Swiss regulator publishes its practice on the rules of conduct applicable when providing financial services

On 22 November 2024, the Swiss Financial Market Supervisory Authority (FINMA) released its circular on the rules of conduct under the Financial Services Act (FinSA) and the Financial Services Ordinance (FinSO). This circular describes the requirements for the implementation of the rules of conduct. The circular also covers to a certain extent organisational measures of financial service providers as well as general definitions and regulations concerning the classification of clients.

Scope

The circular applies to financial service providers as defined in the FinSA subject to supervision by FINMA or another supervisory authority within the meaning of the Financial Market Supervision Act (FINMASA).

The foregoing means that the FINMA's circular in principle only applies to supervised persons and entities falling within the scope of the article 3 of the FINMASA, namely

• persons and entities that under the financial market acts require to be licensed recognised, or registered by the FINMA; and
• collective investment schemes Act that have been or must be licensed or approved.

According to the FINMA, insurance undertakings that provide financial services as defined in the FinSA must also take the circular into account.

On the other hand, the circular is, strictly speaking, not applicable to financial service providers which are not subject to FINMA supervision. This means that registered client advisers, such as for instance employees of non-discretionary investment advisors (no discretion and no authority on assets of third parties) will in theory not be required to apply the principles (where relevant) developed by FINMA in its circular. In practice however, one cannot exclude that the circular of FINMA could influence the practice of civil courts or criminal courts in case of litigation, which may also affect entities not supervised by FINMA. It seems thus prudent that also such entities consider the circular to the extent relevant for their activities.

Corporate Finance Exception

The FinSO excludes certain services in the corporate finance field from the scope of FinSA. In this respect, the circular clarifies that the exception regarding the placement of financial instruments in accordance with Art. 3 para. 3 let. b FinSO applies to services provided to companies and their shareholders that finance themselves on the capital market. "Sell-side" services continue thus to be excluded. As concerns "buy-side" services, the circular mentions that the offering of financial instruments to investors or their sale to clients fall within the scope of the FinSA. Considering the additional explanations of FINMA, the activities of "sell-side" service providers that place financial instruments with investors active on the capital markets who are not their clients (e.g. underwriters or brokers) should, however, still be out of scope.

Client information

Information on the nature of the financial service

Financial service providers must describe and document for their clients the nature of the investment advisory service (portfolio-based advice or transaction-based advice) in an appropriate manner, for instance by means of a written contract or in another way that can be proven by text or by a documented statement at the time of the advice.

The information may be made available to clients in a standardised form on paper or electronically, provided that it can be consulted, downloaded and collected on a durable data medium at any time.

The description of the nature of the investment advisory service must take place prior to the conclusion of a contract or the provision of a financial service and does not generally have to be repeated during the client relationship. However, if the provision of the financial service undergoes decisive changes during such relationship, the financial service providers may have to inform the clients accordingly again.

Specific information on risks for CFDs

Financial service providers are required to disclose certain specific information on risks related to contracts-for-difference (CFDs), in particular on:

• the possible obligation to make additional payments and the potential risk of unlimited losses;
• the leverage effect, the way margin works, the counterparty and market risks (including slippage);
• quarterly, on the shares (in %) of private clients with CFDs in the last twelve months who:

-         have lost money;

-         suffered a total loss of margin on closing their positions;

-         had to make an additional payment after closing their positions to make up a negative balance. If a financial service provider grants private clients protection against a negative balance, the calculation of this indicator is not necessary.

According to FINMA, clients investing in CFDs are more likely to lose money than to make gains and the absence of protective rules like the EU protection mechanism again negative balance requires (at least) a comprehensive and detailed information about the risks associated with CFDs. This information of private clients plays thus an important role in the investor's protection. The additional information on CFDs that needs not to be repeated may be provided as a supplement to the Swiss Bankers Association brochure or as a dedicated information.

Information on financial service risks

If during the provision of portfolio management and portfolio-based investment advisory services an unusual concentration of risk on the market cannot be ruled out within the client's portfolio, the financial service provider must draw the client's attention to the nature and extent of the risks.

According to FINMA practice now reflected in the circular, indications of such unusual concentration may be:

• a concentration of 10% or more in individual securities;
• a concentration of 20% or more in certain issuers.

Collective investment schemes may be exempted from these limitations. According to FINMA, although the rules on risk diversification may differ depending on the nature of the collective investment schemes authorised or approved by FINMA, they remain subject to regulatory provisions on risk diversification and are internally diversified by virtue of the applicable law. In addition, clients are informed of their risk structure in the fund prospectuses and other documents. FINMA is however of the view that an extension of this exception to other instruments, such as AMCs or bonds would not be appropriate.

We note that the publication of this practice in the circular may be welcomed by market participants as it clarifies without ambiguity the expectation of FINMA and potential requested amendments of internal guidelines.

On the other hand, one may question whether the general and abstract legal basis set out in FinSA allows FINMA, from a strict legal standpoint, to publish such specific limits, even if they can been seen as rather standard, at least in the context of liquid assets. We also note that the circular should not prevent duly justified exemptions on concentration risks depending on the nature of a portfolio and the risks accepted (or even requested) by clients.

Verification of suitability and adequacy

When establishing a client's risk profile, a financial service provider is required to collect all information necessary for a proper verification of appropriateness and suitability. This requirement implies that the financial service provider must find out about their clients' knowledge and experience for each investment category included in their financial service offering. The level of detail of the questions must be adapted to the complexity and risk profile of the investments and investment strategies likely to be used for the financial service in question.

Financial service providers may rely on client's statements unless there are indications that these do not correspond to the reality. The purpose of this rule does not involve having to verify all the information provided, but to ensure that it is not manifestly incorrect or contrary to existing client's information.

As a reminder, the collection of information on client knowledge and experience is only required for private clients. For professional clients, there is as a matter of principle no collection of such information required.

Use of clients' financial instruments / securities lending

The information to be provided to clients and recorded as part of the risk assessment must include at least the following information:

• whether the financial service provider acts as a counterparty (principal) or whether it acts solely as an intermediary for a third party in the capacity of agent;
• indication that ownership of the financial instruments is transferred to the counterparty and that there is only a replacement right of the same nature and quantity;
• in case of bankruptcy of the counterparty or any guarantor, the client has only a non-preferential cash claim of equivalent value (in the case of securities lending for private clients, there is additional cover up to the of the collateral received);
• the financial (e.g. dividend) and social rights pass to the counterparty;
• the client retains the risk of impairment of the financial instruments;
• the client may terminate the agreement on the use of financial instruments with immediate effect or, if a fixed term has been expressly agreed on a case-by-case basis, that the use only ends with the expiry of the agreement;
• the client may exclude certain financial instruments from securities lending.

Securities lending involves a high-level of risk for clients. For this reason, clients must give their express consent to the use of their financial instruments in an agreement separate from the general terms and conditions. According to the FINMA practice, it is accepted that a securities lending agreement may be combined with other contracts. Clients must therefore indicate their consent by an appropriate means (e.g. by ticking a box).

It is important to recall that these rules do not apply to institutional clients but only to private and professional clients. Contrary to certain other rules of conduct, the latter cannot waive the rules.

Conflicts of interests

Financial service providers are required to inform clients whether the market offer considered when selecting financial instruments consists solely of their own instruments, a mix of their own instruments and third-party instruments or solely of third-party instruments.

When financial service providers inform their clients that they are taking into account a mix of their own financial instruments and third-party financial instruments, they must take appropriate organizational measures to avoid conflicts of interest, in particular by selecting financial instruments using a process based on objective criteria used in the industry. If conflicts of interest cannot be avoided entirely, the financial service provider must inform the clients of the risks involved. Financial service provider do not have the right to promote their own financial instruments by means of special incentive remuneration of the persons at the point of sale.

According to FINMA, own financial instruments are not only financial instruments issued by the financial services provider or by one of its group companies, but also financial instruments issued or offered by third parties with whom the financial services provider has economic ties, such as self-managed products, private/white label products, products for which the financial services provider is the guarantor, or third-party products for which the financial services provider receives retrocessions or similar remuneration.

Economic links with third parties may thus result from significant participations in group set-ups. However, they may also arise from contractual relationships (e.g. distribution agreements providing for remuneration) or from personal relationships between individuals of the financial services provider who must guarantee irreproachable activity (i.e. be fit and proper) and third parties.

More generally, FINMA is of the view that conflicts of interest must always be avoided or any disadvantages for clients resulting from such conflicts must be excluded. Avoidable conflicts of interest cannot be resolved by disclosure. These conflicts of interest must be avoided, otherwise the financial service must not be provided. Only in the exceptional case of unavoidable conflicts of interest where a disadvantage for the client cannot be avoided or can only be avoided by disproportionate means the financial service may still be provided, subject to transparent disclosure of the conflict of interest to the client.

Remuneration (retrocessions)

According to FINMA, the rules on remuneration apply in the same way to all financial services including with respect to the provision of execution-only financial services. The rules in FinSA and FinSO which are of a regulatory nature must be distinguished from the current debates in private law on the scope of application of the information duty and the extent of the duty to return certain remuneration.

In contracts presented as forms, information relating to remuneration must be visually highlighted. It must also be provided to clients in physical form, or clients must be able to easily retrieve an electronic version.

If it is not possible to determine the actual amount of remuneration before providing the financial service concerned or before concluding the contract, the financial service provider must communicate to the client:

• a range of remuneration taking into account the different categories of financial instruments;
• additional information on the range of remuneration in relation to the value of the portfolio and the agreed investment strategy. The foregoing applies to portfolio management and portfolio-based investment advisory services (but not to transaction-based investment advisory services). As concerns the latter, the reference point for the financial services provider will have to be the recommended investment strategy, as the investments and thus the ultimately implemented investment strategy depend on the client's decision in case of investment advisory services, even if they are portfolio-based.

Information about retrocessions must be communicated before the financial service is provided and does not need to be repeated as long as conditions remain stable. However, if strategic asset allocation or model portfolios are modified over time to such an extent that the resulting remuneration for the financial service provider exceeds the defined range, further disclosure may be appropriate.

In the case of website references, a direct link pointing towards the relevant information is generally expected. This means that, on the other hand, the information requirements are not met if the financial services provider merely provides a general reference to a website, where clients must search for the information by themselves.

On request, financial service providers must in principle inform their clients free of charge of the amounts actually received. A reasonable flat rate, covering at most the costs incurred, is only legitimate in cases requiring exceptional effort. Such a situation may, for example, be present in case of repeated requests for information several times a year.

The regulatory requirements clarified in the circular are to some extent more detailed than what has been decided by the civil courts regarding the disclosure of retrocession payments in the context of mandate contracts.

Conclusion

The new FINMA circular contains selected clarifications of the rules of conduct provided for in FinSA and FinSO. It aims particularly to further increase transparency towards clients in the provision of financial services in accordance with the legal provisions.

The circular enters into force on January 1, 2025. However, a transitional period of 6 months applies for the implementation of certain (but not all) requirements contained therein.

From a practical point of view, we believe that the main call for action to financial services providers concerns the disclosures on remuneration (retrocessions), which must be brought in line with the requirements of the circular (if this is not yet the case). But, for instance, also CFD providers may be impacted by the new requirements set out in the circular to the extent their current level of information does not yet meet them.

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