With effect from 18 March 2016, FINMA introduced a new circular on video and online identification and amended the circular regarding guidelines on asset management. These changes are a first step to develop technology-neutral regulation and to reduce potential hurdles to technological innovation in the Swiss financial sector.
By Katrin Ivell / Benjamin Leisinger (Reference: CapLaw-2016-21)
1) FINMA’s Position Towards Technological Innovations / FinTech Strategy
Back in September 2015, Mark Branson, the CEO of the Swiss Financial Market Supervisory Authority (FINMA), held a speech about technological change and innovation in the financial sector. Amongst others, he referred to financial technology – or FinTech – as an important new development. He reminded his audience that it was one of FINMA’s responsibilities as a supervisor to stay abreast of technological changes in the financial sector. In fact, Art. 5 of the Financial Market Supervision Act (FINMASA) states that one of the objectives of financial market supervision was to contribute to the competiveness of Switzerland’s financial centre.
One of the aspects mentioned by Mr. Branson was that regulation should be neutral with regard to technological change and should neither encourage nor hinder it. Mr. Branson also mentioned that it was vital to prevent the emergence of technology-based regulatory gaps which might threaten client protection and the financial system as a whole. Bearing this in mind, he said that FINMA had a vital interest in developing and adapting regulation to the needs of a digital world.
2) Indentifying Obstacles to Technological Innovation
According to a press release issued by FINMA on 17 March 2016, FINMA reviewed the existing regulation with a view to establishing whether specific provisions in the various FINMA ordinances and FINMA circulars disadvantaged some technologies. In FINMA’s view, very few such obstacles existed. One of the areas where FINMA identified potential for improvements without risking disadvantages to client protection and financial stability and security was the identification process for anti-money laundering purposes in the course of the onboarding of clients. In FINMA’s view, the new video and online identification circular, therefore, is an important step towards eliminating potential disadvantages to some technologies.
3) FINMA’s Video and Online Identification Circular (FINMA Circ. 2016/7)
Legally, FINMA circulars merely summarize FINMA’s practice. They do not create legally binding obligations vis-à-vis regulated entities or even third parties. Notwithstanding this, these circulars nevertheless play an important role in the Swiss financial market regulation – possibly similar to no action letters, interpretive letters, or exemption letters issued by the staff of the U.S. Securities and Exchange Commission, albeit not focused on a specific request as a no action letter but rather on a more generalized fact pattern or question of interpretation.
In publishing the new FINMA Circ. 2016/7 facilitating video and online client identification for know-your-customer and anti-money laundering purposes, FINMA took a first step to keep Mr. Branson’s word. FINMA’s new FINMA Circ. 2016/7 entered into effect on 18 March 2016 and sets out the anti-money laundering due diligence requirements for digital business. Unlike other jurisdictions, Switzerland heavily relied on in-person identification in face-to-face meetings for the identification of future customers in the onboarding process. In the past, the financial intermediary thus had to identify the contracting partner by inspecting an official identification document with a photograph (passport, identity card, driving license or similar document) and putting on record a copy of the identification document. Alternatively, when a business relationship was established by correspondence or via the internet, the bank had to verify the identity of the contracting partner by obtaining an authenticated copy of an identification document as mentioned before and checking the contracting partner’s address either by postal delivery or by another equivalent method (see Articles 9 and 10 of the Agreement on the Swiss Bank’s Code of Conduct with regard to the exercise of due diligence (CDB 16)). Quite obviously, this procedure could result in some obstacles for FinTech providers, i.e., providers of financial services that solely (or at least predominantly) rely on the internet or mobile apps to contact their clients and to communicate with them. In order to level the playing field and to foster technological developments, FINMA Circ. 2016/7 now provides for the possibility of financial intermediaries to on-board clients by means of video transmission and other forms of online identification.
Such video onboarding is subject to specific requirements, though. In order to be eligible, for example, the video identification must occur via live communication between the contracting party and the financial intermediary, and the technology used must ensure a secure transmission and the reading and deciphering of the information contained in the so-called Machine Readable Zone (MRZ) on the identification document. The quality of the live communication must be such that the flawless identification of the contracting party is possible. For purposes of the video identification, the full length of the discussion must be recorded. For purposes of identifying the contracting partner via video, the circular contains specific rules, including asking certain questions or paying attention to certain behaviours that should detect fraud. If the quality of the communication is not sufficient, if doubts exist regarding the authenticity of the identification document of the identity of the customer, or if the relationship is one of certain pre-defined increased risks , the financial intermediary must abort the online identification. In that case, the financial intermediary remains free, however, to refer the person to a traditional means of identification (face-to-face meeting, traditional identification by correspondence).
For legal entities or business partnerships, additional requirements apply. These requirements include excerpts from relevant registers and acknowledgment of the regulations for representation of the legal entity and identification of the persons acting on behalf of the legal entity.
For online identification, the circular contains rules on required documents in case of an onboarding by way of correspondence, or where the online identification occurs by means of an electronic copy of the identifying document. FINMA Circ. 2016/7 also includes provisions on the identification and declarations of beneficial owners and control persons. Finally, the FINMA circular clarifies how some specific provisions of the anti-money laundering ordinance of FINMA can be read (and fulfilled) in a technology-neutral way.
4) Guidelines on Asset Management (FINMA Circ. 2009/1)
The “Guidelines on asset management” circular (FINMA Circ. 2009/01) contained the requirement for written client identification for certain contracts. In light of the review of FINMA and the new FINMA Circ. 2016/7, this requirement was removed to make the regulations fully technology-neutral.
5) Is this Enough?
It remains to be seen whether the detailed rules set forth in the new FINMA Circ. 2016/7 do away with the hurdles for service providers in the FinTech world. According to FINMA’s report on the consultation comments received with respect to the circular, the idea was not to lower the requirements but to simply make them “technology-neutral”. In fact, for FinTech start-ups, the regulations can be difficult to comprehend – one of the reasons why FINMA introduced a specific section of FINMA’s website devoted to FinTech (https://www.finma.ch/en/authorisation/fintech/). In fact, while the consultation of the new FINMA Circ. 2016/7 was generally positively received, several submissions contained a request to reduce the stringent requirements and (perceived or existing) complexity of the existing regulation.
In light of these requests and the need for innovation to keep the Swiss financial market competitive, FINMA explicitly stated in its press release of 17 March 2016 that it supported the introduction of a new licensing category for financial innovators and a licence exempt area (so-called sandbox). The new licensing category would be for business models which carry out some banking activities, but with limited acceptance of client assets and no lending activity. In FINMA’s view, because the risks are lower and the scope of business limited, the licensing requirements would be less extensive than for a banking licence. For example, financial services providers that do not accept more than CHF 50 million in deposits could apply for this type of financial innovators’ licence provided they hold 5% of the deposits and at least CHF 300,000 capital as collateral. The issuance of such licences would lower the entry threshold for providers of payment systems, applications for managing assets digitally and crowdfunding platforms. The sandbox, i.e., a fully licence-exempt environment would be conceivable in FINMA’s views particularly for start-up companies, up to a deposit threshold of CHF 200,000 and irrespective of the number of depositors. According to the press release, FINMA is currently discussing a range of ideas with the banking sector and the competent authorities.
It remains to be seen how far FINMA and the legislator are actually willing to reduce regulatory hurdles in order to further incentivize technological innovation in the Swiss financial sector.
Katrin Ivell (katrin.ivell@homburger.ch)
Benjamin Leisinger (benjamin.leisinger@homburger.ch)