Switzerland’s Financial Sector on the Move: Gearing up for Reform

Switzerland has never been renowned for fast-paced political reform processes, to say the least. However, at present, there are unmistakable signs of change in the Swiss financial sector: the ratification of the Hague Convention on the recognition of trusts, the introduction of a central regulatory body, and most importantly in September 2007, the launching of a comprehensive reform package by the financial sector to make Switzerland’s financial sector more competitive.

The Hague Convention

On July 1, 2007, Switzerland’s ratification of the Hague Convention on the International recognition of trusts entered into force. Unlike other countries, which have already ratified the Convention, Switzerland has also introduced specific rules in its private international law dealing with the international jurisdiction and the recognition/enforcement of judgments in trust-related matters. The ratification of the Hague Convention creates a firm legal basis for Switzerland’s growing trustee business. The Swiss government has also enacted parallel amendments to Swiss federal legislation on international private law, and debt enforcement and bankruptcy. On the international private law level, there is freedom of choice with respect to a legal forum. For example, a beneficiary may sue a Swiss trustee in Switzerland and, in the absence of a trust jurisdiction clause, also in the jurisdiction by whose laws the trust is governed. On the other hand, it shall be possible for Swiss trustees to apply to the courts of that other jurisdiction. As regards debt enforcement and bankruptcy, the Swiss government amended the federal debt enforcement and bankruptcy act to explicitly distinguish between the personal Assets of the trustee and the trust in Swiss based debt enforcement proceedings, even though Articles 11(a) and (b) of the Hague Convention state that the recognition of the trust concept must imply in particular “that the personal creditors of the trustee shall have no recourse against the trust assets, and that the trust assets shall not form part of the trustee’s estate upon his insolvency or bankruptcy”.

Although, in the past, trusts were already broadly recognised by the Swiss courts, the legal situation remained encumbered with considerable uncertainty. There is obviously a significant economic interest in greater legal certainty, particularly as a solid legal foundation creates a better climate for the setting-up and administration of trusts in Switzerland, and thereby promotes the country’s appeal as a perfect location for private wealth management.

A New Regulator Combining the Activities of Three Watchdogs

The new Federal Financial Market Supervisory Authority (FINMA) will become operational in 2009. Finally, following years of political wrangling, FINMA will group together the regulatory work of the Federal Banking Commission, the Federal Office of Private Insurance, and the Money Laundering Control Authority.

FINMA will be established as an institution under public law, which has functional, institutional, and financial independence, and a modern management structure with a governing board, executive management and an auditing body. FINMA’s independence, on the other hand, calls for accountability and political supervision by the Confederation. FINMA personnel will be employed under private law. This ‘ties in’ with the regulations agreed for the Audit Supervision Authority which has yet to come into existence.

Along with organisational issues, the Financial Market Supervision Act (FINMA Act) also contains principles on financial market regulation and rules on liability, as well as harmonised supervisory instruments and sanctions. The FINMA Act effectively has the function of an umbrella law for the other laws covering financial market supervision.

However, the legally-defined task of the supervisory authority remains the same, and the particulars of the different supervisory sectors have been taken into account. Thus, the banks still have to fulfil the requirements of the Banking Act, insurance companies must fulfil those of the Insurance Supervision Act, the investment funds those of the Investment Fund Act, and so on. Even the system of self-regulation in accordance with the Money Laundering Act and the Stock Exchange Act will be retained.

One of the Top Three Financial Centres by 2015

Although there is no direct causal link, it is interesting that the nascent FIN MA coincides with the most ambitious reform package ever launched by the Swiss financial sector as a whole. The general purpose of the reforms is to catapult Switzerland to the top three of the Financial Centre ‘league’ within the next eight years.

This master plan was presented in September 2007 by the newly restructured Swiss stock exchange, together with leading players in the banking, insurance and fund management sectors. It painted a bleak picture of the traditionally strong Swiss financial sector.

As can be seen in the graph on page 145, the Swiss financial sector has slipped from second to sixth place internationally in the past two decades. It is hoped that the proposed reform measures would directly create at least 80,000 new jobs, and inject CHF70bn into the economy.

The rate of wealth creation in Switzerland has dramatically slowed since the 1980s, while in the largest markets, New York and London, growth has rocketed by 7 to 9 per cent. A raft of lost opportunities relating to foreign exchange trading, commodities trading, hedge funds, and alternative investments have contributed to the malaise.

“Given the increased competition between financial centres, growth in Switzerland can be expected to slow further if nothing is done to turn the situation around,” said stock exchange chairman, Peter Gomez. The advocates for reform further emphasise that Switzerland must improve research and education, implement stronger regulation to enhance transparency and supervision, have better collaboration between the finance industry and politicians, while overhauling taxes and infrastructure.

In addition, a closer interaction between the various finance industries in Switzerland is expected to attract more skilled workers, encourage hedge funds to ‘set up shop’ in Switzerland, attract more venture capital, and give Swiss firms access to the international pension fund business.

The aim of the proposed reform measures is to double the financial sector’s contribution to Switzerland’s gross domestic product (GD P) to CHF140bn, increasing its slice of the total GD P from 15 per cent to 30 per cent, and adding somewhere between CHF11bn and CHF17bn in new tax receipts. The focus of the proposed reform measures is on the following eight areas of business:

• private banking
• retail banking
• investment funds
• pensions business
• hedge funds
• private equity
• Swiss capital market
• commodity trade finance.

These eight areas of business have been analysed in detail as part of a broad study.

Developments in the different segments over the last ten years have been compared with those seen in the Swiss financial centre’s direct competitors (London, New York, Luxembourg, Singapore, Ireland). This comparative geographical analysis has been used to form a clear picture of the prospects for the future, and to determine what action is needed in the different areas of business in order to enhance the competitiveness of the Swiss banking sector.

On this basis, more than seventy specific institutional, regulatory, and tax related measures have been drawn up, of which, after careful deliberation, twenty were given priority status and included in this position paper. Core elements of these proposed measures aimed at realising the growth potential of the Swiss financial centre are:

• strengthening competitiveness in tax matters
• strengthening competitiveness through appropriate implementation of international standards while maintaining bank-client confidentiality
• fostering the effectiveness of the authorities in matters relating to Switzerland as a financial centre
• fostering the attractiveness of Switzerland for collective investment schemes
• improving the framework conditions for trusts and foundations
• making the regulatory framework more flexible for pension funds business.

In order to enhance the competitiveness of the Swiss financial centre, banks and other financial intermediaries aim to ensure that new business opportunities can be tapped and effectively exploited. In this context, they need to pay particular attention to the maintenance of strict financial privacy rules, outstanding advisory and service quality, innovation and technology, and to enhance and defend its overall attractiveness as a ‘location of choice’ for internationally-mobile and highly qualified employees.

One of the most remarkable aspects of this reform package is that it goes far beyond the traditional, limited defensive strategy related to banking secrecy and asset management. Rather, it is an offensive approach, and recommends very specific regulatory and fiscal actions with the aim of establishing Switzerland as a top world player with regard to traditional mutual funds, hedge funds, and private equity, and to retain and further sharpen its competitive edge in such areas as commodity trade finance.

Among the suggested measures are the abolition of stamp duty, clarifying/ simplifying the tax treatment of trusts, establishing a clear and internationally competitive tax framework for hedge fund/ private equity managers, facilitating hedge fund registration, increasing investment rule flexibility for qualified investors, ensuring pragmatic approval practices by the authorities, and protecting/enhancing client privacy and confidentiality.

Adopting all of these reforms will certainly meet some political resistance. However, the sheer scope and depth of the proposed reforms is an event in itself. Although not directly related, or specifically advocated, the Swiss federal government announced a reduction in the corporate tax rate from 8.5 per cent to 5 per cent as this article went to print.