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James Williams, Hedgeweek

Regulation and fund distribution challenges in Switzerland

Even though the introduction of regulation into Switzerland under the revised Collective Investment Schemes Act (CISA) has changed the landscape it doesn’t appear to have put off fund managers. Markus Fuchs, Managing Director of the Swiss Funds & Asset Management Association (SFAMA), says that the number of applications for FINMA license shows that more managers (mainly alternatives managers) are establishing in Switzerland “than I expected and that’s encouraging”. 

That’s not to suggest that Switzerland is about to witness an influx of new managers but regulation could, potentially, prove to be a useful fillip for the country. After all, it is home to some 4,998 UHNW individuals according to the latest Research and Markets report. This number is forecast to rise by 24 per cent to 6,847 in 2018. Put simply, managers need to look beyond the hassle of FINMA registration; there is a lot of serious investment at play. 

Switzerland had no choice but to introduce the revised CISA. It needed to move into line with the rest of Europe under AIFMD and ditch the veil of secrecy that has long dominated its private banking industry. 

Hans-Jorg Baumann is the Chairman of the Alternative Investment Council at the Swiss Funds Association. He says he has a “neutral stance” on the revised CISA. “Like in any case more regulation leads to more compliance issues and thus costs for the industry have risen in general. But this situation is a general fact for all members in the industry inside or outside of Switzerland.”

“Regulation is definitely a necessary development,” says Leila Khazaneh, general counsel at Jabre Capital Partners. “When we first established ourselves in Switzerland [in 2007] there was perhaps a perception that there was less of a regulatory framework. It has been valuable that FINMA has done more than was required to show their public equivalency in relation to AIFMD. It enhances the reputation of Switzerland.”

Generally speaking, there is little difference between the revised CISA and AIFMD. As Daniel Häfele, CEO of ACOLIN Fund Services, a leading independent fund distribution company, says: “Swiss-based managers have to become licensed with FINMA if they are running CHF100m or above (CHF500m for closed-ended vehicles). We’ve more or less copy and pasted AIFMD.” 

“It is fair to say that European countries have even more difficulties establishing a user-friendly environment because of a lack of definition and simplicity for market participants,” says Baumann. “Germany is a classic example of overdoing parts of the AIFMD and is creating uncertainties for the alternative investments industry. Switzerland, in a nutshell, adheres to the new standards and is not straying away from the objectives of AIFMD in Europe.”

Jabre Capital Partners is already registered with FINMA; something it did voluntarily back in 2009 when it decided to launch a UCITS fund – the JABCAP (LUX) Global Balanced fund – in Luxembourg. To distribute the fund into Switzerland required having a regulated investment manager. So the challenge for the firm now is not on the asset management side under the revised CISA but on the distribution side. This is because distributors must now also become regulated under FINMA with effect from March 2015. 

Referred to as ‘inward equivalence’, this is set to change the way foreign hedge funds are distributed into Switzerland. It will, in short, become a more costly exercise. 

The distribution challenge

What was known previously as private placement is now known as ‘Distribution to Qualified Investors’. Previously, only the “public offering” of non-Swiss investment funds was subject to regulation. Now, the rules of investor protection will apply to all investors including pension funds, corporate treasuries, family offices etc. Whether these sophisticated investors really need nannying is wide open to debate. But by abolishing the concept of public distribution, the revised CISA has effectively put private placement to bed.

From next March onwards, marketing offshore hedge funds to qualified investors will require the appointment of a FINMA licensed Swiss legal representative and paying agent. 

“We are waiting to see how this plays out,” says Khazaneh. “A lot of service providers who are thinking of getting into this business have yet to announce their price structure so we haven’t chosen who we will work with to become the Swiss representative of our funds. Everybody is waiting to see which players will emerge and who can offer the best service rather than how much it is going to cost.”

Both UBS Fund Services and ACOLIN Fund Services have reacted swiftly to get their Swiss representative solutions in place respectively. 

“The new regime was criticised for complicating distribution and thus having no positive effect on the Swiss fund industry. Personally, I am not a fan of overregulation and I believe in the self-responsibility of the (qualified) investor. As an investor, however, I would probably appreciate the comfort I get if a fund is represented by a reputable service provider. Due to the representative‘s duty of care towards investors and reputation risk we at UBS have decided to accept only mandates from AIFs if they have passed our operational due diligence,” confirms Yves Schepperle, Head of Product Development at UBS Fund Services Switzerland. 

A fund manager will, in addition to appointing their legal representative and paying agent, need to sign a distribution contract to which the legal representative is party. “There is no FINMA filing, no requirement to publish anything but the manager must have a FINMA licensed Swiss representative and paying agent. The role of the representative is to supervise distribution and to provide information to Swiss investors and, in case something happens to the fund, to be the main point of contact for FINMA,” says Häfele.

There is, however, some small room for manoeuvre and avoiding appointing a Swiss representative. Under the revised Collective Investment Schemes Ordinance (CISO), paragraph 4.3 says that if somebody does not distribute and privately places to financial intermediaries they have to make sure that the information provided to them by the manager cannot be seen by any other qualified or non-qualified investor. 

“A fund which is only distributed to Swiss private banks to be used solely for their discretionary mandates will not trigger the requirement for a representative and a paying agent,” comments Schepperle. But the necessity for a regulated financial intermediary to ensure that a fund’s marketing material does not fall into the wrong hands leaves them exposed to potentially too much risk and as Häfele adds: “We strongly recommend any alternative investment fund manager wishing to distribute their offshore funds into Switzerland to comply fully with the ‘Distribution to Qualified Investors’ regulation. We can act as the Swiss legal representative on their behalf.” 

Another point to clarify is that the appointed representative is liable to any damages or losses incurred in the AIF. Operational due diligence is therefore critical before a firm agrees to become the Swiss representative. Häfele confirms that this function is performed by New York-based Renovare Global LLC (whilst ACOLIN itself conducts due diligence on EU-based funds). 

“We represent offshore structures but we don’t run the operational due diligence ourselves. Over the last three months we have been involved with preparing more than 100 funds for distribution. There’s huge demand. We are getting enquiries every day, mostly from Anglo-Saxon managers. They recognise that they can no longer distribute into Switzerland without being compliant with the new regulation. The grandfathering period to appoint the Swiss representative runs until next March for any AIFs that were being distributed prior to February 2013. Any funds that were distributed after that have to comply immediately with the regulation,” explains Häfele. 

Consolidation similar to the Swiss watch industry

One of the potential outcomes to this new regulatory environment, and the additional distribution costs involved, is that smaller managers will fold and that what Switzerland will be left with is a hedge fund industry populated with large well-established players providing high-quality institutional products to Swiss investors. 

What will likely happen is that smaller managers will seek to consolidate. 

“It’s too expensive for smaller managers to do it alone in terms of the resources that are required now by FINMA. Managers need to have independent compliance, independent risk management and some of them are looking around to see who they could consolidate with to be able to share resources,” says Khazaneh, adding that the situation could become analogous to the Swiss watch industry. 

“One of our independent directors [Edgar Brandt] wrote an article last year comparing what is happening within the hedge fund and wider financial services industry in Switzerland to the watch making industry at the turn of the century. It does feel like that is what FINMA wants to happen. It wants an industry with large, better quality management firms. After all, Swiss watch manufacturers are a huge success story.”

So quality not quantity. It’s a distinct possibility. Not that this would necessarily benefit Swiss institutional investors; the more choice available the better.

“It is certainly a risk. Increased regulation straightaway means increased costs and there’s no doubt that if a manager has assets below the CHF100m threshold it is an issue. There are certain companies who will likely be too small to survive (unless they consolidate),” says Fuchs.

Some firms, however, are well aware of the pressures facing smaller managers. Pfaeffikon-headquartered Etops is an independent operational service provider that has combined forces with Deloitte to bring an outsourced solution to market entitled ‘Assetbox’. It comprises a suite of modules spanning regulatory support, compliance and operations as well as tax reporting and distribution support. In theory, smaller managers can focus on the investment management process and use Assetbox to address all of the operational requirements expected of a FINMA licensed manager. 

“We wanted to support managers with a service offering that is different from standard advisory and auditing services that the other ‘Big Four’ offer,” comments Marcel Meyer, Partner at Deloitte. “Michael Appenzeller and myself have worked together previously and we developed this idea of a cooperation between Etops and Deloitte which combines operational and risk management expertise with the whole regulatory and advisory set-up expertise that you find in any of the Big Four auditing firms. Deloitte has a deep heritage as a hedge fund advisor in North America, which we want to build on. 

“Assetbox brings us closer to the client. We work with them on a day-to-day basis. Managers are happier to engage us for this kind of service because it makes them better qualified to serve institutional clients and gives them more than they would otherwise get by using us solely for advisory purposes.”

With respect to risk management all the data is housed in a data centre which the portfolio manager can access via the cloud. That same set of data provides the input for reports used to support the compliance and risk management functions so there is “in-built efficiency” says Michael Appenzeller, founder of Etops. 

Once a manager has decided which modules within Assetbox they intend to use they are able to leverage the experience of the Assetbox team – which comprises numerous risk and operations experts and compliance officers – and effectively make them part of the hedge fund’s organisational chart. 

“Instead of having numerous service providers, one of our dedicated team members will visit the manager on a regular basis and be their day-to-day contact to respond to any regulatory and compliance questions,” adds Meyer. “On the operations side we work as an in-house team. We are in constant contact with the traders and other staff and execute daily middle office tasks,” adds Appenzeller. 

As mentioned, part of the Assetbox solution is distribution support. This is helpful to Swiss managers wishing to continue privately placing their funds into Europe. However, the point made earlier about smaller funds potentially needing to consolidate is not only because of Swiss regulation but AIFMD as well.

“They are looking to consolidate in Switzerland to meet the FINMA requirements but also looking ahead to 2015 and thinking: ‘What’s my European solution for AIFMD?’ When the funds passport becomes available to Swiss managers will they be able to avail of it or will it still be advantageous to consolidate with an EU-based manager?” says Khazaneh, adding: “We are looking to possibly expand our EU presence to sell our five offshore hedge funds under the AIFMD. Our UCITS funds are based in Luxembourg so that could be a natural fit for our business.”

“The distribution module in Assetbox helps Swiss managers to decide which countries they would like to focus their distribution efforts on. Once they’ve decided which countries to enter it gives them a single overview, summarising the registration status and the ongoing reporting requirements in those countries, which may be completely different,” concludes Appenzeller. 

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