The Structured Products Law Review: Switzerland
The turnover of structured products issued or distributed by major financial institutions negotiated on the national and international markets amounts to 82 billion Swiss francs, and there are currently around 12,000 structured products in Switzerland tradable at SIX Swiss Exchange. This exceptional diversity makes it difficult for investors to compare products, which can lead to inappropriate investments due to misinformation.
Following the entry into force of the EU Prospectus Directive, MiFID II and PRIIPs regulations, and to harmonise the Swiss regulatory landscape with international standards, including OECD guidelines, Switzerland has revised its entire financial regulatory regulation. The Upper Chamber of the Swiss Federal Assembly approved, as a plenum in its 2016 winter session, draft acts for the Financial Services Act (FinSA) and the Financial Institution Act (FinIA). FinSA contains rules of conduct that financial service providers must observe with respect to their clients, including in respect of structured products. FinIA standardises the authorisations for financial service providers, including securities and issuing houses. Three ordinances – the Financial Services Ordinance (FinSO), the Financial Institutional Ordinance (FinIO) and the Supervisory Organisations Ordinance (SOO) – of 6 November 2019 supplement these laws.
On 1 January 2020, both acts and the three above-mentioned ordinances (New Regulation) entered into force. Thus, we primarily analyse structured products in Switzerland under the New Regulation in this chapter. In addition to the New Regulation, the Swiss Financial Market Supervisory Authority (FINMA) will pass a number of implementing provisions pertaining to selected, mainly technical issues. As a result, FINMA has published a new Financial Institutions Ordinance (FinIO-FINMA) as well as amendments to current FINMA ordinances and circulars. FINMA held a public consultation on the FinIO-FINMA, which ended on 9 April 2020.2 To date, FINMA has not yet communicated any timeframe as to when the FinIO-FINMA and amendments on FINMA ordinances and circulars will enter into force; however, we expect that they will be implemented before the end of the year.
Switzerland has so far been a playground with a light financial regulation of certain financial sectors such as asset management and advisory services, the distribution of products (with the exception of funds, which are over-regulated) and foreign advisers. There is currently no clear obligation to inquire about a client's knowledge and experience before entering into a transaction or to warn them of the risks arising from an inappropriate transaction. The New Regulation will address most of these concerns and codify some of the existing practice.
Unlike investment funds, structured products are not subject to a regulatory licence upon issuance: it is securities and issuing houses that are subject to regulatory approval and supervision. Disclosure rules are newly defined in the New Regulation. A distributor of structured products will be subject to a new requirement of being listed in an advisers register under the New Regulation. Foreign distributors will also need to register.
The Swiss regulatory system around structured products is further developed in this chapter.
Legal and regulatory framework
Financial market supervision is carried out by FINMA, which is structured as an independent, self-organised public law institution with its own legal personality.3 FINMA's role is therefore to supervise and monitor the proper application of the financial legislation, which aims at protecting creditors, investors and insured persons as well as ensuring the proper functioning of the financial market.4
Hence, FINMA supervises and carries out enforcement proceedings. It has jurisdiction to impose criminal sanctions when provided by law.5 Moreover, FINMA's mandate includes granting practice authorisations to the following financial institutions:
- securities dealers (which will be renamed securities firms under FinSA);
- insurance companies;
- fund management companies;
- custodian banks;
- asset managers of collective investment schemes (funds); and
- representatives of foreign collective investment schemes (funds).
These entities and actors will then be subject to ongoing prudential supervision by FINMA.6
Until the entry into force of the New Regulation on 1 January 2020, structured products were governed by the Swiss Collective Investment Schemes Act of 23 June 2006 (CISA), which had already been subject to several legislative modifications since that date. They are not per se submitted to the requirements applicable to collective investment schemes,7 even if there are many similarities between the two financial instruments.8 The only provision of CISA dealing with structured products is Section 5 CISA.9
In Switzerland, as in many other jurisdictions, structured products have been in the spotlight for several years. Following the 2008 financial crisis and the bankruptcy of the Lehman group, FINMA conducted a large-scale investigation into the distribution to retail clients in Switzerland of structured products that were guaranteed by the subsidiaries of Lehman Brothers Holdings Inc.10 Indeed, the fall of the Lehman group had significant repercussions on the Swiss financial centre. In particular, many retail investors had invested in products with guaranteed capital, and thus had suffered a substantial risk exposure with the insolvency of the Lehman group.11
At that time, structured products were considered a fashionable alternative to collective investments schemes. Even if the risk exposure was generally known, the probability of a failure of the reputable issuers was low rated.12 One thing led to another, and many banks were presenting structured products, including structured products with guaranteed capital, as prudent investments.13
Investigations revealed the existence of a big deficiency in the law: the former Swiss Federal Act on Collective Investment Schemes, in force at the time, provided that a simplified prospectus was to be made available at the issuance of a structured product in the secondary market phase.14 In the case of Lehman, however, the great majority of subscriptions took place on the primary market, between the publication of the offer and the issuance (i.e., at a moment when a prospectus was not yet required under the law).15
On the basis of these findings, FINMA concluded that, even if structured products with guaranteed capital were, as such, adapted to retail clients, the regulations of the time, and in particular those regarding investor protection provisions, were totally ineffective.16 Following FINMA's recommendations, the revised CISA, including the Section 5 that is currently found in the law, entered into force on 31 March 2013.17
Despite these legislative changes in 2013, the overall financial regulations in Switzerland, including the law on structured products, are still considered to be inconsistent and incomplete, particularly with regard to behavioural rules and financial products regulation.18 The Swiss obligations applicable to financial product prospectuses are very divergent and incomplete, and the information contained in prospectuses is often too detailed and not clear enough for customers.19
In respect of the above, the aim of the legislator when adopting FinSA and FinSO was to provide a clear and comprehensible framework for investors through imposing disclosure requirements on financial service providers.
In Switzerland, three different types of tax apply to structured products: income tax (collected at the cantonal and federal level), withholding tax and stamp duty. The system is extremely complex, as each tax depends on the type of structured product considered. For the purpose of this chapter, we present only a brief overview of the situation.
i Income tax
In general terms, income tax applies to all income of taxpayers, whether one-time or periodic payments.89 This includes returns on movable assets,90 whether in terms of the function of the type of structured product, as periodic interest or as the difference between the purchase and sale price.91
ii Withholding tax
Moreover, Switzerland levies a 35 per cent92 withholding tax on income from movable capital if a debtor is domiciled in Switzerland.93 The withholding tax is then reimbursed under certain conditions based on double taxation treaties or, when the investor is a natural person domiciled in Switzerland, at the end of the taxable benefit period.94
iii Stamp duty
Finally, stamp duty may apply to the issuance and trade of structured products depending on the composition of the underlying derivatives or securities forming the structured product.95 Assessing whether stamp duty applies is a very difficult exercise. In this respect, it is not advisable to self-assess a product: SIX Financial Information SA issues information as to the taxability of each product, and a reliance on SIX's tax indication is accepted and recognised by the tax administration.
If stamp duty applies, the rate is 0.15 per cent (0.075 per cent for each contracting party) if the structured product is considered as a Swiss security, and 0.3 per cent (0.15 per cent for each contracting party) if the structured product is considered a foreign security.96
Outlook and conclusions
The New Regulation is fresh in the industry's mind in Switzerland, given its implementation in January 2020. We will see how the entire framework plays out once the amendments to the FINMA ordinances and circulars, as well as the FinIO-FINMA, enter into force. The increase in reporting, disclosures and licensing requirements is likely to result in some players reconsidering their model, as has already been seen in the EU.
The New Regulation does not address the current lack of definition of structured product, but codifies the offering process and the disclosure requirements. To date, structured products remain excluded from the definition of derivatives in FMIA, but are nevertheless treated as such when listed on the Swiss Stock Exchange. It is too early at the time of writing to see how the courts in Switzerland will address this in light of the New Regulation.
1 Dominique Lecocq is the managing partner and Lucile Cesareo-Hostettler is senior associate and head of office at lecocqassociate.
2 FINMA press release dated 7 February 2020, FinSA/FinIA: follow-up regulation by FINMA.
3 Section 5 of the Federal Act on the Swiss Financial Market Supervisory Authority.
4 Section 4 FMSA.
5 Section 50(1) FMSA.
7 According to Section 5(4) CISA, in all other respects, structured products are not governed by this Act.
8 Beguin, Nicolas/Richa, Alexandre, Le mandat de gestion de fortune, 2e Ed, Zurich, 2017, p. 2 and Gomez Richa, Lucia, Les produits structurés et la protection de l'investisseur, Zurich, 2015 p. 127.
9 Section 5 CISA and Chapelain de la Villeguerin, Donatienne/Mentha, Yves, 'La distribution de fonds de placements et de produits structurés in Services financiers: Suisse et Union européenne', DDE – Dossiers de Droit Européen Band, No. 31, Ed Kaddous, Christine/Matthey, Sylvain, Zurich, 2016, p. 124.
10 FINMA Report of 2 March 2010, Madoff Deal and Distribution of Lehman Products: Impact on Investment Advisory and Wealth Management Activities (FINMA report of 2 March 2010), p. 4/21.
11 FINMA report of 2 March 2010, p. 14/21.
12 FINMA report of 2 March 2010, p. 15/21.
13 FINMA report of 2 March 2010, p. 15/21.
14 Official Compilation of Federal Legislation (RO) 2013 585, p. 587.
15 FINMA report of 2 March 2010, p. 18-19/21.
16 FINMA report of 2 March 2010, p. 3/21.
17 RO 2013 585, p. 603.
18 Message from the Federal Council on the Financial Services Law and the Financial Institutions Act of 4 November 2015, (Message), p. 8,112.
19 Message, p. 8,112.
20 Section 3(a)(4) FinSA.
21 Section 3(a)(4) FinSA.
22 Beguin, Nicolas/Richa, Alexandre, Le mandat de gestion de fortune, Zurich, 2017, p. 25, Gomez Richa, Lucia, Les produits structurés et la protection de l'investisseur, Zurich, 2015, p. 23 and noted references.
23 Gomez Richa, Lucia, Les produits structurés et la protection de l'investisseur, Zurich, 2015, p. 88.
24 Beguin, Nicolas/Richa, Alexandre, Le mandat de gestion de fortune, Zurich, 2017, p. 25.
25 Messages, p. 8192.
26 Section 70(1) FinSA.
27 Section 70(1) FinSA.
28 Section 96(3)(a) FinSO.
29 Section 96(3)(b) FinSO.
30 Section 4(2) FinSA.
31 Section 5(2)(a) FinSA.
32 Section 5(2)(b) FinSA.
33 Section 5(5) FinSA.
34 Section 5(1-bis) CISA and Gomez Richa, Lucia, Les produits structurés et la protection de l'investisseur, Zurich 2015, p. 104.
35 Section 96(1) FinSO.
36 Message, p. 8,192 and BSK KAG-bishof/Lamprecht/Schwob /in, Art. 5 No. 23.
37 BSK KAG-bishof/Lamprecht/Schwob /in, Art. 5 No. 23.
38 Swiss Banking Act of 8 November 1934.
39 Section 5(1) FinSA.
40 Section 4(3) and (4) FinSA.
41 Section 70 FinSA.
42 Swiss Structured Products Association, FinSA Q&A dated 27 January 2020, p.9.
43 Swiss Structured Products Association, FinSA Q&A dated 27 January 2020, p.9.
44 Section 28(1) FinSA.
45 Section 31(1) FinSA.
46 FINMA press release dated 7 July 2020, Implementation of the FinSA/FinIA: FINMA authorises first supervisory organisations.
47 FINMA press release dated 7 July 2020, Implementation of the FinSA/FinIA: FINMA authorises first supervisory organisations.
48 Section 29(1)(a) and Section 6 FinSA.
49 Section 29(1)(b) and FinSA.
50 Section 29(1)(c) and Section 74 FinSA.
51 Section 29(2)(a) and (b) FinSA.
52 Under FinSA, financial service providers are persons who provide financial services in a professional capacity in Switzerland or to clients in Switzerland, and are therefore considered to professionally carry out any independent economic activity in order to obtain a regular income (Section 3(d) FinSA).
53 Section 8(1) and (2) FinSA.
54 Section 8(3) FinSA and Message, p. 8,123.
55 Section 60(1) FinSA.
56 Section 60(2) FinSA.
57 Section 58(1) FinSA.
58 Message, p. 8,169.
59 Message, p. 8,172.
60 Message, p. 8,172.
61 Message, p. 8,173 and Section 43 FinSA.
62 Section 51(1) FinSA.
63 FINMA press release dated 28 May 2020, FinSA implementation: FINMA licenses reviewing bodies for prospectuses.
64 Section 60 FinSO and Annex 7 FinSO.
65 Comments from the Federal Department of Finance on the Financial Services Ordinance, Financial Institutions Ordinance and Supervisory Bodies Ordinance of 6 November 2019, (Comments), p. 49.
66 Section 10 FinSA.
67 Section 13(1) FinSA.
68 Section 13(2) FinSA.
69 Swiss Structured Products Association, FinSA Q&A dated 27 January 2020, p.9.
70 Message, p. 8,158.
71 Gomez Richa, Lucia, Les produits structurés et la protection de l'investisseur, Zurich 2015, p. 261.
72 Section 69(1) FinSA.
73 Title 7 FinSA.
74 Gomez Richa Lucia, Les produits structurés et la protection de l'investisseur, Zurich 2015, p. 149.
75 Meylan Delphine/Ben Hattar Ariel, 'Le concept de dérivé dans la LIMF', GesKR 2018 p. 205 ss, 209.
76 SIX Swiss Exchange Ltd, Benchmark for Investment Strategies: SIX Structured Products Strategy Indices, 2019, p. 4 ss.
78 SIX Swiss Exchange Ltd, Benchmark for Investment Strategies: SIX Structured Products Strategy Indices, 2019, p. 2.
79 Section 27(1)FMIA.
80 Section 27(1) FMIA.
81 The SIX Swiss Exchange rules and regulations are available on its website.
82 SIX Exchange Regulation Ltd, Listing Rules, version of 1 July 2019.
83 Section 43 Listing Rules.
84 Section 45 Listing Rules.
85 Section 49 Listing Rules.
86 Sections 1 and 3 of the Directive CONNEXOR Listing Enhancement of 2 May 2019.
87 SIX Swiss Exchange's website.
88 Section 39 of the Additional Rules for the Listing of Derivatives.
89 Section 16(1) of the Swiss Federal Direct Tax Act of 14 December 1990 (FDTA).
90 Section 20(1) FDTA.
91 Informations fiscales, éditées par la Conférence suisse des impôts CSI, Traitement fiscal des obligations, produits dérivés et combinés, p. 16 ss.
92 Section 13(1)(a) of the Swiss Withholding Tax Act of 13 December 1965 (WTA).
93 Section 1(1) and 4(1)(a) WTA.
94 Section 22(1) WTA.
95 Section 13(2) of the Swiss Stamp Duty Act (SDA).
96 Section 16(1) SDA.