By James Williams – “Hell, there are no rules here – we’re trying to accomplish something.” Thomas A Edison. On 1 March 2013, Swiss fund managers awoke to a new dawn. Overnight, they had gone from operating in a market free of the shackles of regulation to one where the Swiss government gave its imprimatur to the revised CISA (Collective Investment Schemes Act). This, along with the Collective Investment Schemes Ordinance (CISO), means that all Swiss-based asset managers overseeing fund investments now fall under the watchful gaze of FINMA, the Swiss regulator.
“Where we are in Ticino (southern-most canton), I got the sense that when the original rules came out, managers here were terrified. It was like the sky was falling in. But the revision was much better and far more reasonable,” comments Christopher Cruden (pictured), CEO of Insch Capital SA, and a long-term advocate of fund manager regulation in Switzerland.
This is a radical shift for a country where secrecy and discretion have long dominated. But the world has changed immeasurably in recent years. Since the financial crisis in 2008, global regulators have been quick to implement change, to shore up the financial framework and avoid another catastrophe. Switzerland is no longer a stand-alone country free to operate as it pleases.
As a result, the Federal Council (the seven-member executive council which constitutes the Swiss federal government) has been jolted into action. In July this year, the European Union will usher in the long-awaited Directive for Alternative Investment Fund Managers (AIFMD). This will require all Alternative Investment Fund (AIF) managers to register with an EU member state – e.g. UK, Ireland, Luxembourg – following which they will then be able to passport their fund(s) across all other EU member states. Think UCITS regulation for alternative fund managers.
Unsurprisingly, Switzerland, with its revised CISA, is aiming to achieve an equivalent regulatory framework to that of the Directive. “In summary the final result reflects common parameters similar to the European regulation. The approved new regulation can be considered as a reasonable compromise for the industry,” comments Hans-Jorg Baumann, Senior Partner and CEO of Swiss Capital Group, a Zurich-based firm that offers services spanning alternative investments, corporate finance and wealth management.
Baumann notes that given that Level 2 implementation of AIFMD is yet to be fully crystallised it’s difficult to predict whether all elements of the Directive will be compatible with current Swiss regulation. “However we feel comfortable that Switzerland matches the main relevant criteria to be outlined within the European framework of AIFMD. It has to be said that Switzerland is not part of the European decision making process. It will look at the final European guidelines and try to be flexible to make sure that cross-border business reciprocates European standards.”
To clarify, the revised CISA only applies to managers who manage their clients’ money through a fund. If that money is being managed through mandates (e.g. managed accounts), they don’t need to be regulated. Although, as Dr Matthaeus Den Otter, CEO of the Swiss Funds Association (SFA), points out: “Under CISA, it’s a Directive just like the AIFMD where the collective investment scheme is the point of reference, nothing else. It’s focused on the product, not the activity of the manager – hence why managed accounts are not regulated under the Directive.
“Currently, we cannot use CISA to introduce a general licensing requirement for anyone managing money for clients. But discussions to do so have started (a Financial Services Bill is currently under discussion). Our position, to be clear, is that eventually we want everybody managing money to come under the supervision of FINMA.”
Like the Directive, a “de-minimis” rule applies to fund managers. Only those managers with total AuM of up to CHF100million (including assets acquired through use of leverage) and CHF500million (where no leverage is applied) need obtain a FINMA license, confirms Daniel Roth, Head of FDF Legal Services and General Secretariat at the Federal Department of Finance.
As mentioned, fund managers like Cruden welcome this new era of regulation because “it’s a basic block of credibility. It’s a must-do thing. We’ve always held this position. It is right and proper that you get the highest level of transparency in your business, and being regulated is a part of that.”
Cruden says that Insch Capital was one of the first managers to approach FINMA to sign up for the license, only to be told by the regulator that it was unnecessary right now. That’s because only the very largest managers are being initially targeted.
While Cruden clearly sees revised CISA as a positive development, he nevertheless regards it as a catch-up exercise. “Now Switzerland has to try and earn its living, both internally and externally, and to do that they’re going to need a similar form of regulation to Europe that the rest of the world recognises and wants to see. That’s why we are where we are.”
One interesting point that Cruden makes is that because of the country’s cantonal system, there are substantial differences between cantons: one cannot simply say that the new rules and regulations will be applied equally across the country. Ticino, for example, has two levels of regulation: the first level is a basic Self-Regulating Organisation (SRO), which all asset managers belong to. The second is canton-level regulation.
“The reason they have this dual level of regulation in Ticino is because a) they think it’s required, and b) it gives extra comfort to investors, which in my view is a good thing. In Ticino, the regulators are approachable and not adversarial which is vitally important. I hope this dual regulation doesn’t disappear under FINMA. The transition that FINMA has in mind is going to be complex and far more time-consuming than anyone first envisaged. But I think they’ll get it done right.”
Two key benefits under the revised CISA are that foreign-based asset managers will now have the opportunity to set up a local branch in Switzerland, should they wish to.
Additionally, with respect to fund distribution into the country, Den Otter says that the rules under CISA are “less prescriptive” than those in the EU and that private placements will continue to exist until 2018 at the latest, especially when doing business with regulated financial intermediaries such as banks and broker-dealers. “Our distribution market will therefore remain very attractive,” says Den Otter. “We also expect Switzerland to remain attractive as a hub for institutional business in non-EU-countries all over the world.”
Before coming to the issues of fund distribution and “outward equivalence” – both of which could potentially put Switzerland at a distinct disadvantage – it is worth touching upon the issue of “inward equivalence”.
In a nutshell, this is the same rule that applies to the AIFM Directive in that any non-EU manager wishing to market their products will need to have a bilateral cooperation agreement in place between the jurisdiction they operate out of, and the Swiss government. This puts Switzerland on an equal footing with the rest of Europe.
Roth explains: “External managers are henceforth subject to the revised CISA instead of simply being offered the possibility to apply for an authorisation. They are furthermore allowed to establish a branch on certain strict conditions and, if they do so, must comply with all legal requirements applicable to Swiss fund managers.”
Two areas where revised CISA goes further than AIFMD
While the intentions of revised CISA are to replicate the AIFMD in Switzerland, thereby creating a level playing field, in some respects it is a more onerous regulatory framework. The fear is that this will have serious long-term implications for the competitiveness of the Swiss fund market; an industry which generates gross added value of CHF7.5billion annually and employs around 21,000 people, according to the Swiss Funds Association.
Two elements of revised CISA in particular are causing concern among managers. The first relates to how funds can be distributed under “inward equivalence” in Switzerland, while the second relates to how Swiss-based managers perform their own marketing activities across the rest of Europe under “outward equivalence”.
Representative agents = higher costs
The way that external managers distribute into Switzerland has irreversibly changed under revised CISA. Previously, a US manager of a Cayman hedge fund could fly into Zurich, do a road show for 20 different pension funds and conduct private placement in an entirely unregulated fashion.
That is no longer possible.
What revised CISA has done is delineate between qualified and non-qualified investors meaning that there are three channels of distribution available. The first is retail distribution of UCITS funds to non-qualified investors (no change to regulation). The second is traditional private placement distribution where asset managers use regulated financial intermediaries (banks, broker-dealers). The third and final route is distribution to qualified investors; what was previously referred to as private placement.
To do this, a non-Swiss manager may continue to privately place his offshore hedge fund(s) to qualified investors (institutions) but they will now be required to appoint a representative and a paying agent in Switzerland. That’s the sea change that external managers now face. The result being that they will, as a consequence, face additional costs.
“It will become more burdensome,” says Den Otter. “But if you want to actively target pension funds, then you need this representative agent.
“Let’s see whether this really will improve investor protection. FINMA was hit with complaints from investors post-08 because of FoHFs using side pockets and freezing assets. Even though they had representatives in Switzerland, all of a sudden those foreign funds cancelled contracts with their local Agents and were nowhere to be seen anymore. That’s why CISA has also introduced a requirement that the cancellation of the contract between the foreign fund company and the Representative Agent needs prior approval from FINMA.
“I’m fully aware that this makes things a bit more bureaucratic and costly but we’re working hard to prepare the necessary documents for dealing with these rules.”
Hannes Glaus is a partner at law firm Bratschi Wiederkehr & Buob in Zug. He notes that the appointment of a Swiss representative requires an agreement in writing between the representative and the investment fund (manager) meeting certain requirements.
“The representative itself is a regulated person and must ensure on the one hand the smooth flow of information between the investment fund and the Swiss investors as well as FINMA. Most importantly, the representative is, on the other hand, responsible for the compliance of the distribution agents with Swiss law.”
As a rough summary the following persons are deemed to be qualified investors requiring lesser protection in particular with regard to the distribution of non-Swiss investment funds:
• Regulated financial institutions (banks, insurance companies, securities dealers, fund management companies);
• Pension funds and business enterprises with a professional asset management department;
• High net worth individuals who “opted in”, i.e. opted to be qualified;
• Investors who entered into a written discretionary asset management agreement with a regulated financial intermediary, including external asset managers (and did not “opt out”).
Daniel Häfele, Chairman and CEO, Acolin Fund Services AG, which specialises in fund distribution across Europe and Switzerland, thinks that the need for representative agents will potentially limit the number of external funds and providers distributing in Switzerland. “We have 600 management companies distributing into Switzerland at the moment, maybe 100 or so will stop doing so because of the cost implications.”
Häfele notes that most regulated financial intermediaries are actually driving managers to register their products with representative agents before they’ll consider introducing them to their qualified investors. Why? Because under the new regulations, were a bank employee to accidentally distribute a fund factsheet to a non-qualified investor, it could be hugely problematic.
“The requirements set out in article 3, paragraph 4 of CISO demand that any information distributed to regulated financial intermediaries (RFIs) must not be seen by any other qualified or non-qualified investors. So we expect that the majority of RFIs will ask to be treated as qualified investors,” says Häfele.
Managers have two years to appoint a representative yet Häfele observes that there is a rush among Acolin’s clients to get the ball rolling straight away. “There’s no reason for any manager today to appoint a representative. We don’t have a sample distribution agreement from the SFA yet. We will get this during Q2, and only then will we be able to tell fund providers what is needed and not needed.”
Baumann believes that for small- and mid-sized institutional clients “this representative function limits information freedom, but as we all know there is no freedom without limits – however, the limits of freedom always have to be weighed carefully. This balancing act in respect of regulation gives a lot of ground for criticism amongst various parties.”
Outward equivalence – the “third country” issue
The cost implications of distributing funds into Switzerland could potentially stifle the country’s competitive edge under revised CISA. On top of this, Swiss-based managers face having to deal with outward equivalence when marketing their products into the EU as Switzerland is considered a “third country” under the AIFMD.
Through amendments to CISA, and thanks to a cooperation agreement signed by FINMA and ESMA on 3 December 2012 – Switzerland is the only country to have signed such an agreement, along with Brazil – Swiss asset managers can continue to manage AIFs in the EU through delegation and continue with private placement to institutional investors.
“Acknowledgment of outward equivalence under revised CISA is expected to secure access to the European market for Swiss fund managers as well as fulfill international standards,” says Roth. “This issue is even more important for smaller fund managers who have no representation in a EU-member state and would, when lacking outward equivalence, no longer be authorised to manage EU-based funds in Switzerland.”
This will continue up until 2015 at which point, potentially, ESMA will allow third country managers to passport their AIFs across all 27 EU Member States, provided they have a single physical presence in the EU. Up until then, any Swiss managers wishing to distribute across the EU will have no choice other than to establish a representative office and become AIFMD-compliant: a costly exercise.
Of course, this is not a problem for large asset managers as most of them already have offices in the EU. “Some smaller asset managers, however, now will have to decide where to set up shop within the EEA to comply with the new AIFMD,” says Den Otter.
For those that can’t afford this option, the cause for concern under outward equivalence is that between now and 2015, some EU Member States – Germany, for example – might turn around and simply end their private placement regimes.
Häfele, though, remains upbeat: “It’ll be a little more difficult for Swiss AIFs to be distributed over the next two years, but they will not be closed out of the market. Managers shouldn’t have any problems continuing to manage their funds thanks to the cooperation agreement signed with ESMA.”