two questions: first, is a cross-border fund offering in any case a financial service in the sense of the new Swiss Financial Services Act (FinSA), and, second, should this be the case, what Swiss law regulatory requirements would such an offering have to comply with.
For the purpose of this article, there is a focus on fund offerings to professional or institutional clients in Switzerland and offerings to retail clients will not be considered.
Is a cross-border fund offering a financial service?
Genesis of Swiss fund offering regulation
Until the end of last year, a party distributing foreign funds to qualified investors in Switzerland had to be adequately supervised either in Switzerland or in its home-jurisdiction. Therefore, the Swiss Collective Investment Schemes Act (CISA) required that distributors in Switzerland needed to be licensed by the Swiss Financial Market Supervisory Authority (FINMA).
It was questioned as of the introduction of this licensing requirement for distributors under the old Swiss Federal Fund Act whether it made sense and whether for investor protection purposes it was in fact needed at all.
In 2003, the Swiss Federal Banking Commission (FBC), the Swiss financial market regulatory authority preceding FINMA, explained that it did not see a need to regulate distributors and considered a licensing requirement for fund distributors as an overregulation because already the fund, the custodian and the asset manager were all subject to approval or licensing requirements and supervision. Furthermore, FBC noticed that fund distribution was sufficiently regulated since fund distributors were already obliged to comply with the guidelines on fund distribution issued by the Swiss Funds & Asset Management Association (SFAMA).
In 2006, when the Swiss Parliament debated the replacement of the old Swiss Federal Fund Act with the Swiss Federal Collective Investment Schemes Act, the discussion came up again. The Swiss National Council (Nationalrat) supported the licensing requirement for fund distributors, whereas the Swiss Council of States (Ständerat) was opposed. Only in a formalised proceeding to settle this disagreement, did the Swiss Council of States give in and agree to the licensing requirement.
Swiss fund offering regulation under FinSA
Fund offering as a financial service?
Since the regulation of fund distribution in Switzerland was always subject to debate and since the rationale of such regulation was always questioned, it is not surprising that with the enactment of FinSA, the Swiss Parliament decided to abolish the licensing requirement for distributors after all. One of the key arguments was that the licensing requirement was going to be replaced by the regulation of financial services under FinSA.
On January 1 2020, FinSA entered into force. This act not only introduced rules and regulations for persons or entities rendering financial services on a commercial basis to clients in Switzerland, it also had a knock-on effect on Swiss fund and, in particular, Swiss fund distribution regulations.
FinSA provides for a definition of financial services. Financial services are activities carried out for clients such as, for instance, the purchase or sale of financial instruments, the management of financial instruments (asset management), or the issuing of personal recommendations relating to transactions in financial instruments (investment advice). As a matter of FinSA, financial instruments also include interests or units in domestic or foreign collective investment schemes.
As a general rule, financial service providers are subject to the new conduct rules set out in FinSA. In addition, they need to take certain organisational measures and, subject to certain exceptions, they are obliged to register with an Ombudsman, and to register their client advisors in a client advisor register (Beraterregister).
Against this background, it needs to be assessed whether a cross-border offering of a foreign fund to investors in Switzerland qualifies as a financial service or not. Should such an offering be combined with investment advice or investment recommendations, then, for Swiss regulatory purposes, it would clearly be in scope of financial service regulations. However, should the offer be extended to clients in Switzerland without any such recommendations, then the situation is less clear.
As a general rule, financial service providers are subject to the new conduct rules set out in FinSA
The Swiss Financial Services Ordinance (FinSO), which contains FinSA's implementing provisions, further defines the meaning of the term 'financial service', including, in particular, in relation to the "the purchase or sale of financial instruments". According to FinSO, a financial service relating to the purchase or sale of financial instruments includes "any activity directly aimed at certain clients and specifically aimed at the purchase or sale of a financial instrument".
The Federal Department of Finance commented on this provision as follows:
"This provision specifies the type of financial service described in Article 3(c)(1) of FinSA, i.e. the purchase or sale of financial instruments for a client. Pursuant to the meaning and purpose of this provision, it particularly also includes activities vis-à-vis a particular client which are identifiable and specifically aimed at the acquisition or sale of a financial instrument prior to the formal acquisition or sale of financial instruments, but for transaction-related advice has not yet been provided. The clarification of the concept of this type of financial service makes it clear that market participants – in particular, for example, when marketing foreign collective investment schemes through sales representatives in Switzerland at so-called road shows – must, as is already the case today and in accordance with the intentions of the law (cf. Message [BBl 2015 8901, p. 8953, 9008 and 9050] on Art. 9 para. 2 FinSA and on Art. 3 and in particular Art. 13 CISA), comply with duties of conduct and register with the client advisor register. […] Finally, no financial service can be provided if financial instruments are purchased or sold between financial intermediaries, e.g., fund units are offered or sold to a bank which the bank clearly does not want to hold for its own account but which the bank intends to resell to (as yet unidentified) customers of the bank. The law aims to protect the end customer and not the financial service provider under prudential supervision".
Fund offerings as arm's-length counterparty transactions
The Federal Department of Finance also explained:
"It also becomes evident that an offer as such cannot be a financial service. For the additional qualification as financial service, other elements need to be given such as, for instance, rending of investment advice related to the respective financial instrument."
Accordingly, cross-border fund offerings to investors in Switzerland should not qualify as financial services if, first, the addressee of the offer is a financial intermediary and not the end-client, or, second, if an activity directly aimed at certain clients and specifically aimed at the purchase or sale of a financial instrument is not an activity carried out "for a client".
In its definition of the term 'financial service', FinSA lists certain activities qualifying as financial service if carried out "for a client". The definition implies that the financial service provider and the party for which the service is provided are in a client relationship. Such a client relationship could be a mandate or another principal-agent-relationship pursuant to which the service provider is mandated or authorised by the client to carry out certain activities on behalf of the client.
However, in case of a cross-border fund offering, an offer could well be extended to an investor who is independent from the fund as well as the fund distributor and who is not in a pre-existing client relationship with neither the fund nor the distributor. Should such an offer be devised and presented on arm's-length terms as an offer made between independent counterparties, and should this be clear and evident to both parties, then such an offer should not qualify as a financial service rendered for a client and, therefore, should also not trigger respective obligations under FinSA. As a minimum, such an offer should not be qualified as a financial service if extended to a professional or institutional client and if it was clearly described and presented as an arm's-length counterparty offer.
This view is supported by other authors in the Swiss market who concur and explain that "it should be noted that even in cases of direct contractual relationship, a client in terms of FinSA does not necessarily have to be involved. Especially in the area of the purchase or sale of financial instruments, an actual counterparty transaction may exist instead of a customer relationship. In such a counterparty transaction, the foreign financial service provider recognisably pursues its own interests and carries out the transaction for its own account and risk. Such counterparty transactions are also not financial services within the meaning of FinSA, because these services are not currently being provided for a client." (See Schleiffer|Schärli, Cross-border Provision of Financial Services, GesKR 2020, 24 et seq., p. 27).
Not every cross-border offering of a fund to professional or institutional clients in Switzerland should be qualified as a financial service in the eyes of FinSA
A question comparable to the distinction between financial services and counterparty transactions already arose under the old Swiss Federal Securities Dealer and Stock Exchange Act (SESTA). The rules of conduct set out therein were generally applicable to all securities trading transactions with clients, irrespective of their classification under private law. The distinction between customer transactions and market transactions largely reflected the distinction between the scope of application of the law on orders and that of the law on sales, insofar as the service aspect, which is at the heart of customer transactions, is missing from the sales transaction.
FINMA's predecessor authority, the Swiss Federal Banking Commission, declared that in case of doubt, a mandate or commission relationship rather than a purchase relationship should be assumed:
"It should be noted that in securities trading with clients, the order or commission business is the rule. A purchase relationship between a securities dealer and an end client can only be assumed to exist if elements of the origination of the contract make this particularly clear. It must be obvious to the client at all times that the securities dealer is acting in his own interest and therefore should not provide a service to the client."
It can be assumed that the practice of the former Swiss Federal Banking Commission, according to which a mandate or commission relationship must be assumed as a rule of thumb for private clients, must continue to be taken into account. Therefore, it makes sense from the point of view of the financial services provider to draw the attention of clients or counterparties to the different regulatory treatment of client orders and counterparty transactions. In addition, no brokerage or other commission fee should be paid. Business experience and specialist knowledge of the counterparty should also be considered and be relevant.
In sum, we would conclude that cross-border offerings of funds to professional or institutional clients in Switzerland should not be qualified as a financial services if:
- An offer has been devised and presented on arm's-length terms as an offer made between independent counterparties; and
- It is at all times obvious to the client or, for these purposes, the investor that the distributor or the party extending the offer is acting in its own interest and therefore will not provide a service to the investor.
Regulatory requirements if a cross-border fund offering qualifies as a financial service
Should a cross-border offering of funds to professional or institutional clients nevertheless qualify as a financial service in the sense of FinSA, then, in principle, the distributor of the fund or the party extending the offer would have to comply with the conduct rules under FinSA, In addition, it would have to take certain organisational measures and, subject to certain exceptions, it would be obliged to register with an Ombudsman and to register their client advisors in a client advisor register (Beraterregister).
Registration of client advisors with client advisor register (Beraterregister)
Pursuant to Article 28, para. 1 FinSA, client advisors of foreign financial service providers may carry out their activity in Switzerland only if they are entered in a register of client advisors. However, client adviser of foreign financial service providers which are prudentially supervised abroad are exempted from the duty to register if the services they provide in Switzerland are exclusively for professional or institutional clients.
Therefore, should a foreign distributor offering funds on a cross-border basis in Switzerland exclusively to professional or institutional clients prudentially supervised in its home-jurisdiction, then it would not have to register client advisers active in Switzerland in a client adviser register.
Affiliation with Ombudsman
After the enactment of FinSA at the beginning of this year, it was unclear whether the exceptions to the obligation to register client advisers in a client adviser register would also apply to the obligation to be affiliated with an Ombudsman. In principle, and as it stands today, FinSA requires all financial service providers to be affiliated with an Ombudsman. Such affiliation should be completed by the end of the transitional period ending on December 25 2020.
Since such an absolute obligation was unsatisfactory, the Swiss Parliament decided to alleviate the Ombudsman affiliation requirement. Henceforth, it should only apply to financial service providers that serve retail clients, and it should not apply to financial service providers serving solely professional or institutional clients. By professional clients, it seems, that only such professional clients should be meant which qualify as such without having to opt to be treated as professional clients, i.e. the exception should only apply to so-called per se professional clients.
These are, among, others, financial institutions licensed by FINMA, such as: banks; fund management companies; asset managers or insurance companies or foreign financial institutions being subject to prudential supervision; central banks; public entities with professional treasury operations; occupational pension funds with professional treasury operations; companies with professional treasury operations; certain large companies as well as private investment structures with professional treasury operations created for high-net-worth retail clients. However, high-net-worth retail clients or private investment structures without professional treasury operations would be allowed to declare that they wish to be treated as professional clients (opting-out), but they would still not be considered to be per se professional clients.
Even though the alleviation of the requirement to be affiliated with an Ombudsman would only be relevant for financial service providers serving per se professional clients or institutional clients, it is still very much a step in the right direction. It is a clear and important signal that the Swiss Parliament wants to avoid overregulation, including overregulation of cross-border fund offerings to per se professional clients and institutional clients in Switzerland.
Since the transitional period to get affiliated with an Ombudsman expires on December 25 2020, and since the alleviation of the requirement to be affiliated with an Ombudsman for financial service providers exclusively serving per se professional clients or institutional clients in Switzerland will only be enacted after the referendum deadline for the respective amendment to FinSA expires on February 1 2021, FINMA agreed that it will not enforce the affiliation requirement in the period from December 26 2020 to January 31 2021. The Swiss Federal Council will only take its decision to enact the amendments to FinSA in mid-December 2020, in order to give the fund market greater planning security and to avoid that certain financial service providers would have to affiliate with an Ombudsman only to deregister again early next year. In this regard, on November 13 2020, the Federal Department of Finance communicated to the market FINMA's agreement not to enforce the Ombudsman affiliation requirement.
Not every cross-border offering of a fund to professional or institutional clients in Switzerland should be qualified as a financial service in the eyes of FinSA. In particular, an exception should be made with regard to fund offerings to professional or institutional clients (i) having been devised and presented on arm's-length terms as an offer between independent counterparties; and (ii) in relation to which it is at all times obvious to the client or, for these purposes, the investor that the distributor or the party extending the offer is acting in its own interest and therefore will not provide a service to the investor.
This view is supported not only by representative authors in the Swiss literature, it is also in line with previous published practice by FINMA or its predecessor FBC.
It becomes more and more obvious that the Swiss legislator did not intend to overregulate cross-border fund offerings to professional or institutional clients in Switzerland and exceptions are justified to the narrow-minded view that every offer at the same time is a financial service.
The latest development giving evidence of this tendency are the alleviations of the strict requirement for financial service providers to get affiliated with an Ombudsman and FINMA's agreement not to enforce this strict requirement for as long as the alleviation has not been enacted. This tendency can be welcomed because should cross-border fund offerings to professional or institutional clients in Switzerland in any case qualify as financial service, then at least the regulatory consequences should not be too burdensome.
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.