Recent developments in Swiss banking law

Author: Shelby R du Pasquier, Lenz & Staehelin, Geneva

I. Introduction

2010 has been an eventful year for Swiss financial regulation. Among other things, the Swiss Financial Market Supervisory Authority (FINMA) published an important position paper setting out the regulator's position with respect to the cross-border activities of Swiss financial institutions (see Section II below). Further, an expert commission appointed by the Swiss government released its proposals for enhanced capital adequacy requirements applicable to systemically important Swiss banks (see Section III below). Finally, a summary outlook into some of the future developments in the area of Swiss banking regulation will be provided under Section IV below.

II. Regulation of cross-border financial services

On October 22 2010, FINMA released a position paper to formalise its practice with respect to the regulation and supervision of the activities conducted by Swiss financial institutions outside of Switzerland. Since 2006, the number of cases in which FINMA admonished Swiss licensed financial institutions that failed to comply with the legal and regulatory framework applicable in the jurisdictions in which these institutions are active has markedly increased. Several Swiss financial institutions were and are under investigation, both in and outside of Switzerland, for failing to comply with the rules governing cross-border financial services.

The October 22 2010 position paper encapsulates the general principles underlying a series of decisions rendered by FINMA in the recent years. In the position paper, FINMA requires every Swiss financial institution that is regulated by it (A) to identify the legal and reputational risks flowing from its cross-border activities and (B) to implement measures, including, as the case may be, a strategic reorientation, to mitigate such risks. In this context, the review of the cross-border activities conducted by the Swiss financial institution should not be limited to asset management activities, but should include also, for instance, payment services, in particular in relation to countries facing international embargoes and sanctions. The Swiss regulator stresses that the review of the cross-border activities will constitute going forward an essential pillar of the continuing supervision of Swiss regulated financial intermediaries.

FINMA's approach is based on the risks that Swiss financial institutions are facing when operating on a cross-border basis. That being said, the position paper also clearly shows that FINMA will not act as the "long arm" of a foreign regulator. When facing an infringement of non-Swiss rules, the Swiss regulator will assess whether such infringement can be traced back to, or is an indication of, a deficient internal organisation within the Swiss financial institution. In this context, important and repeated breaches of foreign laws will be a strong indication of a non compliance by the relevant Swiss financial institution, along with its management, board and shareholders, with the "fit and proper test" which applies to all Swiss licensed financial institutions.

All Swiss financial institutions are now required to take into account these regulatory developments and adapt their business models, structures and operations accordingly. The risk deriving from the enforcement of foreign rules governing the cross-border business is heightened for those financial institutions which, in parallel to the offshore business, have substantial onshore operations in the relevant jurisdictions. For some institutions, especially the larger ones, the way ahead is likely to be an expansion of the onshore business, at least in the area of private banking. This will involve the setting up of branches or subsidiaries in an EU Member State, in order to give them an EU passport allowing the development of their European activities. For other market players, the focus will probably be to regroup on Switzerland and a smaller number of geographical markets for which they can ensure compliance with the relevant securities and, increasingly, tax law requirements. In all instances, the Swiss banking institutions will need to rethink the type of services they render to their cross-border clientele and the manner in which they offer those.

III. Capital adequacy requirements

Switzerland has implemented the "Basel II" capital adequacy requirements and has indicated its willingness to implement the revised set of recommendations generally referred to as "Basel III". In parallel, a government-appointed expert commission, comprising representatives of the financial industry and the authorities, has devised a set of proposals aimed at mitigating the risks deriving from systemically-important financial institutions. The "too big to fail" risk is particularly relevant in Switzerland, to the extent the aggregate balance sheet total of the two major Swiss banking groups, UBS and Credit Suisse, amounts to about five times the size of the country's GDP. In an October 4 2010 position paper, the expert commission advocates the implementation of a policy mix based upon the following pillars: (i) strengthened capital requirements (backed up by new capital instruments in the form of contingent convertible bonds, the so-called CoCos), (ii) organizational measures to ensure the continuity of essential services (payment transactions, deposit business and lending business) in the event of a crisis, (iii) more rigorous liquidity requirements and (iv) a limitation of interconnectedness and cluster risks in the financial sector. The proposed rules will require amendments to the Swiss Banking Act and its implementing ordinances, which should be adopted in the course of this year. The implementation of these measures will be staggered, with an expected completion by 2018. Despite this long transitory period, Credit Suisse has already entered into an agreement with two strategic investors to issue USD 3.5 Billion and CHF 2.5 Billion of Tier 1 Buffer Capital Notes and has placed USD 2 Billion 7.875% Tier 2 Buffer Capital Notes due 2041 in the capital markets. These Buffer Capital Notes, which are expected to qualify as CoCos under the new Swiss capital adequacy regulations, are convertible into Credit Suisse Group ordinary shares (A) if the group's reported consolidated risk-based capital ratio falls below a certain threshold or (B) if FINMA determines that Credit Suisse Group requires public sector support to prevent it from becoming insolvent, bankrupt or unable to pay a material amount of its debts, or other similar circumstances.

IV. Outlook

Since the outbreak of the financial crisis, the Swiss regulator has taken a significantly more active and interventionist stance. Among FINMA's priorities for 2011, the improvement of the protection of investment advisory and wealth management clients appears to be at the top of the agenda. In an October 11 2010 discussion paper, published in the wake of an in-depth investigation on the impact of the Madoff and Lehman cases, FINMA indicated that it considered the current level of investor information and risk diversification practices of the industry to be inadequate. This discussion paper calls for the adoption of a new piece of legislation dealing specifically with investor protection and modeled on certain provisions of the MiFID Directive. This regulatory development is likely to have a significant impact on the business activities of Swiss banks in the years ahead.

Thanks to my associate Philipp Fischer for his assisting in the drafting of this article.