Supervision of Portfolio Managers and Trustees

Under current Swiss law, portfolio managers, which are not acting as asset managers for collective investment schemes, and trustees are not subject to a comprehensive prudential supervision. Portfolio managers and trustees are only required to register with a self-regulatory organization in order to comply with Swiss anti-money laundering laws. Other financial services providers, most notably banks, have criticized this lack of regulatory oversight. Furthermore, the current Swiss regulatory framework for portfolio managers is not in line with international regulatory standards, such as the EU/EEA’s Markets in Financial Instruments Directive (MiFID). This situation is about to significantly change under the proposed new Financial Institutions Act (FinIA). This new act will subject the approximately 2,300 portfolio managers to authorization requirements and comprehensive supervision by a FINMA-approved supervisory organization.

By Patrick Schleiffer / Patrick Schärli (Reference: CapLaw-2016-8)

1) Proposed New Supervisory Framework

Under the FinIA, portfolio managers and trustees will be required to obtain an authorization from a supervisory organization approved by the Swiss Financial Market Supervisory Authority (FINMA). Like other financial institutions, a portfolio manager or a trustee will have to meet a number of authorization requirements, such as organizational requirements and the guarantee of irreproachable business conduct. The authorization requirements also extend to qualified participants in a portfolio manager or trustee. A qualified participant is a person who directly or indirectly holds at least ten percent of the share capital or votes or who can significantly influence the portfolio manager’s or trustee’s business activities in another manner. Qualified participants will have to show that they have a good reputation and that their influence is not detrimental to prudent and sound business activity of the portfolio manager or trustee.

Once licensed, a portfolio manager or a trustee may also provide certain additional services, such as investment advice, portfolio analysis, and offering of financial instruments. Portfolio managers and trustees will be, like any other financial service provider, subject to the conduct rules of the new Financial Services Act (FinSA).

a) Scope of the New Rules

The new regulatory framework applies to portfolio managers and trustees, both of which are not subject to prudential supervision under the current regulatory rules. A portfolio manager is an individual or entity that manages assets on a commercial basis in the name of and on behalf of clients or who may dispose of clients’ assets in any other manner. A trustee is defined as an individual or entity that on a commercial basis manages or disposes of a separate fund for the benefit of a beneficiary or for a specified purpose based on a restricted grant given namely in the instrument creating a trust within the meaning of the Hague Trust Convention of 1985.

Individuals or entities who manage assets on a commercial basis in the name and on behalf of collective investment schemes and pension plans are required to obtain a license as a manager of collective assets, and they are subject to direct FINMA supervision. The FinIA will incorporate the already existing authorization and supervision requirements of the Collective Investment Schemes Act (CISA). The FinIA will also include the existing de minimis rules of the CISA. Managers of collective assets that fall under the de minimis rules, will be required to obtain a license as a portfolio manager.

Persons who solely manage assets of persons with whom they have business or family ties are outside of the scope of the FinIA. Most importantly, this excludes single family offices from the new license requirements.

Finally, the FinIA, as currently drafted, provides for a grandfathering rule for certain portfolio managers: Portfolio managers who already are in the business for at least 15 years are not required to obtain an authorization, provided, however, that they do not accept new clients. Thus, the scope of this grandfathering rule is rather limited, and essentially, will only be available in a run-off scenario.

b) Examination of Portfolio Managers and Trustee

Portfolio managers and trustees will be supervised by a FINMA-approved supervisory organization. As part of this new supervisory framework, portfolio managers and trustees will be subject to periodic examinations. Portfolio managers and trustees will not be directly examined by the supervisory organization. Rather, the examination procedure follows the dualistic approach that already exists in other areas of Swiss financial institutions regulation. Under this dualistic supervisory model, portfolio managers and trustees will have to appoint a special licensed audit firm to perform an annual audit.

As with regards to periodic examination of financial institutions, the FinIA proposes a new feature, namely a risk-based audit frequency. Specifically, the supervisory organization may increase the audit frequency to a maximum of four years, taking into account the portfolio manager’s or trustee’s business and associated risks. In years without periodic examination, portfolio managers and trustees will have furnish to the supervisory organization a (standardized) report on their business activities and compliance with regulatory rules and regulations.

c) Transitional Period

Portfolio managers and trustees that will be subject to the new authorization requirement of the FinIA will have to report to one of the new supervisory organizations within six months of the entry into force of the FinIA. They must meet the authorization requirements and submit an application for authorization within two years of the entry into force of the FinIA. These deadlines may be extended by the competent supervisory organization.

2) The Supervisory Organization

a) Organizational Requirements

As mentioned above, portfolio managers, trustees, and managers of collective assets that fall under the de minimis rules of the FinIA, will be licensed and supervised by so-called supervisory organizations. The FinIA will amend the existing Financial Markets Supervisory Act (FINMASA) to include rules relating to the supervisory organizations and their powers.

The amended FINMASA sets out the authorization requirements for supervisory organizations. According to the proposed new rules, a supervisory must effectively be managed from Switzerland, it must have appropriate management rules, and it must be organized in such a manner that it can fulfill its duties under the FINMASA. This includes having sufficient financial and personnel resources to perform its tasks.

In addition, the supervisory organization and the persons responsible for its management must provide the guarantee of irreproachable business conduct. The persons responsible for administration and management must enjoy a good reputation and have the specialist qualifications required for their functions. In addition, the FINMASA sets out certain independence requirements. More specifically, most of the persons charged with administration must be independent of the supervised persons and entities, and the members of the management board must be independent of the persons and entities supervised by the supervisory organization. The same applies to persons charged with supervision.

b) Multiple Supervisory Organizations

It is possible that multiple supervisory organizations will be established, and the relevant provisions of the amended FINMASA explicitly acknowledge this possibility. Moreover, the amended FINMASA specifically addresses a situation where there are multiple supervisory organizations: In this case, the Swiss Federal Government may enact rules for the coordination of the organizations’ activities and the subjection of the supervised persons and entities to a given supervisory organization. It is not yet clear, pursuant to which criteria the activities of multiple supervisory organization will be coordinated. We take the view that primarily the market should determine the number of supervisory organizations and their field of activities. Coordination rules should only be implemented to prevent regulatory arbitrage.

The already existing industry organizations for independent asset managers are the likely candidates for becoming a supervisory organization of portfolio managers. Already today, these industry organizations implement rules and procedures for the supervision of their members (e.g. through their FINMA-recognized minimum standards for asset management services). It is to be expected that some or even all of these industry organizations will try to obtain an authorization as a supervisory organization. In light of the authorization requirements, it is however not likely that every industry organizations will be successful in obtaining an authorization as a supervisory organization.

c) Funding

The supervisory organizations will be funded with fees for supervisory proceedings and services. In addition, like FINMA, the supervisory organizations will levy an annual supervision charge on supervised persons and entities to cover their costs that are not covered by the fees. This supervisory charge will be based on the amount of assets under management, the gross earnings, and the size of the business of the supervised persons and entities.

d) Powers

The new supervisory organizations can make use of a wide array of supervisory powers and instruments. It can request information and documents from supervised entities, open supervisory proceedings, publish its supervisory rulings, prohibit persons from acting as client advisers, confiscate profits, and revoke licenses.

The supervisory organizations may also issue circulars in their field of supervision on the application of the financial markets laws. These circulars will require FINMA approval, which will be granted as long as the circulars do not lead to a conflicting supervisory practice.

e) Transitional period

The draft FinIA does not provide for transitional rules with respect to supervisory organizations. However, establishing these new supervisory organizations and obtaining the required FINMA approval will take time, even for the already existing industry organizations. To prevent a gap in supervision, the FinIA should provide for a rule that allows the existing industry organizations for independent asset managers to continue their operations for a certain period of time (or until they obtained a FINMA approval). Further, portfolio managers should continue to be members of these industry organizations until they receive an authorization from one of the new supervisory organizations.

3) Proposed Swiss Rules Compared to Foreign Jurisdictions

a) Supervision of Investment Firms under MiFID/MiFID II

Under MiFID/MiFID II, persons who provide investment services to third parties or perform investment activities on a professional basis are subject to licensing requirements under the relevant national laws. Investment services include, among other things, portfolio management and investment advice. MiFID II also sets out certain minimum requirements that investment firms have to meet in order to obtain the required license. These requirements relate to, inter alia, effective and prudent management of the investment firm (including prevention of conflicts of interests), policies, and organizational structure. Additionally, the members of the management of an investment firm must have a good reputation, possess sufficient knowledge, skills and experience and commit sufficient time to perform their function.

In addition to defining initial licensing requirements, MiFID II requires that each member state ensures that the competent authorities monitor the activities of investment firms as to assess compliance with the operating conditions of MiFID II.

b) Supervision of Investment Advisers in the United States

U.S. law does not provide for a single supervisory framework for persons and entities that engage in the business of managing assets for others. Rather, the supervisory status of asset managers, or, to use the U.S. term, investment advisers, depends on the nature and size of an investment adviser’s business. As a general rule, investment advisers with more than $100 million in assets under management are required to register with the United States Securities and Exchange Commission (SEC) pursuant to the Investment Advisers Act. Small and midsized investment advisers are generally required to register with the relevant State securities commission instead. In case an investment adviser advises on such things as commodity futures, swaps, or foreign currency transactions, a registration as a commodity investment adviser under the Commodity Exchange Act is required. Commodity investment advisers are subject to the supervision of the Commodity Futures Trading Commission (CFTC). Additional licensing may be required if the investment adviser also acts as a broker. In this case, a registration with the Financial Industry Regulatory Authority (FINRA) is required pursuant to the Securities Exchange Act.

Similar to the proposed rules of the FinIA, the Investment Advisers Act also exempts family offices from the registration requirement. Under this fairly detailed rule, single family offices may render investment advice to family members and certain former family members.

The SEC’s Office of Compliance Inspections and Examinations (OCIE) is responsible for examining investment advisers. Under the Investment Adviser Act, the OCIE conducts both periodic and special examinations. Special examinations include such things as examinations of an investment adviser based on customer complaints, and industry-wide reviews of particular compliance risk areas. The entire examination process is risk-based and takes into account, among other things, the investment adviser’s risk profile. In addition, investment advisers are required to prepare an annual report that is filed with the SEC.

4) Conclusion

The proposed new regulatory framework of the FinIA will subject portfolio managers and trustees to a set of significantly stricter authorization and supervision rules.

While the FinIA does provide for some relief for smaller businesses, most importantly the risk-based examination, higher overall regulatory costs will most likely lead to a consolidation of the asset management industry. It is to be expected that a lot of smaller businesses will wind down in light of the new regulatory requirements and associated costs. Also, the FinIA only provides for a limited grand fathering that will only be available in a run-off scenario.

The proposed rules appear to be in line with rules known in other jurisdictions, most importantly, the rules applicable in the European Union. Compatibility with European law is one of the key reasons for overhauling the current Swiss regulatory framework. Under MiFID II, market access will only be granted to those third countries that provide for an equivalent regulatory framework.

Patrick Schleiffer (
Patrick Schärli (