On 30 January 2023, the Swiss regulator FINMA published guidance 02/2023 with which it provided an update on the status of the licensing process for portfolio managers and trustees. At the same time, FINMA gave an outlook on its enforcement activities in 2023, which serves as a clear warning for those portfolio managers and trustees that continue to operate their business without the appropriate FINMA license.

By Patrick Schärli (Reference: CapLaw-2023-04)

1) Portfolio managers and trustees: overview of the new license requirements

With the entry into force of the Financial Institutions Act (FinIA) on 1 January 2020, Switzerland introduced for the first time a comprehensive licensing regime for portfolio managers and trustees. Prior to the entry of the FinIA, these type of service providers have been largely unregulated and were only subject to an obligation to affiliate themselves with a self-regulatory organization for purposes of anti-money laundering supervision.

Pursuant to the FinIA, a portfolio manager is a person that is mandated to manage assets on a commercial basis in the name of and on behalf of clients within the meaning of article 3(c)(1)-(4) of the Financial Services Act (FinSA). Breaking down this somewhat technical definition of the FinIA shows that the definition of portfolio manager consists of the following individual elements: (i) acting for a client, (ii) on a commercial basis, (iii) based on a mandate (which is required to be set out in a written contract), i.e. within a long-term relationship, (iv) which grants the portfolio manager power of attorney over the client’s assets, and (v) relates to financial instruments within the meaning of the FinSA. If one or more of these elements are not present (e.g. because the service provider does not have the power to dispose of the client’s assets), the relevant activity is not subject to the FinIA licensing requirements for portfolio managers. Moreover, the FinIA provides for a number of exemptions from the licensing requirements, including for statutory mandates (such as mandates as guardian or executor), activities for economically tied persons (e.g. activities for other group companies) or activities for family related persons (e.g. activities of single family offices).

As for the trustee licensing requirements, the FinIA defines a trustee as a person who on a commercial basis manages or holds assets for the benefit of the beneficiaries or for a specified purpose, in each case based on the instrument creating a trust within the meaning of the Hague Convention of 1 July 1985 on the Law Applicable to Trusts and on their Recognition (the Hague Trust Convention). Similar to the situation for portfolio managers, the FinIA exempts certain trustee activities from the licensing requirements, including activities for economically tied persons or family related persons (e.g. private trust companies). Given that the FinIA trustee definition specifically refers to the Hague Trust Convention, the scope of application of the trustee licensing requirements is limited to acting as trustee for trusts within the meaning of the Hague Trust Convention. Acting through similar vehicles or arrangements, such as purely contractual fiduciary arrangements, would thus not be within the scope of the trustee licensing requirements. The same is true for similar types of service providers, such as protectors, corporate service providers, or nominee directors, which all do not fall within the scope of the trustee licensing requirements under the FinIA (but which may be subject to other Swiss regulations, including under the Swiss AML laws and regulations).

As mentioned above, portfolio managers and trustees were not subject to comprehensive licensing requirements prior to the entry into force of the FinIA. With the FinIA, this has changed significantly: like other financial institutions, portfolio managers and trustees are required to obtain a license from the Swiss regulator FINMA in order to operate their business. Once licensed, they are subject to ongoing regulatory supervision. With respect to licensing and ongoing supervision, the FinIA introduced a new system in which so-called privately organized, FINMA-approved supervisory organizations (SO) are responsible for the ongoing supervision. FINMA remains responsible for initial licensing as well as any enforcement action. 

In terms of initial licensing, portfolio managers and trustees have to go through a two-step procedure. In an initial step, an applicant files its license application with one of the SO, with the goal of obtaining a membership in such SO. Following the SO’s review of the licensing application, the SO then forwards the application package, together with the SO’s confirmation of eligibility for affiliation, to FINMA. FINMA then reviews the application package and decides on whether or not the license is granted.

2) Transitional periods: the clock has run out

Appreciating the fact that the new FinIA licensing requirements may prove to be a significant challenge for a number of the existing portfolio managers and trustees, many of which are small-scale operations, the FinIA provided for rather long transitional periods of up to three years, i.e. until 31 December 2022. Moreover, within six months of the entry into force, i.e. until 30 June 2020, portfolio managers and trustees had to indicate to FINMA whether they intend to apply for a license. With this initial feedback, FINMA aimed to get initial data on the potential number of license applications.

During the transitional period, a portfolio manager or trustee that was already operating its business prior to the entry into force of FinIA, had to prepare its licensing application and file such application with FINMA. Until FINMA decides on the license application, the portfolio manager or trustee can continue operating its business also beyond the expiry of the three years transition period. Different regimes apply for portfolio managers or trustees that started their business activities only after the entry into force of FinIA.

In light of the large number of potential license application, FINMA early on communicated that it does not expect to grant any deadline extensions and urged market participants to submit their applications to the SO well ahead of the end of the expiry of the three years transition period. FINMA recommended that this initial step, i.e. the submission to the SO, be completed by no later than 30 June 2022. In this context, it is important to note that only the forwarding of the application from the SO (together with the SO’s assessment of the application) to FINMA was sufficient to meet the 31 December 2022 deadline.

By the end of the transitional period, FINMA had received 1,699 license applications. These included 1,534 applications from portfolio managers and 165 from trustees. As at 31 December 2022, FINMA had granted licenses to 670 institutions (642 portfolio managers, 22 trustees and six institutions acting as portfolio managers and trustees). Accordingly, as at 31 December 2022, more than 1,000 license applications were still pending with FINMA. Institutions with a pending license application can obtain a status confirmation on FINMA’s EHP platform, confirming the filing of the application with FINMA (and example of such status confirmation is included in FINMA’s guidance 02/2023). 

FINMA also got in touch with all of the institutions that initially indicated an intent to obtain a license, including by registering on FINMA’s EHP platform. As at beginning of January 2023, 1,060 institutions have informed FINMA that they will not be submitting an application and most of those institutions are either adapting their business model or continuing their business activity below the commerciality threshold. In the context of FINMA’s reach out, several hundred companies did not respond to FINMA.

3) Portfolio managers and trustees: a diverse category of financial institutions

As part of its guidance 02/2023, FINMA provided statistical information on the portfolio managers and trustees that have already obtained a license. The majority of the 670 already licensed portfolio managers and trustees are very small businesses with fewer than five-full time employees. The large majority of the licensed portfolio managers and trustees are in the form of a corporation, with only around 40 businesses using other legal forms (limited liability companies, sole proprietorship).

In terms of assets under management, the total amount of the assets under management for all 670 already licensed institutions was CHF 121 billion, with the average AuM being CHF 180 million. According to FINMA, large variation of the amounts of AuM have been observed. This ranges from very small operations to rather larger businesses. For example, in the case of four licensed companies, the total assets under management amounted to more than CHF 2 billion.

4) Potential FINMA enforcement action

FINMA communicated that since 2020, it opened 307 investigations into suspected unauthorized activity as a portfolio manager or trustee. Moreover, by 31 December 2022 FINMA had submitted 27 criminal complaints to the criminal law division of the Federal Department of Finance based on suspicion of operating an unlicensed portfolio management or trustee business. In addition, FINMA placed 153 institutions on its warning list.

Given the large number of unresponsive businesses (see section 2 above) and businesses that communicated to FINMA that they adapted their business model to fall outside of the scope of license requirements, it is to be expected that FINMA’s enforcement activities will continue focusing on the portfolio manager and trustee industry. In its guidance 02/2023, FINMA emphasized that institutions that failed to apply for a license during the transitional period, or which are pursuing a commercial activity as a portfolio manager or trustee without an appropriate license may become subject to enforcement action and potential criminal sanctions (which falls within the authority of the Federal Department of Finance). Potential criminal sanctions range from fines of up to CHF 250,000 in case of negligent behavior to imprisonment of up to three years in case of willful non-compliance.

In light of the continued enforcement focus of FINMA and considering the potential criminal liability, unlicensed businesses are well-advised to carefully assess their business operations in light of the FinIA portfolio manager and trustee licensing requirements. In particular, businesses that adapted their business model to “advisory-only” or similar types of services need to ensure that the new business model is followed in practice. 

Patrick Schärli (patrick.schaerli@lenzstaehelin.com)