There was a degree of trepidation among foreign hedge funds when Switzerland formerly introduced a revised version of the Collective Investment Scheme Act (CISA) on 1 March 2015, bringing hedge funds under the watch of FINMA, Switzerland's financial regulator, for the first time.
Previously, only funds that were registered for public offerings – now referred to as distribution to non-qualified investors (i.e. retail investors) – had to appoint a Swiss legal representative and paying agent. As of last year, it also became a requirement for foreign hedge funds looking to raise assets from Swiss qualified investors, defined under CISA as including pension funds, corporates and individuals with at least CHF5 million in financial assets.
So one year in, have those fears been proven right? Have foreign hedge funds run for the hills and turned their back on one of the world's largest private wealth markets? Apparently not.
CISA – nothing to fear
To canvass the views of alternative fund managers and investors, Montfort Funds AG, a specialist provider of Swiss fund representation services, conducted a survey and broadly speaking the consensus opinion is that CISA has been a success.
"We are 12 months in and according to the Association of Foreign Banks in Switzerland 4,000 alternative funds have already appointed a Swiss representative and paying agent. Only 10 per cent of managers said they rely on reverse solicitation. However, it's not all good news. When we asked managers about the impact of regulation on investors and product transparency, only six per cent thought it would be positive for investors. The majority, 77 per cent, think it will be neutral," says Roman Pelka, Montfort CEO.
Luis Pedro, CEO of Oligo Swiss Fund Services, which provides representative services to both traditional and alternative funds, agrees with Montfort's survey findings and that CISA has gone some way to assuaging initial concerns; in other words, it really isn't onerous, nor expensive, to comply with the regulation.
"The reason FINMA introduced CISA regulation was to move in line with European regulations and to enhance investor protection (by extending the Swiss legal representative to institutional investors). Pension funds are in scope of the regulation as part of this broader wave of investor protection. The initial reaction among fund managers, when they heard that FINMA was going to introduce regulation, was that it would be much more complicated and costly to do business in Switzerland. Thankfully, many have realised that this is nothing to worry about. There are compelling reasons to come here and there really isn't much to do to become compliant under the new rules," comments Pedro.
"Switzerland is a small country and has its own specific set of rules and we make sure that the fund managers are kept abreast of them. They don't need legal counsel to perform this task (thereby avoiding duplication of costs). We make sure that all the fund's documentation is compliant with Swiss law and we answer all the questions on behalf of the manager that FINMA may ask."
Although hardly the most complex piece of legislation ever introduced, various questions have arisen in implementing the legal representative provision.
One aspect in particular that has led to demarcation difficulties is the fact that the provisions relating to representatives were drawn up for foreign collective investment schemes requiring approval for non-qualified investors, "and their application to collective investment schemes for qualified investors was often not clear. However, in the meantime a steady practice has developed. I am happy that SFAMA was able to help clarify various legal uncertainties, amongst others with a FAQ issued on that topic in August 2015," says Markus Fuchs, Managing Director, Swiss Funds & Asset Management Association.
Fund raising intelligence
One point that foreign fund managers need to be aware of is that distribution in Switzerland is broadly defined; it includes taking meetings, phone calls, sending emails to investors. If a US hedge fund turns up to Zurich, meets a Swiss pension fund and they talk about the weather…well that is hardly a criminal offence.
Trying to offer that same pension fund your hedge fund, without a Swiss legal representative, most definitely is.
"If you sell your fund to FINMA-regulated entities (i.e. Swiss private banks) then you are not engaged in distribution," explains Pelka. "The reality is that increasingly, banks will ask fund managers to appoint a Swiss representative before they distribute it to their private banking clients; it's not necessarily required but that is what they prefer.
"What we try to bring to the table is fund raising intelligence and insights on the local investor scene. Montfort has both buy- and sell-side experience in-house and that really helps our clients when it comes to identifying the right target investors in Switzerland. We aim to be a Swiss partner to our clients and add value, for example, by identifying the top Swiss investors a fund manager should focus on given his strategy and set up."
Some US managers tend to overlook European regulations and feel that complying with US regulations is sufficient enough.
According to Dermot Butler, who co-founded SwissRepCo in January 2014 with Lancelot Frick, that is not a sensible mindset to adopt now in Europe, especially as the cost of having a Swiss representative is minimal. "Depending on how complex the fund is, it costs between CHF5,000 and CHF7,000 to onboard a fund for representation, with ongoing costs of approximately CHF7,000 per annum," confirms Butler.
A heightened sense of alertness
Expanding on Pelka's point regarding the need to not have Swiss representation if distributing to FINMA-regulated entities, Butler explains: "A private bank that is investing in your fund for its own book does not need a legal representative. If, however, you are selling to a private bank that is acting as a custodian for clients of an independent investment adviser, or they have their own clients where they are acting as the investment adviser, then those clients are qualified under Swiss law as unregulated and you must therefore have a Swiss legal representative; these investors would be HNW individuals, family offices, etc.
"What FINMA is trying to do is make Switzerland more attractive to the EU market so that Swiss managers can more easily passport their funds into Europe. That's the impression I get on the street."
Whilst increased regulation might well encourage Swiss investors to increase their allocations to hedge funds, Fuchs believes there is still some need for education in Switzerland with respect to the asset class. "Raising of awareness of the particular features, risks and chances of hedge funds is not only necessary on the investor's side but also amongst regulators," opines Fuchs.
Service providers, too, need to adapt to Switzerland's new regulatory environment.
Garrick Smith heads up BNP Paribas Securities Services (Switzerland). He confirms that there is a heightened regulatory alertness not just to strengthen the way that administrators and depositary banks support Swiss funds but also foreign funds that are being distributed into the country.
"It is important to have a robust and exhaustive Fund Representative capability and at BNP Paribas Securities Services we have the largest franchise for providing representation services for third party traditional funds which now also covers alternative funds," says Smith.
One could argue that the greater regulatory transparency and oversight of hedge fund distribution activities is helping to give Swiss institutional investors a heightened sense of security; after all, many turned their backs on hedge funds in 2009 following the Madoff scandal.
"The ones that are coming back to alternative investments are those that have been around a long time. It is a trend we are seeing. And it will continue to grow. Here in Switzerland, we think that the convergence taking place between traditional and alternative fund managers will make this a more complex business for an administrator to be in, and will put us in a strong position.
"We can help clients successfully converge their strategies on both sides of the industry, which is why technology, specifically as it relates to data management, will become so important. We are excited about the future. Not just in Switzerland but in the funds industry at large, across the group," comments Smith.
Improved due diligence
To further improve confidence among Swiss investors, Oligo Fund Services hosts regular events in Switzerland during which a handful of managers are invited to present their fund proposition. The fact that Oligo is the legal representative to the funds helps reassure investors who attend because ultimately, they know that Pedro and his team have done extensive due diligence.
"We do on site due diligence of every fund that we represent. We go to their offices, we ask detailed operational questions to seek reassurances that each fund is properly run. We concentrate much less on the strategy, as we are not allocators. To us, the most important thing in terms of strategy is that it is properly implemented, operationally speaking," says Pedro.
In the last few months, Oligo Fund Services has received a number of phone calls from Swiss allocators; for example, a Zurich-based FoHF manager told Pedro that they wanted to invest in a New York-based hedge fund doing a lot of distribution in Switzerland but they didn't want to go to New York.
"They asked us to provide details on the sort of due diligence we did on the manager to get a better understanding. We were happy to do this. It avoided them having to travel to meet the manager in person, and they decided to invest in the fund. So the Swiss legal representative definitely gives Swiss investors more confidence. I think for now it helps all concerned. We are getting more calls from allocators to double check on the details of the funds they are considering," comments Pedro.
Democratising hedge fund investing
One company in particular that is using regulation to leverage off of its technology capabilities is Etops. Over the last couple of years, it has steadily built out a unique offering called Fundbase, one of very few regulated fund platforms for investors to access hedge funds.
"We are the only democratised hedge fund marketplace. Around 60 per cent of the investors who use Fundbase are located in Switzerland, the UK and the US. I would estimate that 25 per cent to 30 per cent of the investor capital on the platform is Swiss capital. In addition, we are starting to take over the complete hedge fund sourcing activities for some investors; an illustration of the way in which technology is changing the investment marketplace," outlines Michael Appenzeller, founder of Etops.
There are 11,000 or so funds on the platform, with Etops providing legal representation to around 80 funds. At the end of the day, Fundbase is designed more to support investors by allowing them to effectively source funds based on their own criteria, and contact managers to see if they are willing to take in new capital.
"For those funds on the platform who also select us for legal representation, they are more likely to be in pole position to get in front of new investors given how we bundle this with the premium exposure package; that's not something that anyone else can offer," says Appenzeller, confirming that Fundbase is currently adding around 50 to 100 new investors each month.
"We work with prime brokers whose funds are on Fundbase and who use our tools to distribute. We have tools that allow us to see exactly who looked at particular funds; did they just look at the performance charts or did they go further and look at the PPM etc. There are various tools that investors can use to search for managers, build long and short lists, etc. Some independent Swiss wealth managers are starting to build hedge fund portfolios this way, with our support."
If a particular fund is not on Fundbase, the Etops team will make efforts to approach the manager in question. Indeed, this is how its US fund numbers, in particular, have grown. Fundbase has grown in direct correlation to investor demand with Appenzeller explaining: "It's not as though we are pulling together a number of different fund databases or curate a small number of hedge funds to distribute. Our funds are directly linked to Fundbase and to a large degree are brought on board by investor demand. Some of our competitors do take these approaches. In the short term it might be easier for them but we don't think it is scalable and disruptive enough.
"As we can offer advisory support on how investors might want to think about constructing portfolios, it opens up the market to a wider range of smaller and mid-sized managers and not just the big established managers doing a soft close.
"Going with the largest managers cannot be the only wise strategy as there's no guarantee that large funds are going to perform as well as smaller funds (where perhaps managers are more hungry and keen to build a strong track record). Numbers from various research reports clearly support this."
For smaller hedge funds who still perhaps haven't developed an extensive distribution network in Switzerland, Oligo's Pedro concludes by confirming that as part of the legal representation service it provides it will also perform due diligence on third party distributors operating in the country; a direct benefit to managers keen to safely explore their marketing options.
"Part of our role as the Swiss legal representative is to supervise the distributors that a specific hedge fund uses. When there is a distribution agreement in place between the hedge fund and a third party distribution company, we also sign that agreement and do due diligence on that distributor as well as making sure they understand Swiss regulation, and stick to it," concludes Pedro.
So one year in to CISA, with no sign of foreign hedge funds turning their backs on Switzerland, all that remains to be said is: "Happy First Birthday!
