By Simon Gray – Proposed changes to the regulatory regime governing Switzerland’s fund industry have prompted a number of alarmist headlines in recent weeks. Is the country that up to now has not sought to supervise managers of funds domiciled outside the country, even if they actively desired it, now planning regulatory changes so drastic that they could drive managers into other jurisdictions, even inside the European Union, hardly a byword for supervisory laxity? The reality is rather more complex.
The proposals to revise Switzerland’s Collective Investment Schemes Act (CISA) and their potential impact on the industry were the prime focus on the recent Swiss Funds & Asset Management Forum 2012 organised by the Swiss Funds Association in Bern. The organisation’s president, UBS Global Asset Management managing director Martin Thommen, noted that the fund business – which is intertwined with Switzerland’s world-leading wealth management sector and other facets of the financial industry – generates gross added value of CHF7.5bn annually, and around 21,000 people are employed directly or indirectly in fund and asset management activities.
“The business has significant growth potential, and can become a strong third mainstay for the Swiss financial sector in addition to private and investment banking,” Thommen told participants. “However, this will only be possible if the operating environment is successfully improved. This is why the partial revision of the CISA is so pivotal for the Swiss financial sector. International standards must be met, but the CISA should not be unnecessarily transformed into an EU straightjacket for the entire world.”
The SFA is particularly concerned to ensure that the legislative changes do what is necessary to ensure that Swiss-based managers continue to enjoy access to sophisticated investors across the European Union once the EU’s Alternative Investment Fund Managers Directive comes into effect in July 2013, but that the AIFM Directive rules are not ‘gold-plated’ or otherwise put the country’s fund management industry at a disadvantage to their EU counterparts.
It doesn’t help that the debate over revision of the legislation is coloured by the emotive background of the losses sustained by a handful of Swiss-managed funds of funds that had investments with Bernard Madoff, as well as a more general concern that the country’s existing regulatory framework no longer meets global standards as they have evolved in the wake of the financial crisis.
However, the association argues that the proposed regulations are more restrictive than those that will be applied in the EU, and cast aside measures that have served the Swiss financial industry well in the past. There is particular concern that the regulations governing distribution will present Swiss managers with new obstacles, and that overall the proposals will fail to strengthen the country's competitiveness. The SFA is working closely with the Swiss Bankers Association to seek improvements in the text.
According to Daniel Roth, head of legal services and the general secretariat at the Federal Department of Finance, who also spoke at the Funds & Asset Management Forum, the revisions to the legislation seek to strike a balance between the in some respects divergent objectives of investor protection and market access and competitiveness. In the Federal Council’s view, the draft is a balanced one that will strengthen the reputation of the financial sector, but it does not meet all the preferences of regulators and stakeholders.
Officials of the SFA and industry members note that the draft legislation is still in a consultation stage and being examined by Swiss parliamentary committees, in the process of which they hope stakeholder input will allow changes to be made. A vote in Parliament is expected in October, although it could be later, and the new legislation is scheduled to take effect early next year. The ultimate deadline appears to be the AIFM Directive implementation date the following July, by which time regulatory arrangements for Swiss providers of services to EU alternative funds need to be in place.
One thing that is certain is that the changes will bring an increase in costs for managers and that some will be able to cope with this better than others. A Swiss hedge fund manager recently told the Financial Times that if all the regulatory changes in Europe and Switzerland took place in the way that they were currently planned, managers would need EUR500m in assets to be sure of being profitable, and other asset managers tell similar stories.
“One of the things people don't always realise about regulatory developments is that it adds significantly to your cost base and required staff skills, which can be particularly difficult for small players,” says Andre Keijsers, a senior managing director at Gottex Asset Management.
His colleague Dominique Küttel, managing director and head of European marketing and sales, adds: “It's part of the evolution of the whole industry. You see how banking has changed over the past 25 years, and the alternative industry will have to change as well.
“It’s not just because of the extensive market volatility over the past four years but changes in demand and regulation that will trigger changes in the industry. Some players are waiting to see what things will look like when the dust settles, while we and others are more proactive. But eventually everyone is effected by the changes in the law including registration with [Swiss financial regulator] Finma and changes in distribution rules.”
Gottex, a long-time bastion of the fund of funds sector that today offers a broader spectrum of multi-manager investment solutions, is just one of the Swiss asset managers that say they would have been regulated by Finma long before, given the chance. Another is Lugano-based alternative fund manager Insch Capital Management, whose chief executive, Christopher Cruden, says he is relaxed about compulsory registration and supervision.
Up to now the firm has been supervised by PolyReg, one of Switzerland’s largest self-regulatory organisations based in Zurich. “PolyReg has been perfectly amenable, we've had no issues at all with them, but we are very pleased that Finma is now going to regulate companies like ourselves,” Cruden says.
“In fact about a year ago we made enquiries about whether we could become directly regulated by Finma, even if it meant becoming either a broker-dealer or a bank, which is matter of capital requirements and change of business plan. However, we were overtaken by events since under the new legislation all fund managers will have to be regulated by Finma anyway. From our point of view that can only be a good thing.”
Insch’s interest in regulation is not so much about obtaining an AIFM Directive passport to market funds into the EU since the firm does not currently manage any Swiss-domiciled funds. In fact the company is considering acquiring an entity regulated by the UK’s Financial Services Authority (or its successor) that would be subject to compliance with the EU directive.
Says Cruden: “I hope the Swiss will be successful in holding the line to what they want to do, rather than become subsumed into the big EU plan. Our interest in it is simply that Finma appears a professional and competent regulator. From our point of view, a higher level of regulation is always good from a marketing perspective, if you can demonstrate that you are subject to open and transparent supervision. Whether or not you actually use all the permissions, rights and privileges offered by the legislation is down to each company. For example, it's unlikely that we would want to manage Swiss funds.”
Gottex is broadly happy with the thrust of the legislation, but with some reservations. “One positive benefit is that it will become compulsory for all asset managers to be regulated, which is what we wanted, and we know of a lot of other firms that also want to be regulated.” Keijsers says. “Secondly, it will put Switzerland on a level regulatory playing field with the EU following the implementation of the AIFM Directive, which will be crucial if the country is to remain a centre of excellence in asset management.”
He notes that, like the EU directive, for external funds to be marketed in Switzerland, the current legislative proposals would require the regulatory framework of the fund domicile and of the jurisdiction in which the fund manager is based to have the same effect as that overseen by Finma. “However, we and a lot of other people are worried that the Swiss legislative changes seems to be taking a substantial step further,” he says.
“In addition to inward equivalence, which also applies under the AIFMD, the new CISA legislation incorporates two further measures. First, foreign managers will need a distribution representative in Switzerland. This does not apply to Gottex and other Swiss-based groups, but a UK-based fund manager would have to appoint a Swiss representative, possibly with a certain responsibility at a regulatory level. If these responsibilities are onerous, that could become a costly affair.
“Possibly more worrying would be so-called outward equivalence. The way the latest draft has been written, this would mean that a Swiss-based manager would be able to distribute its products only in countries whose regulators have a co-operation agreement with Finma certifying that the regulatory framework is the same is in Switzerland. For certain countries outside the EU and North America, this might take some time.
Keijsers fears the result could be that Swiss managers will start moving certain functions, in particular their marketing and distribution activities, outside Switzerland – quite possibly into the EU, given that many of them already have funds and management vehicles in Luxembourg or Ireland, and that such a move could simplify compliance with the AIFM Directive rules. He adds: “Gottex is happy that everyone should be regulated and be on a level playing field with the AIFMD, but the additional measures, particularly outward equivalence, are a step too far.”
It’s understandable that the Swiss authorities might desire to strengthen the country’s reputation as a solid and well-supervised financial centre, and would not like to see its good name endangered by lack of oversight in a third country that affected a Swiss-managed fund and hurt investors in other countries.
However, industry members fear that with some countries targeted by Swiss asset managers the establishment of co-operation arrangements may in practice prove a lengthy process, even though the local regulators do fulfil the equivalence requirements. This could conceivably restrict the distribution capabilities of locally-based managers, at least temporarily, and ultimately impair Switzerland’s ability to remain a global centre of excellence for asset management.
There appears to be some sympathy for this view in political circles in Switzerland, which may prove amenable to arguments that unless thought out carefully, the proposal could lead to highly skilled jobs leaving Switzerland for rival jurisdictions. Fund industry representatives are currently lobbying intensely to get their arguments across.
Hans-Jörg Baumann, chief executive and senior partner at Swiss Capital Alternative Investments and head of the SFA’s Alternative Investments Committee, says: “It’s vital that the regulatory system should differentiate in our regulation between private clients and institutional business,” he says. “Overall, people in the industry believe that the legislation goes too far on the institutional side, which could have consequences in terms of arbitration where the business is going.
“Nobody is complaining about the idea that providers should be regulated, but do we need to regulate even more tightly than what is happening in Europe? I think not. The European standards should be taken as a benchmark. That’s not being lax, because European regulation is already very strict. If you are more stringent, international business will go away. I hope the decision-makers understand that and find the right balance.
“If an international fund manager wants to market its products or services to a large pension scheme in Switzerland, which has in-house alternative investment knowledge and expertise, why should it have to go through a Swiss-regulated introducer? That would simply result in all the discussion taking place outside Switzerland. It is illogical, and it doesn’t happen in other jurisdictions.”
Outward equivalence rules would have a similar impact, Baumann believes. “Under the proposed regulations, Dublin- or Luxembourg-domiciled products from a Swiss asset manager that were marketed in Abu Dhabi or Singapore would be subject to a quality check under Swiss rules. In that event, providers would do better to move to another European country to ensure that the offering process is outside Switzerland.”
Gerhard Schreiber, founding partner of Swiss Hedge Capital, argues that the legislators should consider an asset threshold above which managers would be subject to full regulation. “Entry barriers will become very high for new managers if you have full-scale regulation from day one,” he says. “I would welcome a minimum threshold, say CHF50m, which would keep the full weight of regulation off founders of small and start-up fund businesses. As it is currently proposed, the law does not include such a threshold.”
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