Mifid II Report 2017: Switzerland

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Neither Directive 2014/65/EU of May 15 2014 on markets in financial instruments (the Revised Mifid) nor Regulation 2014/600/EU of May 15 2014 on markets in financial instruments (Mifir, and collectively with the Revised Mifid, Mifid II) will apply directly in Switzerland.

However, outbound cross-border activities conducted from Switzerland will fall into the scope of Mifid II. This will primarily affect firms providing investment services and activities in the sense of Mifid II in the EU.

As regards transactions with private clients in the EU, the market access rules of the Revised Mifid do not require equivalence recognition of the Swiss rules, but each EU jurisdiction may require a minimum presence on-shore in the relevant EU market concerned. As regards professional clients and eligible counterparties, the full EU market access of Swiss financial institutions will depend on the EU Commission taking the decision that the Swiss regime is equivalent to Mifid II, which will then permit a Swiss financial institution to register with the competent EU authorities and passport its services to the whole EU. Moreover, EU courts may be the competent courts in the event that a consumer brings a legal action against a Swiss financial institution.

Besides financial institutions, Swiss commodities and energy trading firms will be impacted by Mifid II if their trading volume exceeds the thresholds set by the ancillary activity exemption according to Art. 2(1)(j) of the Revised Mifid. This market includes more than 700 firms, which are in most cases below the relevant thresholds. However, such firms must review their trading portfolios to monitor Mifid II compliance.

Given that the Swiss rules are currently not fully aligned with the rules of Mifid II, the Swiss financial markets legislation is under review with the aim of obtaining an equivalence decision by EU authorities, as needed to ensure full EU market access.

As regards the matters regulated by the Swiss Financial Market Infrastructure Act (FMIA), which entered into effect on January 1 2016, Swiss law is already aligned with Mifid II. The FMIA regulates financial market infrastructures (regulated markets, multilateral trading facilities (MTFs), central counterparty clearing house (CCPs), trade repositories, securities custodians and payment systems); organised trading facilities; activities of systematic internalisers; pre- and post-trade transparency requirements; algorithmic trading; and the derivatives market, as far as the implementation of the G-20 commitments are concerned (clearing, reporting, risk mitigation and trading obligations).

The FMIA will be supplemented by a Financial Services Act (FSA) and a Financial Institutions Act (FIA), which are in the process of being debated in the Swiss Parliament (the debate in the second chamber starting on September 13 2017). The FSA will, as far as equivalence to Mifid II is concerned, align the conduct of business rules for offering financial services with the requirements applicable in the EU: client segmentation; disclosure of information; suitability and appropriateness checks; treating clients fairly; best execution; conflicts of interest; receipt and payment of inducements; documentation and accountability; organisational requirements; qualification of employees; and registration of front office staff.

The FIA will expand the scope of the current regulation of investment firms and the regulation of asset managers by introducing licensing requirements also for asset managers of portfolios not invested through collective investment schemes and trustees. It will further align the regulation of investment firms with the rules applicable in the EU. The FSA and FIA are scheduled to enter into force as of January 2019. In this article, we are discussing the rules of the FSA as currently proposed, subject to further amendments by the Swiss Parliament.

The FSA will apply to any person or entity that is a financial services provider (i.e. any person that is providing financial services in relation to financial instruments in the meaning of the FSA in Switzerland or to clients in Switzerland on a professional basis), a client advisor or a structurer of financial instruments. However, insurance companies and pension funds will be exempted. What constitutes financial services and financial instruments in the sense of the FSA will be aligned with the definitions of Mifid II.

Financial services providers will need to ensure that their processes are fully compliant with the new rules of conduct of the FSA (including for instance suitability and appropriateness requirements, information requirements, best execution and organisational requirements). This will also be relevant for non-Swiss financial services providers, even if they do not establish a Swiss presence but conduct their business on a mere cross-border basis in Switzerland.

Client advisors of non-Swiss financial services providers that are not subject to prudential supervision by a Swiss regulator would have to register with a client advisor registry in order to provide financial services in Switzerland. This registration obligation would also apply to such employees or agents that are resident or/and have their workplace outside of Switzerland. However, the exemptions to this obligation are yet to be defined in secondary legislation to the FSA.

Also, the offering of financial instruments to private clients will – in certain conditions – be subject to an obligation to make available a key information document.

Under the proposed FSA rules, financial services providers may only accept inducements by third parties if they either (i) inform the client before the provision of the relevant service or the relevant contract about inducements, including information on the existence, type and value of such inducements or – if not known at this moment – about the calculation parameters or (ii) pay any inducement received entirely to the client.

This disclosure obligation extends the scope of the case-law of the Swiss courts as applicable pre-FSA regarding inducements provided by third parties under investment management or advisory agreements and will apply also to execution-only relationships (for which the Swiss courts have not yet established such practice).

In several leading cases, the Swiss Federal Supreme Court held that financial intermediaries, as recipients of inducements, are subject to a duty of restitution based on the mandatory rules applicable to mandate agreements pursuant to Swiss contract law. According to such case-law, this duty may only be waived by the client if (i) the client has been duly informed of the existence and the scope (calculation basis, percentage or calculation parameters) of such inducements and (ii) the waiver has been expressly provided.

To the extent that the rules of the FSA regarding inducements will not be further amended in the legislative process, the Swiss framework deviates from the rules of Mifid II, where investment firms – provided that they are holding themselves out as providing investment advice independently – are not permitted to keep inducements, which are not classified as fees for services provided, irrespective of client waivers.

The proposed FSA rules do not provide for separate rules governing the receipt of research. However, this may become part of secondary legislation. In the absence of specific rules or guidance, the receipt of research should be addressed as the receipt of a non-monetary benefit or a soft commission, which may be classified as an inducement. Further to the general waiver requirement for inducements as set out above, the SFAMA Transparency Guidelines applicable to the fund industry require a full disclosure of soft commissions. This should generally be also taken into account when an investment firm receives research without paying a consideration.

Pricing research is generally compatible with the existing legal and regulatory frameworks.

While Swiss law does not include requirements on the unbundling of research and the way research should be paid for at present, to the extent that the receipt of research without payment is treated as a soft commission within the meaning of the SFAMA Guidelines, clients should be informed about the research received and an inducements waiver should be in place.

The types of activities most affected are those falling into the scope of the EU third country jurisdiction access rules as set out under 1.1 above.

A key challenge in the Swiss market with respect to trade reporting is to ensure compliance with the new reporting obligation applicable to derivatives transactions. As regards OTC derivatives with underlyings (exceeding 25%) traded on a Swiss regulated market or MTF, the new trade reporting requirements (Swiss equivalent of Art. 26 Mifir) will enter into effect as of October 1 2018. For other financial instruments traded on a Swiss regulated market or MTF, such reporting obligations already apply today, but will be aligned with Mifir as from January 1 2018 (e.g. requiring reporting of the identity of the beneficial owner of transactions). As regards the transaction reporting of derivatives (Swiss equivalent of Art. 9 Emir), these obligations have a different timeline (the obligations start to go live on October 1 2017 for large financial counterparties).

Pre-trade transparency requirements are new to the Swiss market and will apply for equities as of January 1 2018.

Swiss exchanges will have to obtain the recognition decision under Art. 23 Mifir to ensure that they may continue to be used as a trading venue for shares in the EU.

As regards investor protection rules, the Swiss rules proposed under the FSA will be closely aligned to those of Mifid II. However, in some respects, the Swiss rules are designed to be more liberal (e.g. allowing the sale of complex financial instruments to execution-only clients, limitation to appropriateness when advising on single investment only or regarding inducements).

Financial service providers will have to classify their clients as "private clients", "professional clients" or "institutional clients". The category of institutional clients will include financial services providers subject to prudential supervision and insurance companies. Clients are private clients by default if they are not institutional clients or professional clients (which includes pension funds, public law entities and corporate entities with professional treasury operations). The status of a qualified investor for the purposes of distributing funds, collective investment schemes as structured products includes also natural persons who entered into asset management mandates with financial institutions or qualifying external asset managers.

Assuming similar requirements as those specified under Mifid II are met, a private client may opt-out from its status into the status of a professional client. Conversely, professional clients may opt into the status of a private client. Similarly, institutional clients may declare to be considered as professional clients. A financial services provider must inform its professional and institutional clients about their opt-in possibilities.

The level of investor protection depends on the client classification:

FSA Obligations	Private Client	Professional Client	Institutional Client
Information obligations towards clients	Yes	Yes, but waiver possible	No
Obligation to provide key information document (where applicable)	Yes	No	No
Obligation to conduct suitability or appropriateness test	Yes	Yes, but assumption of necessary know-how and experience and financial suitability of investment risks	No
Documentation/accountability obligations	Yes	Yes, but explicit waiver possible	No
Transparency obligation	Yes	Yes	No
Best execution obligation	Yes	Yes	No
Organisational requirements	Yes	Yes	Yes
Professional qualification of client advisors	Yes	Yes	Yes

FSA investor protection requirements, such as best execution, appropriateness and suitability as well as information requirements are largely based on Mifid II. Investment firms will have to review their processes and documentation (including contractual documentation) to ensure a proper implementation of these requirements. Also, the further implementation of the requirements in self-regulatory codes of conduct (e.g. in respect of best execution the rules specified by the Swiss Bankers Association) should be considered further.

The alignment of Swiss law with Mifid II by implementing the FSA and the FIA should ensure the continued market access of Swiss firms to the EU. To the extent that the Swiss rules are more liberal than those of Mifid II (e.g. in respect of inducements), a risk would be that this may compromise the equivalence recognition of Swiss law. Also, a further risk could be that certain EU markets require a local on-shore presence for accessing retail markets in full.

As regards non-Swiss firms accessing the Swiss market, they should monitor to what extent they will be affected by new obligations arising from the FSA and the FIA (e.g. new conduct of business rules, registration requirements of front office staff).

About the author
		Olivier Favre Partner, Schellenberg Wittmer Zurich, Switzerland T: +41 44 215 5252 F: +41 44 215 5200 E: olivier.favre@swlegal.ch W: www.swlegal.ch Olivier Favre focuses on derivatives and structured finance transactions and advising clients on financial services, securities, commodities and fund regulation. He also advises clients on financing and capital markets transactions, on fintech solutions and on insurance regulatory matters. He acts for a broad range of clients, including financial institutions, buy-side firms, issuers, insurance companies and industry associations. Olivier is an authorised representative at the SIX Swiss Exchange. He studied law at the University of Zurich (lic. iur. 1998, Dr. iur. 2003) and at Harvard Law School (LLM 2004).

About the author
		Philippe Borens Partner, Schellenberg Wittmer Zurich, Switzerland T: +41 44 215 5252 F: +41 44 215 5200 E: philippe.borens@swlegal.ch W: www.swlegal.ch Philippe Borens' main areas of practice are banking and finance law, including the regulation of financial intermediaries and financial services, equity and debt capital markets, and investment law. He has authored and co-authored various publications in the field of Swiss securities law and competition law, and is a lecturer at the University of Zurich. Before joining Schellenberg Wittmer, Borens studied law at the University of Basel (lic. iur. 1993, Dr. iur. 1999) and the College of Europe in Bruges (LLM 1995). From 2013 to 2016, he was the managing director of Schellenberg Wittmer in Singapore.

About the author
		Vaïk Müller Senior Associate, Schellenberg Wittmer Geneva, Switzerland T: +41 22 707 8000 F: +41 22 707 8001 E: vaik.muller@swlegal.ch W: www.swlegal.ch Vaïk Müller advises on banking and finance law, in particular regulatory matters, financial services, derivatives, collective investment schemes and other investment products. He has a specific expertise on cross-border legal and regulatory issues (in- and outbound), advising in particular foreign investment firms, such as fund manager and banks as well as investors on Swiss applicable requirements. He is the author of several publications on financial regulations. Hi obtained his degree in law from the University of Geneva in 2005 and earned his PhD from the University of Zurich in 2015. He was admitted to the Geneva Bar in 2010.