On 30 June 2019, the European Commission did not extend the so-called equivalence recognition of the Swiss legal framework applicable to stock exchanges. As a reaction, the Swiss Federal Department of Finance activated countermeasures designed to protect Swiss financial market infrastructures, in particular Swiss stock exchanges. This article provides an overview of the events surrounding the equivalence of the legal and supervisory framework applicable to stock exchanges and further discusses key legal considerations relevant to financial market participants.

By Ramona von Riedmatten (Reference: CapLaw-2019-26)

1) The Equivalence Recognition by the European Commission and its Significance for Swiss Stock Exchanges

On 3 January 2018, the EU Markets in Financial Instruments Directive (2014/65/EU) (MiFID II) and the EU Markets in Financial Instruments Regulation ((EU) No 600/2014) (MiFIR) were implemented. Article 23 MiFIR introduced a so-called share trading obligation, which imposes a trading obligation for shares admitted to trading on a regulated market or traded on a trading venue in the European Union (EU). Under this obligation, EU investment firms are required to trade such shares only on a regulated market, multilateral trading facility (MTF) or systematic internaliser in the EU, or on a third-country trading venue considered equivalent in accordance with MiFID II. Consequently, EU investment firms may trade shares on Swiss trading venues only if the European Commission recognizes the equivalence of the legal and supervisory framework applicable to such Swiss trading venues in accordance with MiFID II (such equivalence recognition, the “Equivalence”).

Since most Swiss issuers currently have their equity securities traded on one or more EU trading venues (either at their request or, more often, based on an unilateral decision of the relevant trading venue and a sponsor firm), the EU share trading obligation applies to numerous shares issued by Swiss issuers and Equivalence is of importance for Swiss stock exchanges in order for EU trading participants to be allowed to continue accessing the Swiss market locally. Absent such recognition, EU investment firms are generally not permitted to place orders (either directly or through brokers) to trade shares on the Swiss stock exchanges SIX Swiss Exchange (SIX) and BX Swiss (BX). A non-recognition of Equivalence does therefore generally result in the order flows from EU investment firms being redirected from SIX and BX to EU trading venues and significantly reduces the liquidity of Swiss equity markets. Moreover, lacking Equivalence, EU investment firms’ options to buy on whichever exchange provides the more favorable price and to implement best execution are affected.

2) Recent Events in Connection with the Equivalence Recognition

Against the background of the approaching applicability of MiFID II / MiFIR, in December 2017, the European Commission recognized that the legal and supervisory framework applicable to SIX and BX was equivalent to the requirements imposed by EU securities laws. However, the European Commission’s decision was limited to a period of one year ending on 31 December 2018. The European Commission had indicated at the time that an extension of the applicability of its equivalence decision was, inter alia, subject to sufficient progress made towards an agreement establishing a common institutional framework between the EU and Switzerland, thereby provoking criticism about the linking of the technical equivalence decisions with non-related political matters.

One month prior to the expiration of the Equivalence and failing a positive decision from the European Commission with respect to the extension, the Swiss Federal Council announced that it had adopted special regulations designed to protect Swiss financial market infrastructures on 30 November 2018. More specifically, the Federal Council has adopted the Ordinance on the Recognition of Foreign Trading Venues for the Trading of Equity Securities of Companies with a Registered Office in Switzerland (ORFTV). 

In December 2018, the European Commission confirmed the extension of the Equivalence for another six months until 30 June 2019. Another extension going beyond such date has not been granted as of today.

On 24 June 2019, the Federal Department of Finance (FDF) announced that it will activate the protective mesure under the ORFTV as of 1 July 2019 in case the European Commission has not announced by then that it will extend Switzerland’s exchange equivalence in due course. Expecting that the European Commission would not grant extension in time, on 27 June 2019, the FDF confirmed that the protective measure will be activated as of 1 July 2019. 

3) The ORFTV in Detail

The key feature of the ORTFV is the duty of trading venues having their registered office outside of Switzerland (foreign trading venues) to obtain prior recognition from the Swiss Financial Market Supervisory Authority (FINMA) if equity securities of companies having their registered office in Switzerland and listed on a stock exchange in Switzerland or traded on a trading venue in Switzerland (Swiss listed equities) are traded at such foreign trading venues. This new recognition requirement is complemented by the possibility of temporary authorization for foreign investment firms desiring to participate in Swiss trading venues. 

a) Legal Basis and Objectives

The Federal Council introduced the ORFTV based on its competence for foreign relations under the Swiss Constitution, authorizing the Federal Council to issue ordinances and rulings without involving the Swiss Parliament where safeguarding of the interests of the country so requires. 

The objective of the ORFTV is that EU investment firms can continue to trade Swiss listed equities on Swiss trading venues which is only possible if in doing so, EU investment firms neither violate the EU share trading obligation nor Swiss law. 

In its communications, the FDF continuously emphasizes that the Federal Council’s primary objective remains to obtain an unlimited extension of Equivalence. 

b) Duty to Obtain Recognition for Foreign Trading Venues 

According to article 1 ORFTV, trading venues with registered office outside of Switzerland must obtain prior recognition from FINMA if Swiss listed equities are traded at such trading venues or if such trading venues facilitate the trading of Swiss listed equities. 

FINMA shall grant recognition if the foreign trading venue is subject to appropriate regulation and supervision and does not have its registered office in a jurisdiction that restricts its market participants in trading Swiss listed equities on Swiss trading venues and thereby significantly and adversely affects the trading in Swiss listed equities on Swiss trading venues (article 2 ORFTV). The FDF publishes a list of such restricting jurisdictions. The latest update of this list was published on 27 June 2019 and the only jurisdictions included in the list are the member states of the European Union. Consequently, no recognition can be granted to EU trading venues as of 1 July 2019.

Unable to obtain recognition from FINMA, EU foreign trading venues violate ORFTV and potentially face criminal liability (see paragraph d) below) if Swiss listed equities are traded on them. If EU trading venues want to comply with ORFTV, they must not permit the trading of Swiss listed equities (except for certain shares with dual listing). Given that the share trading obligation according to article 23 MiFIR only applies with respect to shares admitted to trading on an EU regulated market or traded on an EU trading venue, article 1 ORFTV generally results in non-applicability of the share trading obligation with respect to Swiss listed equities. Therefore, since 1 July 2019, EU investment firms can trade Swiss listed shares on (non-equivalent) Swiss trading venues without violating EU law. Further, the share trading obligation does not apply if the trading occurs non-systematically, ad hoc, irregularly and infrequently (article 23 (1) (a) MiFIR). Thus, even if a certain trading volume with Swiss listed equities remains on EU trading venues, EU investment firms can generally trade Swiss listed equities on SIX or BX and be in compliance with MiFIR. In summary, ORFTV provides a basis for EU investment firms to continue trading Swiss listed equities on Swiss trading venues, absent Equivalence, without breaching the EU share trading obligation. 

However, the share trading obligation still applies to equity securities issued by European issuers and such equity securities can no longer be traded by EU investment firms on Swiss trading venues despite the protective measure. Against this background, SIX Swiss Exchange suspended the trading of all listed shares in the “Sponsored Foreign Shares” trading segment starting from 1 July 2019 and ceased to offer Swiss EBBO service for on-exchange, hybrid trading of Swiss equity securities, which seeks to achieve trades at European best bid and offer prices on a best-effort basis (cf. https://www.six-group.com/exchanges/swx_messages/online/swx_message_201906281150_en.pdf)

Foreign stock exchanges do not require a recognition with respect to the trading of Swiss listed equities that were already admitted to trading or listed on the foreign stock exchange prior to 30 November 2018 with the consent of the relevant Swiss issuer, i.e., if the relevant Swiss issuer had a secondary listing in the EU at that time (article 1 (2) ORFTV). 

c) Temporary Authorization of Foreign Participants

Today, foreign participants at Swiss trading venues require an authorization by FINMA (cf. article 40 of the Swiss Financial Markets Infrastructure Act (FMIA)) and are subject to record-keeping and reporting obligations (articles 38 and 39 FMIA). In order to quickly enable EU investment firms (who used to trade Swiss listed equities on EU trading venues) to participate in Swiss trading venues directly (and not only via a Swiss broker) FINMA can, pursuant to article 4 ORFTV, temporarily grant authorization for up to one year and such newly authorized foreign participants have to fulfil their record-keeping and reporting obligations by August 2019 (with trades executed between 1 January 2019 and 31 July 2019 being recorded and reported retroactively by 1 October 2019). This possibility accounts for the surge of requests for authorization that may result from the restrictions imposed on foreign trading venues.

How many EU investment firms will make use of this temporary authorization is not yet clear. In many cases, firms wishing to trade in Swiss listed equities may simply choose to go through an existing participant on the SIX or BX, thereby avoiding (even the limited) administrative expenditure. In case the Equivalence will not be granted for a prolonged period of time, it is to be expected that more EU investment firms will likely make use of this opportunity.

d) Criminal Sanctions

The ordinance is deemed to be a financial market act (article 5 ORFTV). Therefore, the criminal provisions set out in the Swiss Financial Market Supervision Act (FINMASA) apply, providing for a prison term of up to three years or a monetary penalty of up to CHF 540,000 in case of intentional breach, or a fine of up to CHF 250,000 in case of negligence when carrying out without a recognition an activity requiring such recognition (article 44 FINMASA). 

4) Conclusion and Outlook

According to market participants neither disruptions nor illiquidity in stock trading were observed due to the activation of ORFTV in the first week of July 2019. In fact, trading turnover in Swiss shares on SIX during the month July 2019 was considerably higher compared to the average trading turnover in Swiss shares during the month July in the last ten years.

So far, the ORFTV has proven effective in protecting and safeguarding the functioning of Swiss stock exchange infrastructures. However, the long time effects of the ORFTV regime will materialize only over time and the full effect of the non-Equivalence and Switzerland’s protective measures depends on the duration of the current set-up in particular. Further remains to be seen to which extent foreign trading venues will comply with ORFTV and how effectively FINMA will be able to enforce it. 

In the context of the Swiss Equivalence discussions, the question arose, whether a withdrawal of equivalence from the UK trading venues could be used as a negotiating tool in the Brexit debate. Whilst commentators have different views on this, many of them doubt that the European Commission would choose the same approach in Brexit negotiations, particularly when taking into account that the UK stock market has approximately twice the size of Switzerland’s market, and further given the fact that UK clearing houses are and will continue to be a core part of Europe’s trading infrastructure. 

The ORFTV is time-limited until year-end 2021 and can also be repealed by the Federal Council before then. 

While market participants and market commentators currently find themselves somewhat in a “wait and see” situation, I can concur with what the Swiss Federal Council and the FDF repeatedly emphasized: an unlimited extension of the stock exchange equivalence is the preferred solution and best for all parties involved.

Ramona von Riedmatten (ramona.vonriedmatten@lenzstaehelin.com)