The following article deals with the differences between the rules of conduct under MiFID II and FinSA. In the first part, the initial situation is described. Subsequently, the individual differences are discussed in more detail. The main differences in regulation can be found in the areas of client segmentation, definition of the service types, appropriateness and suitability test and dealing with retrocessions.

By Peter Sester / Dario Sutter (Reference: CapLaw-2018-62)

1) Starting Point – desired equivalence of Swiss Financial Market Regulation

In addition to the creation of a level playing field for financial service providers and the improvement of the competitiveness of the Swiss financial sector, the main objective of the Financial Services Act (FinSA) is to improve customer protection, in particular through the instrument of codes of conduct. The goal of ensuring access to the EU internal market should not be underestimated: the increasing international integration of financial markets forced the European Union to introduce a so-called third-country regime. While under MiFID I, the third-country regulations differed from one Member State to the other, MiFID II created a consistent regulatory framework. Market access for non-EU financial service providers is now equal across all Member States. In doing so, the EU requires either the establishment of a branch in the European Union and compliance with EU legal provisions or that the third country – such as Switzerland – has an equivalent financial market law. The EU is therefore examining whether Switzerland’s legal and supervisory framework is comparable to that of the European Union. If the equivalence exists, Swiss financial service providers would get an EU passport and could thus – without the need of establishing a branch – do business across the EU.

Driven by the fact that the access to the European market is of the utmost importance for Swiss financial service providers, Switzerland’s regulation of financial markets has changed considerably in recent years and today it offers a completely new architecture adapted to the EU law. This alignment of the Swiss financial market regulation with the EU regulations is carried out through the autonomous reproduction of European law by Switzerland. The autonomous reenactment can be achieved either through the unchanged or almost unchanged adoption of foreign law or through the creation of an equivalent legal framework.

The (only) temporary recognition of the equivalence of the Swiss stock exchange regulation by the EU following the introduction of the Financial Market Infrastructure Act (FMIA) made it once again clear that the access to the EU internal market is crucial for Swiss financial service providers. This market access would be easiest to achieve via a permanent equivalence recognition, which should now be achieved for the FinSA.

This article deals with the differences regarding the rules of conduct in the Swiss and European regulation. Thereby, the different regulations and definitions of the customer segments and service types are discussed. They are particularly important since they have an impact on the appropriateness and suitability test, which is then discussed in more detail. Furthermore, the differences regarding the treatment of retrocessions between the EU and Switzerland will be discussed.

2) Comparison of the Rules of Conduct according to FinSA and MiFID II

a) Customer Segmentation

Customer segmentation under FinSA and MiFID II is of particular relevance for the application of the Code of Conduct. Basically, both regulations are familiar with the following three types of customers: retail customers, professional customers and institutional clients. Retail customers are referred to as private customers (Privatkunde) in Switzerland (see article 4 (1) (a) FinSA), while the EU uses the term retail clients (Kleinanleger) (article 4 (1) (11) MiFID II). Retail customers in both jurisdictions are those customers who cannot be classified as professional customers. This group enjoys the highest possible level of protection. The second group consists of professional clients, while the third group is defined by both regulations as institutional customers, whereby this last customer segment is a subset of the second customer group – professional customers. In the EU, institutional clients are called eligible counterparties (see articles 4 (3) and 4 (FINSA) and Annex II (MiFID II)).

Both systems allow customer groups to switch to a higher or lower level of protection if certain conditions are met:

• In both jurisdictions retail customers can demand to be treated as professional clients. According to Annex II, MiFID II such an opt-up is possible if such retail customers (2 out of 3 points have to be fulfilled) (1) conduct an average of 10 trades a year, (2) have at least 500,000 Euros of bankable assets, or (3) have professional financial knowledge of one year or more. In Switzerland, an opt-out (which corresponds to the opt-up as defined by EU regulations) is possible if relevant knowledge is given and the private customer has bankable assets of at least CHF 500,000 or if a client has assets of at least CHF 2 million – whereby the criterion of knowledge is irrelevant. Thus, in contrast to MiFID II, the FinSA does not acknowledge the criterion of the number of investment activities carried out and the qualification as a professional client based solely on available assets is also not recognized by European regulation.
• Pension funds, occupational pension funds, and companies with professional treasury operations, according to article 5 (3) FINSA, are required to be treated as Institutional Clients. This is also possible for Swiss and foreign collective investment schemes (article 5 (4) FinSA).

Furthermore, according to MiFID II as well as to FinSA, there is the possibility for certain customer groups to benefit from the protection of the next lower customer group:

• In Switzerland professional clients who are not institutional clients can be treated as private clients (opt-in) (article 5 (5) FinSA).
• For institutional clients it is possible to switch to the protection level of professional clients (opt-in) (article 5 (6) FinSA).
• According to Annex II MiFID II, professional clients must also be able to benefit from the higher level of protection of the next-lower customer group (opt-down).

b) Definition of the service types

Concerning the segmentation of the different services, there is a difference between the EU and Swiss regulation regarding investment advice and execution-only services. On the other hand, portfolio management is treated similarly in both regulations, but in Switzerland the FinSA uses the term “Vermögensverwaltung”. In terms of investment advice, MiFID II relies on the criterion of independence regarding specific clients and the FinSA differentiates between whether the advice was given based on a portfolio context or if it was related to a single transaction. Execution-only business relationships are – in contrast to Switzerland – further subdivided across the EU by differentiating between complex and non-complex financial instruments.

c) Appropriateness and Suitability of Financial Services

The primary objective of both MiFID II and FinSA is to improve customer protection, which is achieved through the means of assessing appropriateness and suitability. First of all, both article 10 FinSA and article 25 MiFID II require financial service providers to carry out appropriateness and suitability assessments.

The appropriateness test regulated in article 11 FinSA refers to individual transactions carried out by the financial service providers and does not take into account the entire customer portfolio. In this purely transactional investment advice the examination of the appropriateness with regard to the investment objectives and the financial circumstances of the customer are eliminated; it is only checked whether the financial instrument is appropriate with regard to the knowledge and experience of the client. In doing so, the client advisor must inform himself about the knowledge and experience of the customer and check whether the recommended financial instruments are appropriate for the corresponding clientele. MiFID II does not recognize such a distinction, but always requires the full assessment of appropriateness and suitability in investment advice.

However, if a holistic investment advice or asset management service related to the client’s portfolio is provided, the suitability must be examined, part of which is the appropriateness test. In addition to the appropriateness test, however, the financial circumstances and investment objectives of the customer must also be taken into account in order to identify the suitability. The suitability test (article 12 FinSA) refers to investment advice taking into account the whole customer portfolio or the asset management in general. Hereby, the financial service provider should inquire about the financial circumstances and investment objectives as well as the knowledge and experience of the customer.

Moreover, article 13 FinSA regulates the exemptions from the obligation to prove suitability and appropriateness. For example, in the case of mere execution or submission of customer orders (i.e., execution-only), no appropriateness or suitability test must be carried out. According to paragraph 2, the client has to be informed that no such examination has been carried out. In contrast to the FinSA, MiFID II makes an additional distinction in article 25 (4) and assumes that the appropriateness test can only be skipped if it concerns non-complex financial instruments such as equities.

d) Treatment of Retrocessions

Article 17 FinSA establishes the principle of good faith in the processing of customer orders. In addition, the financial service provider must ensure that clients’ orders are executed in a manner that achieves the best possible result. From a financial point of view, not only the price of the financial instrument, but also the costs incurred by its execution and the compensation of third parties (e.g., retrocessions) must be taken into account. The acceptance of such third-party compensation is governed by article 26 FinSA; specifically, they must either be passed on completely to the customer, unless the customer having all relevant information willingly gives up his respective rights. While the FinSA, taking into account the case law of the Swiss Supreme Court, allows the receipt and retention of retrocessions under certain conditions, the requirements under MiFID II are so strict that withholding of retrocessions by financial service providers seems virtually impossible. MiFID II basically prohibits any retention of retrocessions. The only exception – depending on the type of service – would be if the retrocessions are non-monetary as well as insignificant or service quality improving (see article 24 MiFID II). However, it would be extremely difficult for financial service providers to bring the proof of evidence.

3) Conclusion

In view of the above stated differences, it remains questionable whether the parliament’s changes to the MiFID II-compliant draft will ultimately result in a non-compliant final version of the regulation. However, only full compliance with the EU law would lead to the recognition of the Swiss regulation by the EU and, therefore, to direct access to the EU internal market for Swiss service providers. This market access would lead to the fact that Swiss service providers would not need to deal with various different regulations, thus reducing the total costs of being compliant. Nonetheless, it is important for the Swiss financial sector, that EU regulations are only adapted to the level which is required by the European Union in order to receive equivalence acceptance and not beyond. Introducing an even stricter regulation than the one of the EU would only lead to a discrimination of Swiss financial service providers compared to those of the EU. It should also be noted that the FinSA regulation affects service providers that do not serve EU customers. In any case, institutions serving EU clients are expected to be MiFID-compliant since the Lugano Convention allows EEA clients to denounce a MiFID II infringement in a national court. Due to this fact, most of such financial service providers have already implemented EU-compliant business policies. A pragmatic solution would therefore be that the Swiss legislator not only accepts compliance with FinSA, but also with the more stringent MiFID II rules – in a way a reverse equivalence recognition. While this would allow the FinSA to be less restrictive and non-EU-serving institutions to not bother with stricter EU-equivalent regulation, it is important not to forget that customer protection is also an important topic within the Swiss financial industry.

Peter Sester (peter.sester@unisg.ch)
Dario Sutter (dario.sutter@unisg.ch)