Between 15 May 2024 and 15 July 2024, the Swiss Financial Market Supervisory Authority FINMA (FINMA) held a public consultation on a new circular on the rules of conduct under the Financial Services Act (FinSA). The circular is expected to enter into force in early 2025. This article outlines and critically evaluates some of the key aspects of the draft circular.

By Manuel Baschung / Fabrice Eckert / Philipp Klein (Reference: CapLaw-2024-34)

1) Introduction

FINMA’s proposal submitted for consultation consists of a draft circular and an explanatory report. It is framed by FINMA as a means for creating transparency and legal certainty regarding a selection of FINMA’s supervisory practices on the implementation of the FinSA by financial service providers subject to its supervision. According to the explanatory report, the topics selected for inclusion in the draft circular reflect questions of practice and interpretation that have arisen since the rules of conduct became applicable.

The draft circular comprises just three pages. The accompanying explanatory report, on the other hand, runs to several times as many pages and contains remarks that go beyond a mere explanation of the points set out in the draft circular. On some key aspects of interpretation, FINMA’s views are expressed solely in the explanatory report.

Pursuant to the Financial Market Supervision Act (FINMASA) and its implementing ordinance, FINMA may issue circulars to increase transparency on FINMA’s supervisory activities, and the explanatory report identifies this as a main objective of the proposal. In addition, the explanatory report also references the aim of increasing legal certainty, as well as FINMA’s strategic goal for the period 2021-2024 to have a sustained positive impact on the conduct of supervised financial institutions.

Against this background, the draft circular and the associated explanatory report should be judged on whether they improve legal certainty for financial service providers and their clients, which in our view requires that these documents (i) are drafted clearly and precisely and (ii) adhere to generally accepted interpretations of the FinSA and the Financial Services Ordinance (FinSO). In light of the market practices and doctrine that have evolved since the FinSA’s entry into force, we would also expect any deliberate departure by FINMA from such interpretations to be presented clearly and unequivocally.

2) Addressees of the Circular

The circular is addressed to financial service providers supervised by FINMA or supervisory organizations pursuant to article 43a FINMASA. According to the table of addressees in the draft circular, this primarily includes (i) banks within the meaning of article 1 of the Banking Act, (ii) portfolio managers within the meaning of article 17(1) of the Financial Institutions Act (FinIA), (iii) managers of collective assets within the meaning of article 24 FinIA, (iv) fund management companies within the meaning of article 32 FinIA and (v) account-holding securities firms within the meaning of article 41 FinIA. However, the table of addressees at the beginning of the draft circular is only indicative. It is also conceivable that supervised entities not presently mentioned in the aforementioned table (e.g. holders of a FinTech-license pursuant to article 1b of the Banking Act) provide financial services and thus qualify as financial service providers within the meaning of article 2(1)(a) FinSA. The draft circular also applies to such supervised entities. In our view, the description of the scope of the draft circular therefore only provides limited benefit/legal certainty to market participants.

The circular is not intended to apply to financial service providers within the meaning of the FinSA that are not subject to supervision by FINMA or a supervisory organization (e.g. foreign financial service providers that provide financial services to clients in Switzerland). In the case of such unsupervised financial service providers, the enforcement of the obligations imposed by FinSA is ultimately the responsibility of the courts and the Federal Department of Finance (FDF) (see article 89 FinSA in conjunction with article 50(1) FINMASA). As the FDF and the courts may be guided by the circular when interpreting the FinSA, the circular will also be relevant for financial service providers not subject to supervision in Switzerland.

The draft circular follows the structure of the FinSA and covers the six topics described below.

3) Topics of the Draft Circular

a) (Unregulated) Corporate Finance Services vs (Regulated) Financial Services

FINMA’s proposal contains a relatively brief paragraph (margin no. 3) in the draft circular (and a much longer commentary in the explanatory report) on the exemptions pursuant to article 3(3)(a)-(c) FinSO, according to which services in the context of corporate finance and M&A advice, the underwriting and/or placement of financial instruments, as well as the financing of such transactions are not considered (regulated) financial services. FINMA’s proposal is to exempt such activities from treatment as regulated financial services only if the clients use the service primarily for industrial, strategic, or entrepreneurial purposes rather than investment or hedging purposes. The explanatory report suggests that both the draft circular and the additional explanations that form part of FINMA’s proposal respond to questions encountered by FINMA during the course of its supervisory activities. However, from our perspective, we also see aspects where the proposal could (re)introduce further legal uncertainty.

At least according margin to no. 3 of the French-language draft circular, FINMA seems to consider that the exemptions pursuant to article 3(3)(a)-(c) FinSO apply only if clients use the service primarily for industrial, strategic, or entrepreneurial purposes rather than investment or hedging purposes, and not that this is merely one important instantiation of these exemptions (the German-language draft circular is not quite as unambiguous).

The criterion of whether service recipients use the service primarily for industrial, strategic, or entrepreneurial purposes rather than investment or hedging purposes appears suitable mostly for distinguishing the (regulated) financial service of investment advice (article 3(c)(4) FinSA) from (unregulated) corporate finance and M&A advisory services (article 3(3)(a) FinSO), which is the context in which it was devised under MiFID. Even in that context, its application can be highly context-dependent (e.g., pursuant to the Committee of European Securities Regulators’ (CESR) Q&A document on the definition of advice under MiFID of 19 April 2010, CESR/10-293, which FINMA relies on in the explanatory report, “[i]n the context of private equity and venture capital, the industrial purpose of the firms providing these services is purely financial” and “[w]here individuals authorised to act on behalf of these firms seek advice, their primary objective is likely to be mainly entrepreneurial, and also aligned to the industrial purpose of the private equity or venture capital firms […]”; para. 84), and its transposition from MiFID to FinSA is not entirely straightforward. The criterion is even more challenging to apply in the context of underwriting and placement activities (article 3(3)(b) FinSO). 

Essentially, we believe that there are two reasons why an activity performed in relation to a third party may not constitute a regulated financial service: First, because the activity is not a typical investment service, it may not be one of the financial services enumerated in article 3(c) FinSA. Second, the interaction with a third party in the context of such an activity may not amount to a (regulated) financial service on behalf of that third party (e.g. an investor) as (end) client within the meaning of the FinSA, as the activity may, in a manner recognizable to that third party (the investor) and possibly subject to further conditions (which are outside the scope of this article), be conducted on behalf of the issuer or for the intermediary’s own account. 

The explanatory report indicates that the exemptions set forth in article 3(3)(a)-(c) FinSO apply only in instances where the service is provided to firms or their participants, or to issuers or offerors, and where such entities do not act as investors. The explanatory report also appears to suggest that the exemptions are primarily applicable to services rendered to the sell side, even in an M&A advisory context. However, we believe that such a narrow reading of these exemptions would lack any basis in the FinSO.

It is important to note that underwriting and placement activities conducted by a financial intermediary on behalf of the sell side, which in that context are exempt from the FinSA pursuant to article 3(3)(b) FinSO, may involve interactions with the buy side. However, these interactions do not necessarily justify an expectation on the part of the buy side that their interests would be placed above those of the sell side. 

In such contexts, it is incumbent upon financial intermediaries to be upfront and consistent as to the side they are representing in the course of such an activity. However, they do not have to inquire about the motives of a third party with no reasonable expectation of loyalty from the financial intermediary, such as the ultimate purpose of an investment. The FinSA does not prevent financial intermediaries from offering their undivided loyalty to the sell side, even if their activities bring them into contact with the buy side. 

Furthermore, it should be noted that under the FinSA a bank’s investment banking division is not prohibited from acting on behalf of an issuer or a selling shareholder even as its private banking division provides investment advice to its clients with regard to an investment in such shares; in such a case, only the private banking division’s investment advisory services may amount to a regulated financial service (if the subscription is made for investment purposes and not for industrial, strategic, or entrepreneurial purposes), with the result that the bank (specifically, the bank’s private banking division) must manage and disclose any potential conflicts of interest in accordance with the FinSA. 

Margin no. 3 of the Draft Circular, even if its reference to “clients” is to be read narrowly (as we believe it should be) so as not to include interactions with third parties who cannot legitimately expect to be treated as clients, does not reflect some of the relevant nuances in relation to the exemptions set out in article 3(3)(a)-(c) FinSO, such as those summarized above.

In our understanding of the FinSA, creating transparency for clients and counterparties as to whether (and what type of) regulated financial services are being provided to them is a core element of the investor protection framework. In light of this, the proposal may inadvertently make it more difficult to achieve this objective, as margin no. 3 of the draft circular and the related commentary in the explanatory report may indicate a broader scope of application of the FinSA than that set out in the FinSA and the FinSO themselves, which, moreover, cannot be easily delineated, thereby reducing clarity for clients and potentially diluting the scope of application of the FinSA.

b) Duty to Provide Information

The draft circular seeks to further specify the information requirements set out in article 8 FinSA and article 7 FinSO, in particular with regard to the information to be provided on (i) the type of financial service offered, (ii) the risks associated with certain financial instruments and (iii) the risks associated with the financial service offered.

i. Type of Financial Service

The FinSA distinguishes between transaction-related and portfolio-related investment advice. The draft circular requires financial service providers to inform their clients whether their investment advice is transaction-related or portfolio-related. While in essence this information obligation seems to be already covered by article 7(1) FinSO, the explanatory report further specifies that in the case of transaction-based advice, clients must be informed that the advice is purely instrument-based, i.e. the financial service provider does not take the client’s portfolio into account in any way and therefore does not carry out a suitability test, but only an appropriateness test.

ii. Risks Associated With Certain Financial Instruments

The draft circular requires financial service providers to inform clients of the risks associated with contracts for difference (CFDs). This includes information on the current share of the CFD provider’s retail clients who have lost money with CFDs or have been required to make top-up payments in connection with such financial instruments, the risk of top-up payment obligations and losses potentially exceeding the initial investment, and the risks related to leverage and margin, as well as counterparty and market risk. The draft circular seems to impose these requirements based on article 8(1)(d) FinSA and article 7(3)(b) FinSO.

One point worth noting is that the explanatory report specifies that the percentage of the financial service provider’s clients who lost money with CFDs and had to make additional payments in this context should relate only to retail clients (and, accordingly, not include professional or institutional clients). 

iii. Risks Associated With the Financial Services Offered

According to the FinSA, financial service providers must inform their clients about the risks associated with the financial services offered prior to the conclusion of a contract or the provision of the services (article (8)(2)(a) in connection with article 9(1) FinSA). According to the draft circular, in the case of portfolio management or portfolio-related investment advice, this includes the obligation to disclose the nature and extent of risk concentrations. The disclosure obligation applies if it cannot be ruled out that the client portfolio (i.e., the portfolio managed by, or the part subject to the investment advice of, the financial service provider) contains concentrations of risk that are not customary in the market. In addition to concentrations in individual financial instruments and asset classes, risk concentrations may result from concentrations of investments in the same issuers and correlated sectors, jurisdictions and currencies. In order to provide greater legal certainty, the draft circular contains two thresholds that indicate an unusual risk concentration: Investments of 10% or more of the client portfolio in individual financial instruments and investments of 20% or more of the client portfolio in financial instruments of the same issuer. However, it should be noted that (i) according to our understanding of the draft circular the thresholds leading to a concentration risk may also be higher, if the financial service provider implements further measures against concentration risks (e.g. portfolio monitoring or measurement of issuer risks on an aggregated basis) and (ii) these thresholds do not apply to collective investment schemes subject to regulatory risk diversification requirements.

c) Appropriateness and Suitability of Financial Services

The appropriateness and suitability test includes an obligation on the part of the financial service provider to inquire about the client’s knowledge and experience. The draft circular stipulates that the client’s knowledge must be inquired about separately for each investment category relevant for the financial service provided to the client whereby the level of detail of the inquiry must be adapted to the complexity and risk profile of the investments that may be used in the financial service. 

According to the explanatory report, in the case of portfolio management and portfolio-related investment advice mandates, the financial service provider must regularly update the information obtained on the client’s financial situation and investment goals. In our view, this applies only if the financial service provider provides the portfolio management or advisory services to the relevant client on an ongoing basis (and not, for example, in the case of one-off investment advice). This view is supported by the dispatch to the FinSA, which the explanatory report refers to.

Furthermore, the explanatory report stipulates that financial service providers are obliged to check the plausibility of the information provided by the client. Since article 17(4) FinSO states that financial service providers may rely on the information provided by the client unless there are indications that it does not correspond to the facts, this can only mean that the financial service provider must question the client’s information in the event of obvious inconsistencies in the information provided by the client. In particular, this does not imply an obligation to actively investigate the accuracy of the details provided by the client or to take into account information that the financial service provider may have received outside of the relevant financial service (e.g. information from a separate credit lending relationship). 

d) Use of Clients’ Financial Instruments (Securities Lending)

In order for a client’s consent to securities lending to be valid, the client must be clearly informed of the risks associated with securities lending (article 19(2)(a) FinSA). The draft circular outlines the information that, according to FINMA’s practice, financial service providers have to provide to their clients to satisfy this requirement. 

On the one hand, the draft circular requires financial service providers to inform their clients about the risks that banks and securities dealers already had to disclose before the FinSA came into force on the basis of FINMA Circular 2010/2 on Repo/SLB Transaction (margin no. 6-9), which has since been repealed. However, according to the draft circular, financial service providers must also inform clients (i) that they may terminate the agreement on the use of financial instruments with immediate effect or, if a fixed term has been expressly agreed in individual cases, that the use only ends upon expiry of the agreement and (ii) that the client has the option to exclude certain financial instruments from securities lending. In our view particularly the second of these additional disclosure requirements introduced by the draft circular is not a risk of securities lending transactions. Rather, the draft circular seems to intend to govern certain rights and obligations of the parties in securities lending transactions and therefore goes beyond article 19(2)(a) FinSA.

e) Conflicts of Interest

In the explanatory report, FINMA takes the view that the information sheets and contractual documentation on conflicts of interest used by financial service providers to disclose conflicts of interest in connection with the financial service provider’s proprietary financial instruments frequently are too general or incomplete. The draft circular thus proposes certain principles that shall apply in connection with the investment in proprietary financial instruments:

– The draft circular holds that conflicts of interest are virtually inevitable with proprietary financial instruments. Nevertheless, pursuant to the draft circular, this fact alone does not make an investment in proprietary financial instruments impermissible. The draft circular explicitly states that financial service providers are allowed to only take proprietary financial instruments into account when selecting financial instruments. In this context, it should be noted that the explanatory report states that proprietary financial instruments do not only include financial instruments issued or offered by a financial service provider or its group companies, but also financial instruments of third parties with which the financial service provider has economic ties. According to the explanatory report, such economic ties may not only result from participations in the issuer or offeror of the financial instrument, but also from contractual agreements (e.g. distribution agreements) or personal relationships between members of the board or management of the financial service provider (Gewährsträger) and the relevant third party. This broad definition of proprietary financial instruments deviates from the principle in articles 10(2)-(3) FinSO, pursuant to which close economic ties require control (by equity participation or otherwise) over the issuer or offeror of the financial instruments (or vice versa), and would likely result in uncertainty for market participants whether a financial instrument qualifies as proprietary or not. 

– A financial service provider must inform its clients on the scope of investment products that it considers when selecting the financial instruments (article 8(2)(c) FinSA). The draft circular and explanatory report add that clients must also be informed of the conflicts of interest that may result from investments in proprietary financial instruments as well as the causes that lead to such conflict of interest. In addition, financial service providers must disclose if they only consider proprietary financial instruments and inform their clients of the risk associated therewith.

– In addition to this disclosure obligation, financial service providers that take into account both proprietary and third-party financial instruments must take appropriate organizational measures to ensure that they do not prioritize their own interests and act to the detriment of clients when selecting financial instruments. According to the draft circular, financial service providers need to establish a product selection process that is based on objective criteria that are customary in the industry (e.g. performance expectations, compliance with risk profile, diversification and costs). The criteria must be designed in such a way that a general disadvantage of clients is avoided when making investment decisions. However, it is not necessary (nor feasible) that such process takes into account the individual interests of each client. In addition to the definition of an objective product selection process, financial service providers will also need to implement functional, personnel and informational separation between the operational units responsible for the creation or management of proprietary financial instruments and the unit responsible for product distribution (e.g. client advisors).

Compliance with the aforementioned disclosure and organizational measures is not only crucial from a regulatory perspective but may also be relevant for the contractual relationship between the financial service provider and its clients. In particular, if a financial service provider has implemented these informational and organizational measures, the case law recently introduced by the Zurich Commercial Court (decision HG190111 of the Zurich Commercial Court of 22 May 2023, consideration 3.5), according to which an asset manager is presumed to be in breach of its duty of loyalty in the event of a conflict of interest – for example when investing in its proprietary financial instruments – can, in our view, no longer be upheld. Any contrary interpretation would create a contradiction between Swiss financial market regulations and civil law, which cannot be the legislator’s intention.

f) Compensation from Third Parties

In the draft circular, FINMA also sets out its expectations regarding the form and content of client information on retrocessions that the financial service providers receive and wish to retain. 

– Content: The explanatory report to the draft circular states that in the case of transaction-related investment advice and execution-only relationships, it is sufficient to disclose to clients the ranges of the expected retrocessions per product category. On the other hand, FINMA requires that portfolio managers inform their clients of the amount of expected third-party compensations in relation to the total value of the client’s assets under management (i.e. as a percentage ratio [range]; similarly, in the context of article 400(1) of the Code of Obligations, decision 4A_355/2019 of the Federal Supreme Court of 13 May 2020). According to the draft circular (and FINMA’s 2021 annual report), this requirement shall also apply to portfolio-related advice. Since the composition of the portfolio of an advisory client depends on the (future) investment decisions of the client (in contrast to a portfolio management mandate), it is questionable which financial instruments the financial service provider should use to calculate the expected amount of retrocessions at the beginning of the investment advisory service (see also decision 4A_574/2023 of the Federal Supreme Court of 24 May 2024, pursuant to which the requirement to disclose to the client the amount of expected third-party compensations in relation to the total value of the client’s assets under management cannot be applied to investment advisory and execution-only relationships). Based on the explanatory report, it seems that in this case the financial service provider can assume that the client will follow the agreed investment strategy and the recommendations of the financial service provider. In practice, however, it seems advisable for financial service providers to briefly explain to their clients the basis on which they have made their calculations.

– Form: The draft circular states that the information on third-party compensations must be visually highlighted (e.g. printed in bold), if the information is provided to the client in a standardized manner. Such a visual emphasis may also be relevant from a civil law perspective. In particular, it results in the clause in question not being subjectively unusual for purposes of the “unusualness” test (Ungewöhnlichkeitsregel). 

Alternatively, third-party compensation may be disclosed in a separate letter or form. This document must either be delivered to the client or the client must be provided with a direct link (website) referring to it.

Finally, the draft circular requires financial service providers, upon request, to inform their clients of all third-party compensations actually received. In particular, the draft circular only permits financial service providers to charge a (cost-covering) fee for that service if a client requests such information more than once annually.

4) Outlook

The public consultation of the draft circular ran until 15 July 2024, and the final version of the circular is scheduled to enter into force at the beginning of 2025. While the intention of FINMA to provide further clarity for financial service providers and their clients with regard to its supervisory practice on some of the rules of conduct of the FinSA is to be welcomed, we believe that certain aspects of the proposal leave or introduce some uncertainty for market participants. It is to be hoped that these ambiguities will be resolved in the final version of the circular.

Manuel Baschung (manuel.baschung@homburger.ch)
Fabrice Eckert (fabrice.eckert@homburger.ch)
Philipp Klein (philipp.klein@homburger.ch)