Something old, something new and some things change – FinIA Update

After a long wait in the Committee on Economic Affairs and Taxation, the Council of States, the upper chamber of the Swiss parliament, approved in its 2016 winter session the bill for a Federal Act on Financial Institutions (FinIA) as well as amendments of other statutes, such as the Federal Act on Banks and Saving Banks of 8 November 1934 and the Federal Act on the Swiss Financial Market Supervisory Authority of 22 June 2007. This approval allows this bill to move forward to the National Council, the lower chamber of the Swiss parliament.

Overall, the bill on the FinIA and its schedules, as approved by the Council of States, remains close to the draft bill presented by the Federal Council (see CapLaw-2016-7). Most changes seek to clarify the project rather than challenge fundamentally the initial proposal. Two exceptions deserve, however, further attention: first, the Council of States refused to create a framework for a new supervisory authority solely responsible for supervising portfolio managers. Instead, it opted to draw a line between day-to-day supervision, which is due to be entrusted to a new supervisory authority, who in turn can rely on the work of audit firms or carry out their own reviews, and more supervisory actions such as licensing and enforcement action, which will remain with FINMA.

By Rashid Bahar (Reference: CapLaw-2017-06)

1) Dual Supervision of Asset Managers and Trustees

The most important change to the FinIA relates to the supervision of asset managers and trustees. Instead of entrusting the supervision of asset managers and trustees to newly created supervisory organizations, the bill approved by the Council of States proposes to share supervisory powers between FINMA and supervisory organizations.

Under this model, FINMA will license and supervise asset managers and trustees (article 43b (1) draft FINMASA and article 57 (1) draft FinIA). However, asset managers and trustees will be required to join a supervisory organization which will be responsible for the day-to-day supervision (article 57 (1) and (1bis) draft FinIA). The supervisory organizations will be entitled to rely on audit firms to inspect asset managers and trustees following the dual-supervisory model applied by FINMA or carry out the inspection themselves, as some self-regulatory organizations already do in the realm of anti-money laundering regulations (article 58 (1) draft FinIA and article 43n (1) draft FINMASA). Furthermore, the supervisory organization will also be responsible to act as a self-regulatory organization under the Federal Act on Combating Money Laundering and Terrorist Financing of 10 October 1997 provided it was recognized as such (article 43a draft FINMASA).

Under normal circumstances, the supervisory organization will be responsible for the day-to-day supervision (article 43b (1) draft FINMASA), while FINMA will stay in the background. Asset managers and trustees will be required to respond to any request for information that the supervisory organization requires to carry out its statutory duties and to inform the supervisory organization of the occurrence of any event that is of material importance for the supervision (article 43p draft FINMASA).

The supervisory organization will not have formal administrative powers, however. This role will remain with FINMA, who will be in charge of licensing and taking formal enforcement action against asset managers and trustees. If, in the course of their supervision, a supervisory organization finds that an asset manager or a trustee breached its obligation, it will be required to set a deadline to the regulated entity to remedy the situation and if it fails to act within the deadline, it will be required to report the matter to FINMA (article 43b (1bis) draft FINMASA). FINMA will then take over the case and will be empowered to use the full palette of administrative measures available to it, including issuing a declaratory ruling (article 32 FINMASA), ordering remedial measures (article 31 FINMASA), prohibiting a person from exercising a controlling function within a supervised entity (article 33 FINMASA), naming and shaming (article 34 FINMASA), confiscating undue profits (article 35 FINMASA), appointing an investigating agent to clarify the facts or manage the institution (article 36 FINMASA) or even withdraw the license (article 37 FINMASA).

The split between supervisory organizations and FINMA will, however, need to be clarified in practice. Indeed, the line between supervision and enforcement is not clear. It is, therefore, likely that FINMA will create a halfway house to deal with entities that need to be monitored closely although their actions would not justify taking formal enforcement proceedings, as it already does in connection with banks and securities dealers that are subject to so-called intensive supervision.

Similarly, there will also be needed some clarity to define the threshold for FINMA to take enforcement actions. Although the bill suggests that FINMA will be required to take enforcement action only against characterized offenders who failed to remedy breaches after the deadline set forth by the supervisory authority (see article 43b (1bis) draft FINMASA), it seems unlikely that FINMA can turn a blind eye to serious breaches. In such cases, it is likely to need to take action, and issue blame or take other enforcement action, .e.g. confiscate undue profits, without giving the entity the chance to clean up.

2) FinTech Exemptions

The second series of changes relate to the broader initiative to create a suitable regulatory for FinTechs, which is spearheaded by the Federal Council and FINMA. In line with the reforms announced by the government, the Council of States proposes to introduce two exemptions which seek to remove undue hurdles for technological innovation in the financial industry. The driving force of this regulation is that financial institutions that accept deposit without engaging in traditional commercial banking should not bear the full brunt of complying with banking regulations. This new regime should allow ‘FinTechs’, e.g., crowdfunding platforms and payment service providers broadly speaking, to carry out their business without being fully regulated as a bank.

First, the bill limits the scope of banking regulations to institutions that accept or publicly solicit deposits in excess of CHF 100 million or entities which accept deposits below this threshold, but either invest the deposits or pay interest on them (article 1a (1) draft Banking Act ). Instead, entities that do not pay interest or invest deposits will be subject to a dedicated ‘FinTech’ licensing regime that will be analogous to the one applicable to banks (article 1abis (1) draft Banking Act). These entities will be required instead to prepare audited financial statements in accordance with the Swiss Code of Obligations and engage an auditor to carry out a regulatory audit (article 1abis (3) draft Banking Act). Although the answer to the questions to what extent the analogy holds and what are the exemptions that these entities will enjoy is uncertain, the Federal Council and FINMA suggested that such institutions would be subject to a simplified capital adequacy regime, thus removing one of the more burdensome requirements.

Second, the bill also allows FINMA to grant a similar exemption to entities that accept deposits in excess of the CHF 100 million threshold provided they do not invest or pay interest on the deposits and take additional measures to protect their clients (article 1abis (1) draft Banking Act) or to financial institutions that do not accept deposits, but nevertheless apply for a license (article 1abis (1) draft Banking Act).

The substance of this lighter regulatory regime remains, however, fairly uncertain at this stage and further details can be expected at a later stage, when the Federal Council will commence hearings on the implementing ordinance, which are likely to include further exemptions for FinTechs.

3) Other Changes

a) More Differentiated Regulatory Regimes for Asset Managers and Trustees

Further clarifications relate to capital adequacy and organizational requirements applicable to portfolio managers and trustees. Overall, these amendments seek to allow the regulation to account for the wide disparity in terms of size within the asset management industry, which range from relatively small owner-operated institutions to large institutional players. Therefore, a number of amendments seek to ensure that the new regulations do not create market entry barriers for smaller players (see, e.g., article 10 (7) draft FinIA allowing qualified shareholders to exercise an executive role in asset managers and trustees, article 18b (2) on requirements applicable to risk management and internal controls, article 19 and 19a draft FinIA on equity and capital requirements) and emphasize the need to account for the size and complexity of the business when implementing and applying the regulations (see, e.g., articles 8 (3), 18 (2) draft FinIA, article 43b (2) Draft FINMASA).

Moreover, the bill that was approved by the Council of States struck out all provisions on consolidated supervision of asset managers for collective assets, and merely enabled the Federal Council to enact such rules should they be required by international standards, as is currently the case.

b) Status Quo on Banking Regulations

The most important resistance to the FinIA concerned banking regulation, where the Council of States refused a number of amendments to the Banking Act proposed by the Federal Council in areas such as the definition of banking business (article 1a (2) draft Banking Act as presented by the Federal Council) and the definition of deposit taking activity (article 1b draft Banking Act as presented by the Federal Council), the legal form of banks (article 1c draft Banking Act as presented by the Federal Council), the regulatory status of branches and representative offices (article 2 draft Banking Act as presented by the Federal Council), licensing requirements (article 3 draft Banking Act as presented by the Federal Council), reporting obligations for cross-border business (article 3bbis draft Banking Act as presented by the Federal Council), and supervision of financial groups and bank controlled financial conglomerates (article 3c ff. draft Banking Act as presented by the Federal Council). Overall, this decision reflects the intent to maintain the current regulatory framework that applies to banks fundamentally unchanged by the FinIA, which had already been voiced in the consultation proceedings preceding the publication of the draft bill.

The Council of States also refused the amendments to bank insolvency that were added to the project of the Federal Council on the basis that they should have been be subject to full consultation proceedings.

c) Limitation of the Scope of the Collective Investment Schemes Act and Voluntary Licensing Process

Finally, the draft bill made some small changes that may have far reaching consequences for financial markets regulation:

The Council of States removed offerings from Switzerland from the scope of the investments on collective schemes (articles 120 (1) and 123 (1) draft CISA). Doing so, the Council of States lifted pure outbound offerings of collective investment schemes from the scope of the Collective Investment Schemes Act, which is likely to significantly decrease the regulatory burden of collective investment schemes that are managed or administered in Switzerland without being offered locally.

Furthermore, the Council of States also amended the FINMASA to allow persons to obtain a license on a voluntary basis, even if they do not intend to exercise a regulated activity and need a license (article 3 (a) draft FINMASA), which should facilitate the licensing of persons who need to be regulated in Switzerland to be able to carry out their activity in other

4) Next Steps and Phasing-in

Overall, the draft FinIA seems to have been well received by the Council of States. The next step for this project is the National Council. The project is scheduled to be examined by the Committee on Economic Affairs and Taxation of the National Council in its spring 2017 session. Considering that the political brokering required to overcome the deadlock already took place to a large extent, it is well possible that the FinIA may be accepted without too much resistance by the National Council and, after the 90 day deadline for a referendum will expire, become law in the course of 2017. This legislative package will, however, require the adoption of implementing ordinances. Therefore, it is not likely to be enacted before mid-2018 or even 2019.

Even then, the bill provides for a generous phasing in process, which was further expanded by the Council of States: trustees and asset managers will then need to report themselves with the FINMA within six months of the entry in force of the FinIA and will have three years to submit their licensing application, provided they are already member of a self-regulatory organization under the AMLA (article 70 (2) draft FinIA). Furthermore, during the first year following the entry in force of the FinIA, new asset managers and trustees will be entitled to commence their operations provided that they immediately announce themselves to FINMA and comply with all requirements under the FinIA, with the exception of joining a supervisory organization. They will then have a year counting from the first licensing of a supervisory authority by FINMA to file their own application to be licensed and join a supervisory authority, provided they joined a self-regulatory organization under the AMLA (article 70 (3bis) draft FinIA).

Rashid Bahar (