Under the new Financial Institutions Act (FinIA) entering into force on 1 January 2020, portfolio managers and trustees will have to apply for a license with the Swiss Financial Market Supervisory Authority (FINMA) and become subject to ongoing prudential supervision by new supervisory organizations (SO). After the Swiss parliament passed the new legislation in June 2018, the Swiss Federal Department of Finance (FDF) released its draft implementing ordinance (Draft-FinIO) for consultation in October 2018. On 6 November 2019, the Federal Council adopted the final version of the Financial Institutions Ordinance (FinIO) as well as the implementing ordinance to the new Financial Services Act, and set the entry into force of the new regulation for 1 January 2020. The final FinIO contains various relevant changes for portfolio managers and trustees compared to the Draft-FinIO. Against the background of the imminent entering into force of the new legislation, the purpose of this article is to provide a summary of the license requirements for portfolio managers and trustees as well as the applicable transitional periods.

By Patrick Schleiffer / Ramona von Riedmatten  (Reference: CapLaw-2019-58)

1) Portfolio Managers and Trustees will be FINMA-licensed Entities

While the new FinIA will only bring limited changes to the regulatory landscape within which the already licensed Swiss financial institutions operate, the changes with respect to portfolio managers and trustees will be substantial. These previously unlicensed businesses will have to apply for a license with the Swiss regulator FINMA, and they will be subject to comprehensive licensing requirements. In addition, under the new law and regulations these businesses will be subject to ongoing prudential supervision by the yet to be established SO. Thus, the FinIA (and its implementing ordinance) will, for the first time, subject portfolio managers and trustees to license requirements and an ongoing prudential supervision. As a result, portfolio managers and trustees will generally be subject to the same type of rules that also apply to other financial institutions. Needless to say that this new regulatory framework is significantly different than the situation under current law, where these types of financial intermediaries were only required to register themselves with a self-regulatory organization (SRO) for purposes of compliance with the Swiss anti-money laundering laws.

a) Scope of the New Rules

The FinIA defines portfolio managers as someone that, based on a mandate agreement, can dispose of a client’s assets by way of the following activities: (i) purchase or sale of financial instruments, (ii) acceptance and transmission of client orders relating to financial instruments, (iii) management of financial instruments (asset management), or (iv) advice relating to financial instruments (investment advice). A portfolio manager has to deposit its clients’ assets segregated per client with a Swiss bank, a Swiss securities firm, or with an institution outside Switzerland, provided such institution is subject to an equivalent prudential supervision.

A trustee is defined under the FinIA as someone that based on a trust deed can dispose of the assets of a trust within the meaning of the Hague Trust Convention. This rather specific definition excludes other trust-related service providers, such as protectors, from the scope of application of the new licensing requirements. Also, persons providing similar types of services (e.g., nominee directors) will not be covered by the new rules.

The FinIA and the FinIO provide for certain exemptions with respect to the activity as portfolio manager or trustee. In particular, there will be exemptions for persons managing the assets of persons with whom they have “economic” or “family” ties. In this respect, the FinIO further specifies what is considered as “economic” or “family” ties (including a list of the relevant family relationships). Such exemptions allow, for example, single family offices to continue to operate without the need for a license. Multi-family offices can, however, generally not benefit from this exemption as they manage assets of a number of unrelated clients. Further, the FinIA and the FinIO also exclude from the licensing requirements persons that are acting based on a statutory mandate (e.g., guardians).

Further, no license is required where financial services or trustee services are provided exclusively to companies/entities within the same group of companies. Lastly, under the final FinIO, unlike under the Draft-FinIO, FINMA may exempt trustees, at their request, from obtaining a trustee license, if the trustee (i) is a trust company owned and supervised by a trustee that holds an authorisation from FINMA to act as trustee, and (ii) only acts as trustee of trusts which have been created by the same person or have been established for the benefit of the same family. This exemption covers the so-called “dedicated trust companies”.

In addition, in order to fall within the scope of the new rules, the activities of a portfolio manager and a trustee, respectively, have to be undertaken on a commercial basis. According to the FinIO, an activity is considered to be undertaken on a commercial basis if any of the following thresholds are exceeded: (i) annual gross earnings in excess of CHF 50,000, (ii) having relationships with more than 20 contractual counterparties in a calendar year, or (iii) assets under management/assets under trust in excess of CHF 5 million. These thresholds largely follow the rules already set out today in the current Swiss Anti-Money Laundering Ordinance and accordingly, as a rule of thumb, portfolio managers that are currently subject to the Swiss anti-money laundering obligations will also be subject to the licensing requirements under the FinIA and FinIO. However, the criterion that trustees and portfolio managers who execute transactions with an aggregate value of over CHF 2 million per year are acting on a professional basis, which was included in the Draft-FinIO (and which also had a corresponding model in the Anti-Money Laundering Ordinance), no longer appears in the FinIO. The revised, more narrow, definition of acting on a “professional basis” may in practice be relevant for private trust companies.

b) License Requirements

As a financial institution, a portfolio manager or a trustee has to meet the general licensing requirements applicable to all types of financial institutions as well as specific requirements applicable to portfolio managers and trustees. Among the general requirements are such things as (i) the requirement to manage the relevant company from Switzerland, (ii) “fit and proper” requirements with respect to the board of directors, senior management and qualified participants (i.e., each direct or indirect holding of 10 % or more of the voting rights or the capital), (iii) duty to notify FINMA of activities outside Switzerland, and (iv) the requirement to be affiliated with a mediation body.

Non-Swiss portfolio managers rendering their services on a pure cross-border (i.e., without permanently employing staff in Switzerland) to clients in Switzerland, will not need a license from FINMA. However, they will have to comply with the regulatory rules under the new Financial Services Act (FinSA). When providing financial services on a pure cross-border basis, the staff of non-Swiss portfolio managers (so-called client advisers) will further have to register in a new register of advisers in Switzerland and be obliged to meet the requirements for being registered (including having the necessary know how and skills to comply with the regulatory rules under the FinSA and being affiliated to an ombudsman in Switzerland) before providing financial services in Switzerland, unless the relevant non-Swiss financial service provider is subject to prudential supervision outside of Switzerland and its client advisors provide services in Switzerland exclusively to professional and institutional clients.

In terms of specific requirements, the following applies to portfolio managers and trustees:

– Affiliation with a supervisory organization:

Portfolio managers and trustees will have to apply for affiliation with one of the new SO (see section 2 below) which will be responsible for the day-to-day prudential supervision of the portfolio managers and trustees. The FinIO specifies that a portfolio manager or a trustee has a right to be affiliated to an SO (i.e., the SO has to accept the application for affiliation) if such portfolio manager and trustee has put in place internal regulations and an organization of its business that ensures compliance with the regulatory requirements (including those set out in the FinSA and those under the Swiss anti-money laundering laws, in each case to the extent applicable). In addition, the final FinIO states that the SO may make the affiliation dependent on portfolio managers and trustees being subject to a special professional secrecy. 

– Composition of the management:

Unlike other financial institutions (such as banks or securities firms), portfolio managers and trustees are not required to set up a two-tiered management structure. FINMA may, however, on a case-by-case basis require certain portfolio managers and trustees to put in place a two-tiered management structure with a board of directors (composed mostly of directors who are not part of the executive management) and an executive management. According to the FinIO, portfolio managers and trustees may become subject to such additional FINMA requirements if they have ten or more employees (full time) or annual gross earnings of at least CHF 5 million, and if required in light of the type and nature of their business. If a portfolio manager or trustee is able to establish that the proper continuation of the business is ensured with one qualified manager only, the two-tiered management structure cannot be imposed by FINMA. 

As a rule, the management of a portfolio manager or a trustee must be composed of at least two qualified individuals. An individual is qualified within the meaning of the FinIA if such individual has an adequate education and sufficient professional experience when taking over the management of a portfolio manager or a trustee. The FinIO further specifies the requirements in terms of education and professional experience. While the Draft-FinIO was much criticized in this respect, as it required that qualified managers had the same level of experience and qualifications as auditors that effect audits of trustees, the final version of the FinIO contains a different and clearer test. According to the FinIO, the requirements concerning education and professional experience are as follows (with FINMA having the power to grant exemptions on a case-by-case basis):

– professional experience of at least 5 years;

– relevant training in the area of portfolio management or trust matters of at least 40 hours; and

– obligation for ongoing training.

In line with European regulations, the FinIO also requires portfolio managers and trustees to set in place appropriate business continuity procedures in case of a prolonged absence or death of a qualified individual.

– Risk management, internal controls and compliance

A portfolio manager or a trustee will have to implement an adequate risk management and effective internal controls, including a compliance function. As a rule, risk management and compliance functions have to be independent from the business side.

Taking into account that internal control systems and compliance can be quite a burden for smaller companies, the FinIO provides for certain exemptions. More specifically, a portfolio manager or trustee does not need to have a risk management and compliance function that is independent from the business, if it:

– has annual gross earnings of less than CHF 2 million or no more than 5 employees (full time); and

– pursues a business model without increased risks.

On the other hand, where a portfolio manager or a trustee has a board of directors composed mostly of directors who are not part of the executive management and annual gross earnings of more than CHF 10 million, FINMA may require such portfolio manager or trustee to put in place an independent internal audit.

The risk management and compliance functions may be delegated to qualified third parties. Such delegation will be subject to the general delegation rules applicable to all financial institutions, including the requirements to have the necessary technical know-how and internal procedures to adequately supervise the delegated functions and to document the delegation in the portfolio manager’s or trustee’s organization documents.

– Minimum capital requirements:

Portfolio managers and trustees will be required to have a minimum capital of
CHF 100,000. In addition, they need to maintain additional equity in an amount equal to one quarter of their fix costs, but no more than CHF 10,000,000. The FinIO further specifies the requirement for additional equity as follows:

– The following qualifies as fix costs: (i) salaries (not including discretionary and/or performance-based bonus payments), (ii) operational costs, (iii) amortization of immovable property, and (iv) costs of valuation adjustments, provisions and losses.

– When calculating the additional capital, companies can take into account the following: (i) fully paid up capital, (ii) legal and other reserves, (iii) undistributed profits, (iv) certain latent/hidden reserves, and (v) certain subordinated loans (provided they have a minimum term of at least 5 years).

– On the other hand, when calculating whether the additional equity requirement is met, companies need to deduct (i) losses of the period and losses carried forward, (ii) goodwill, (iii) book value of participations, (iv) 20% of any subordinated loans during the 5 years preceding the reimbursement, and (v) certain other values as further set out in the FinIO.

– Finally, the FinIO states that a professional liability insurance can cover up to 50% of the additional equity requirement.

2) Supervisory Organizations

Under the FinIA, one or more FINMA-licensed privately organized SO will be responsible for the ongoing day-to-day supervision of portfolio managers and trustees. In terms of timing, the license applications for the new SO have to be filed with FINMA within six months of the entry into force of the FinIA (i.e., by end of June 2020) and FINMA will then have to decide on the license applications by the end of 2020.

Once operational, the SO will be responsible for the ongoing day-to-day prudential supervision of portfolio managers and trustees. As part of this supervision, an SO may conduct audits of portfolio managers and trustees themselves or they can require the portfolio managers and trustees to appoint an external auditor for purposes of the regulatory audit. This rule allows existing SROs with their own audit organization to continue to conduct their own audits (should such SRO decide to apply for a license as SO).

The SO will also have the possibility to reduce the audit frequency of the portfolio managers and trustees supervised by them. This risk-based approach allows smaller entities to benefit from a reduced supervisory burden. In years where there is no audit, the supervised entities will have to prepare and file a (standardized) report on their compliance with the relevant laws and regulations. FINMA will issue further regulatory guidance on the risk-based approach and the requirements for the standardized report.

As mentioned above, the SO will be responsible for the ongoing day-to-day prudential supervision of portfolio managers and trustees. Should an SO learn that a portfolio manager or a trustee does not comply with its obligations, it can set a deadline within which the respective portfolio manager or trustee has to remedy the situation. Other than that and a general right to obtain information from the supervised entities, the SO do not have any other supervisory or enforcement tools at their disposal. In particular, the SO will not be able to open their own enforcement action. Accordingly, if a supervised entity does not comply with its duties, the SO will have to notify FINMA who will then take up appropriate enforcement actions.

In order to avoid duplication of audit work and in order to ensure a harmonized supervision, it is expected that FINMA and the SO will issue further implementing regulations and that FINMA and the SO will coordinate their supervision work.

3) Transitional Period

Taking into account the amount of changes that the new regulatory framework brings to existing portfolio managers and trustees, the FinIA and the FinIO provide for rather long transitional periods. The transitional periods can be grouped in the following three different scenarios:

– Portfolio managers/trustees that are already operating at the time the FinIA enters into force (i.e., activities started before 1 January 2020):

Existing portfolio managers and trustees have to notify FINMA within 6 months of the entry into force of the FinIA, i.e., until 30 June 2020. Following this initial notification, such existing portfolio managers and trustees have to meet the license requirements and file a license application with FINMA within 3 years after the entry into force of the FinIA, i.e., until the end of 2022. Once a license application has been filed, such portfolio managers and trustees can continue their activities until FINMA has decided on the license application; provided, however, such portfolio managers and trustees are affiliated with an SRO for AML purposes.

– Portfolio managers/trustees that start their activities after 1 January 2020 but before the end of 2020:

These portfolio managers and trustees have to immediately notify FINMA of their activities and they have to generally comply with the FinIA licensing requirements from day one. The only exception is the requirement to be affiliated with an SO. For this obligation, the FinIA provides for a transitional period of one year following the point in time FINMA has authorized the first SO. At the same time, these type of portfolio managers and trustees also have to file a license application with FINMA. As is the case with the existing portfolio managers and trustees, once a license application has been filed, such portfolio managers and trustees can continue their activities until FINMA has decided on the license application; provided, however, such portfolio managers and trustees are affiliated with an SRO for AML purposes.

– Portfolio managers and trustees that start their activities after 1 January 2021:

All other portfolio managers and trustees, i.e. all that start their activities after 1 January 2021, first have to apply for a license and an affiliation with a SO. They may only start operating their business once FINMA has decided on the license application.

4) Conclusion

The FinIA provides for a number of significant changes to the regulatory framework within which portfolio managers and trustees will have to operate in the future. Most importantly, portfolio managers and trustees will be subject to stringent licensing requirements and ongoing supervision by yet to be established SO. However, the FinIO takes into account that many of the existing portfolio managers and trustees are smaller businesses with a lean management structure and accordingly, the implementing rules and regulations as currently provided for in the FinIO do provide certain regulatory flexibility. Furthermore, the transitional periods provided for in the FinIA allow for a gradual transition of existing portfolio managers and trustees into the new regulatory regime. It can however not be excluded that the custodian banks with which a portfolio manager deposits the assets of its clients will urge such portfolio manager to obtain the relevant license as soon as reasonably possible as the regulatory duties of a custodian bank towards a prudentially supervised portfolio manager will be less demanding than those in respect of a non-supervised portfolio manager during the transitional period.

Patrick Schleiffer (patrick.schleiffer@lenzstaehelin.com)
Ramona von Riedmatten (ramona.vonriedmatten@lenzstaehelin.com)