By Jürg Frick / Tobias Aggteleky (Reference: CapLaw-2015-59)

1) Investor Protection as Key Objective of Swiss Collective Investment Schemes Regulation

Investor protection is one of the key objectives of Swiss financial market regulation, including the regulation of collective investment schemes (article 5 Financial Market Supervisory Act; article 1 Collective Investment Schemes Act (CISA)). The goal is not to protect Swiss investors against losses as such, but to protect them against risks inherent in the fact that funds from unrelated investors are pooled and managed by a third-party for the account of such investors (Fremdverwaltung). Such management of assets by a third-party results in a principal-agent relationship including its inherent information asymmetries and the risk of opportunistic behavior by the agent or, for that purpose, the fund management company or the asset managers of the respective collective investment scheme.

2) Limitations on Scope of Application of CISA

Even though the Swiss legislator may be tempted to protect Swiss investors against any and all kinds of improper fund activities, including risks associated with investments in foreign collective investment schemes, CISA and its investor protection regulations may only be invoked within the boundaries of its scope of application. In general, the scope of application of administrative laws, including financial market regulation, is subject to the following limitations: (i) subject matter of the law: the respective regulation shall only govern certain facts, situations or activities, e.g. the distribution of foreign collective investment schemes (Sachlicher Anwendungsbereich); (ii) addressees of the law: the regulation shall only apply to certain persons, be it natural persons or legal entities, e.g. financial intermediaries distributing foreign collective investment schemes in Switzerland (Persönlicher Anwendungsbereich); (iii) time limitations on applicability of the law: new regulation shall only be applicable as of its enactment, taking into account transitional periods set forth in the respective laws (Zeitlicher Anwendungsbereich); and (iv) territorial limitations on applicability of the law: the regulator shall only impose regulations on persons being resident or domiciled within the frontiers of its jurisdiction (Territorialer Anwendungsbereich).

The subject matter of this article shall be the territorial scope of application of CISA. In accordance with the so-called principle of territoriality (Territorialitätsprinzip), CISA shall only apply to persons being resident or domiciled or acts taking place within the frontiers of Switzerland. For instance, Swiss collective investment schemes subject to CISA regulations shall only be collective investment schemes having their registered office or their main administration office in Switzerland (article 2 (1)(a) in conjunction with article 119 (1)(a) CISA). Furthermore, foreign collective investment schemes shall only become subject to Swiss regulation if they have a relevant connection to Switzerland, which may be that they are distributed in Switzerland (article 2 (1)(b) CISA).

As a consequence, CISA only protects investors investing in foreign collective investment schemes if the distribution of the shares or units in the respective collective investment scheme took place in Switzerland. As a consequence, provided distribution of a foreign fund occurred in Switzerland, CISA applies irrespective of whether the investor investing in such fund is a Swiss investor or a foreign investor.

This rule can be illustrated by the following examples: In the case of a foreign investor passing through Zurich Airport and receiving a call from a distributor, the offered foreign collective investment scheme falls within the scope of CISA even if the foreign investor picked up the phone in Switzerland by mere coincidence. Equally, the fact that a Swiss investor – regardless of how this term is defined – receives a call or an e-mail while being on holiday outside Switzerland renders the CISA inapplicable. Finally, where the asset manager of a Swiss investor travels abroad to purchase shares of a foreign collective investment scheme on behalf of his or her client, the latter does not enjoy protection by CISA – even if the asset manager went abroad for the sole purpose of evading Swiss regulations.

3) The Doctrine of Effects and its Recognition in Switzerland

The randomness by which the applicability of CISA is determined at times as well as the ease by which it can be circumvented raise questions regarding the principle of territoriality as sole and decisive criterion defining CISA’s scope of application. In particular, if Swiss interests are at stake it is questionable whether CISA protection should in fact be confined to the frontiers of Switzerland.

The aforementioned unwelcome consequence of the principle of territoriality, or an overly strict application thereof, has long been recognized (DFC 133 II 341 et seq.). As a result, the doctrine of effects (Auswirkungsprinzip), complementing the principle of territoriality, has been acknowledged.

Pursuant to the doctrine of effects, a particular provision or an entire act may apply to facts occurring abroad where these facts have an effect on interests within the legislating state’s domain. Most prominently, the doctrine of effects is applied in antitrust legislation. Article 2 (2) of the Cartel Act stipulates that “[it] applies to practices that have an effect in Switzerland, even if they originate in another country.”

However, the application of the doctrine of effects is not limited to antitrust legislation; several financial market laws and regulations around the globe determine their territorial scope of application, at least partly, in accordance with the doctrine of effects. As for derivatives regulation, article 28 (2) of the Markets in Financial Instruments Regulation (MiFIR), concerning the obligation to trade on regulated markets, sets forth that “[t]he trading obligation shall also apply to third-country entities […] provided that the contract has a direct, substantial and foreseeable effect within the Union […].” Equally, article 4 (1) (a) (v) of the Derivatives, Central Counterparties and Trade Repositories Regulation (EMIR) asserts that clearing obligations as set out in this act apply to all OTC derivative contracts “between two entities established in one or more third countries […] provided that the contract has a direct, substantial and foreseeable effect within the Union[…].” Similar language may be found in article 4 (12) EMIR. The same applies in the United States: According to § 722(d) of the Dodd-Frank Act, “Provisions relating to swaps do not apply to activities outside the United States unless those activities (1) have a direct and significant connection with activities in, or effect on, commerce in the United States; […]”. Finally, in Germany the doctrine of effects is generally recognized as the primary rule to determine the territorial scope of financial market laws (see Eva-Maria Köpfer, Anwendung und Auswirkungen des Europäischen Kapitalmarktrechts auf Akteure aus Drittstaaten – Eine Analyse auf Basis der Umsetzung ins Deutsche Recht und der Auswirkungen auf die Schweiz, Diss., St. Gallen 2015, p. 116).

Even though Swiss financial market laws do not expressly stipulate the doctrine of effects, it may still be relied upon: pursuant to the Swiss Federal Supreme Court, Swiss public law may be applicable to facts occurring abroad but having a sufficient effect on Swiss territory, even in the absence of a provision expressly providing for such extraterritorial application (cf. DFC 133 II 331, 342 C. 6.1). In order for such extraterritorial application to be justified, it has to ensure the protection of legitimate Swiss interests. In line with this finding, the Swiss Federal Administration Court recently found in its decision B-5281/2012 of 24 September 2014 that the doctrine of effects is applicable in the context of Swiss financial market legislation. Therefore, Swiss financial market laws may have an extraterritorial application based in the doctrine of effects, provided that legitimate Swiss interests are protected (FAC Decision 5281/2012 C. 4.3.5).

4) Investor Protection as Legitimate Swiss Interest

So far, no general rule has been developed as to what qualifies as legitimate Swiss interests that merit the application of Swiss regulations to facts which occurred outside Switzerland, but had an effect on Switzerland. The applicability of the doctrine of effects can only be determined on a case-by-case basis, the purpose of the respective law being the critical criterion. In the context of financial market legislation, the Swiss Federal Administration Court held that protection of the creditors, protection of the investors and protection of the functioning of the financial market as such are legitimate Swiss interests (ibid.). In other words, investor protection may qualify as legitimate Swiss interest justifying the extraterritorial application of Swiss financial market regulation.

This finding holds particularly true for the CISA as it expressly recognizes investor protection as a primary objective. Moreover, the Federal Supreme Court held that investor protection is to be taken into consideration when determining the scope of application of the Investment Fund Act, CISA’s predecessor (DFC 110 II 74, 81 C. I.3; cf. also Verfügung der Übernahmekammer der Eidg. Bankenkommission vom 30. September 1999 i.S. LVMH Moët Hennessy Louis Vuitton, Paris und TAG Heuer International SA, Luxemburg regarding the scope of the Stock Exchange Act).

The fact that only the protection of legitimate Swiss interests warrants an extraterritorial application of a particular law, leads to the question under what circumstances the protection of investors qualifies as Swiss interest. It seems likely that the respective investors must have a genuine connection to Switzerland in order to justify such extraterritorial application of Swiss law (cf. Erläuterungsbericht zum Bundesgesetz über die Finanzdinestleistungen und Bundesgesetz über die Finanzinstitute of 25 June 2014, p. 164; seemingly dissenting: FAC Decision B-5281/2012 C. 4.4.3). Nationality as connecting factor being out of the question, the domicile of an investor remains the only option. Given that the domicile of the person is generally recognized as connecting factor in private international law, it also seems to be a reasonable option.

With regard to the distribution of foreign collective investment schemes, this finding is further corroborated by the fact that the Directive on Alternative Investment Fund Managers (AIFMD) governs marketing to investors domiciled or with a registered office in the European Union irrespective of where the distribution takes place (article 4 (1)(x) AIFMD). Germany, for instance, has implemented this provision in § 293 (1) of its Investment Code defining the term distribution in an equal manner.

The consequence of the definition of legitimate Swiss interests would be that investors domiciled in Switzerland were generally protected by the CISA, irrespective of the origin of the collective investment scheme and of where the distribution takes place.

5) Desirability of an Extraterritorial Application of the CISA

a) General Pros and Cons of the Doctrine of Effects

At times, Swiss case law referred to investor protection in order to justify the extraterritorial application of Swiss financial market law (cf. supra 3.). But Swiss courts have done so in specific cases only and never suggested a general application of the doctrine of effects in financial market law. Similarly, only few Swiss authors expressly spoke out in favor of it (cf. Pascal Rüedi, Der örtliche und sachliche Anwendungsbereich des Schweizer Übernahmerechts, Diss., Bern 2011, Rz. 141). Given that the majority of German authors recognizes the doctrine of effects as prime criterion to determine the territorial scope of financial market legislation, this reluctance is rather surprising.

The main advantage of the doctrine of effects is that it harmonizes the application of a law with its objectives. CISA would be applicable to all circumstances warranting such application in order to protect Swiss investors – or the stability of the Swiss financial market as the second key objective of the CISA. As a consequence, investor protection could be ensured in a comprehensive manner. In addition, extraterritorial application of investor protection provisions impedes regulatory arbitrage.

On the other hand, the doctrine of effects may lead to a lack of predictability and, consequently, a lack of legal certainty. Depending on the definition of “effect”, the doctrine may lead to all but unlimited applicability of some financial market provisions: The global financial market is not separated by borders and there is a frequent interaction between actors from different jurisdictions. Therefore, an average transaction will often have an effect on several jurisdictions. An overly broad definition of “effect” would result in the applicability of several different laws which, in turn, would lead to undesirable conflict of laws issues.

However, two aspects have to be clarified with respect to this argument: First, the doctrine of effects comes into play only if, from a Swiss law point of view, the applicable foreign law does not sufficiently protect Swiss investors. In case that the applicable foreign law, however, provides for an equivalent standard in terms of investor protection, no legitimate Swiss interests will warrant an extraterritorial application of CISA in the first place. The potential circumstances under which the doctrine of effects may have an impact are thus limited. Second, irrespective of the doctrine of effects, Swiss financial market law, and anti-money laundering law as well as bank insolvency law in particular, contains provisions that apply globally (cf. article 5 and 6 of the Anti-Money Laundering Ordinance and article 3 of the Bank Insolvency Ordinance both issued by the Swiss Financial Market Supervisory Authority, FINMA). These provisions have not lead to unsolvable problems in the past.

b) The Consequences of an Extraterritorial Application of the CISA

Since Swiss collective investment schemes are mandatorily governed by the CISA (cf. supra 1.), an extraterritorial application would exclusively affect foreign collective investment schemes. Particularly, the distribution of foreign collective investment schemes to Swiss investors outside Switzerland could regularly trigger the extraterritorial application of CISA. In such a case, provisions of CISA concerning the distribution of foreign investment schemes in Switzerland should be applied per analogiam.

Coming back to the example of the asset manager travelling abroad, the consequence of an extraterritorial application of CISA would be that even though not being distributed in Switzerland, the acquired foreign collective investment scheme would have to appoint a Swiss representative and paying agent as well as to ensure that the designation of the collective investment scheme does not provide grounds for confusion or deception (article 120 in conjunction with article 120 (2)(c) and (d) in conjunction with article 10 (3ter) CISA per analogiam). Where the investor on whose behalf the asset manager is acting has opted-out within the meaning of article 10 (3ter) CISA, the distributed foreign collective investment scheme would additionally require an approval by FINMA (article 120 (1) CISA per analogiam).

As for the Swiss investor being distributed a foreign collective investment scheme while on holiday outside Switzerland, he or she would be equally protected by article 120 CISA. In contrast, a foreign investor passing through Switzerland would not enjoy protection under the doctrine of effects – unless other legitimate Swiss interests, such as market integrity, would be affected.

The downside of such application of article 120 CISA would be that investor protection rules generally act as a market entrance barrier for foreign collective investment schemes. Particularly the requirement to appoint a Swiss representative and a Swiss paying agent is sometimes conceived by foreign collective investment schemes as being overly burdensome. The extraterritorial application of CISA could, therefore, have a repelling effect on distributors of foreign collective investment schemes in the sense that they would be more reluctant to distribute their funds to Swiss investors. The result would be a limitation of the investment universe available to Swiss investors.

6) Conlcusion

In sum, we conclude that CISA’s scope of application is not strictly limited by the principle of territoriality and confined to the frontiers of Switzerland, but that the doctrine of effects may warrant the application of CISA investor protection also, for instance, to the distribution of foreign collective investment schemes to Swiss investors even though distribution took place outside of Switzerland. Such extraterritorial application may be justified if Swiss interests were negatively affected, should CISA investor protection regulations not be applied. However, Swiss interests should never be affected in case Swiss investors would equally be protected by the relevant foreign law applicable to the distribution of foreign collective investment schemes.

Jürg Frick (juerg.frick@homburger.ch)
Tobias Aggteleky (tobias.aggteleky@homburger.ch)