Switzerland: Offshore Business Sectors
Investment Fund Management
As a magnet for investments, Switzerland had historically been one of the locations in which investment funds business had developed, but in the '80s, when the modern explosion of funds under management began to take on massive proportions, Switzerland found itself left out. The fact was that Switzerland had been overtaken by its competitors such as Luxembourg which offered more flexible regulatory structures, lower taxes, and access to the lucrative EU market on preferential terms.
The Swiss responded with a wholly new parcel of legislation, reduced taxation, and more sophisticated attitudes to investor protection. The Investment Funds Law 1995 loosened the restrictive investment guidelines that had been a feature of the previous law, replacing them with much greater transparency in order to maintain investor protection.
The new law established the principle of reciprocity, permitting the local licensing of funds which are established in regimes with acceptable regulatory regimes; in particular, this applies to the EU. An agreement with the EU to allow Swiss funds to operate under the UCITS guidelines (ie to market themselves freely in the EU) form part of the Bilateral Agreements between the EU and Switzerland; unfortunately for Switzerland, the EU/Switzerland Savings Tax Directive agreement does not exclude UCITS funds from application of the Directive - in the EU internal version of the Directive, UCITS funds are outside the Directive.
The Investment Funds Law recognises several different types of fund, and applies differing prudential requirements to them:
- Securities funds, meaning funds which invest in publicly-issued and traded shares;
- Real-estate funds;
- 'Other' funds, which includes funds of funds, money market funds and hedge funds.
Umbrella funds are permitted, and there are special rules for limited-circulation funds.
Foreign funds are permitted under the reciprocity provisions.
Until 2009, the Federal Banking Commission (FBC) was responsible for licensing and supervising investment funds. The new law introduced a separation of fund management, which for a local fund must be undertaken by a Stock Corporation, and the custodial function. The custodian must be licensed under the Banking Law. Any entity distributing fund shares must be authorised by the FBC. The FBC's role was swallowed up in FINMA when it took over financial regulation in January, 2009.
See Law of Offshore for a fuller statement of the licensing and supervisory regime for investment funds under the new law.
It seems that the new legislation has been successful in attracting a much wider range of foreign funds to Switzerland; but it is not clear whether an upsurge in locally-established funds will now take place given the application of a withholding tax to UCITS funds under the Savings Tax Directive.
In 2007, the Swiss Federal Banking Commission (EBK), the then independent regulator of the Swiss banking industry, expressed its support for changes to the Swiss tax and legal system to encourage more hedge fund managers to base their activities in Switzerland.
The trust business is witnessing rapid growth in Switzerland, having more than doubled in size over the past five years. In 2007, as well, Switzerland ratified the Hague Convention on the Law Applicable to Trusts and their Recognition. The Swiss Association of Trust Companies was officially launched on Tuesday, 11 September, 2007, in Zurich and on Wednesday, 12 September in Geneva, in a bid 'to encourage the professional and ethical development of an industry in full expansion in Switzerland'.
In a report turning the spotlight on the development of the Swiss hedge fund market, the EBK observed that while Switzerland is home to some of the world's biggest hedge fund customers, the Swiss hedge fund industry itself is tiny compared with the main centres of New York and London, with only an estimated 50 hedge fund managers located in Switzerland out of a global total of 9,000 hedge funds.
The EBK stated that more than 5% of the assets invested in Switzerland are invested in hedge fund products, but about one third of the estimated US$600 billion invested in funds of hedge funds comes from Switzerland, making it the world's second-biggest hedge fund investor after the United States.
In November 2007, the SWX Swiss Exchange launched a new segment for exchange traded structured funds (ETSFs), which, according to the exchange, combine the investment flexibility of structured products with the legal security provided by investment funds.
In contrast to ETFs, which track a specific index, ETSFs involve a traditional investment instrument that is combined with a derivative or baskets of underlying instruments from various asset classes, such as shares, bonds or commodities. Depending on how the fund’s assets are structured, it is possible to participate in the underlying instrument(s), optimise yield, or protect the invested capital.
Dozens of London-based hedge fund managers are reportedly relocating to Switzerland to escape new tax rules affecting non-domiciled individuals residing in the UK.
In December 2007, David Butler, founding member of Kinetic, an investment management consultancy, stated that at least 40% of his hedge fund clients have expressed alarm at new tax rules affecting non-domiciles, announced in the pre-budget report, and Switzerland, with its favourable tax climate for wealthy investors, has emerged as the natural alternative for some managers.
"We are seeing literally dozens and dozens of hedge fund managers moving some of their operations, at least, to Switzerland,"
He went on to claim that two-thirds of his hedge fund clients have already moved their entire operations to Switzerland, while others have moved at least 20% of their businesses, including research operations, marketing, distribution, and some fund management activities.
Should this trend continue, Butler predicted that soon, the UK will be used by hedge funds for just finance and back office operations, with key value operations shifted offshore.
More evidence of this trend came in the form of an announcement by Krom River, a London-based hedge fund, in September 2008 that it was to relocate its headquarters to one of Switzerland's low-tax areas in an attempt to reduce the company's tax bill.
The company, which had been running for two years and had accumulated assets in the region of GBP453m, relocated its office to the canton of Zug, a move that will not only save the company in tax, but also allow its fund managers to pay tax at 10% instead of the 40% top rate on the bulk of their income in the UK.
Although a relatively small dot on the global hedge fund map, Switzerland is currently vying to become a premier location for hedge fund managers, and a week previous to Krom's announcement, the Swiss government paired up with some of the country's financial trade groups to announce it was set to alter the country's complicated tax laws by offering hedge fund managers exclusive tax breaks in a bid to encourage more hedge funds and private equity groups to settle in Switzerland before opting for other locations, such as London or New York.
A further announcement from the country's Finance Department noted that the country's Federal Tax Administration is to clarify the tax-related problems linked to performance fee and carried interest, which will therefore provide the operators concerned with the legal certainty they require for tax planning, in addition to making Switzerland a more desirable investment option.
The proposal does not require new legislation in order to be implemented and could generate thousands of jobs and boost the economy if it is accepted.
Statistics released by Swiss Fund Data for Swiss funds for 2012 show that the by the end of September the inflow had increased by CHF21.1bn compared to the end of 2012.
These statistics cover only the assets of the funds authorized for sale in Switzerland, and therefore reflect only a part of the collective investment schemes held by investment clients, which are likely to also include considerable amounts of products that are not offered publicly. Swiss Fund Data suspended its market statistics publication for 2010 and began to report monthly figures from March 2011 onwards.
Latest monthly figures are for December 2012 and are available on the new Swiss Fund Data website. They show a market share for money market funds of CHF81.23 million, compared to CHF88.383 million in December 2011, while the real estate market share stood at CHF28.373 million, up from the CHF27.453 million the previous year.
Real estate funds have enjoyed steady inflows of new assets from capital increases since the end of January 2008. "Coupled with the appreciation in holdings, this resulted in a pleasing increase in assets of CHF1.7bn or around 10%. As an addition to domestic funds, Switzerland’s big banks have set up real estate funds abroad with investment policies with an international focus, and are also successfully selling these products outside Switzerland," the release explained. All in all, the assets invested abroad in real estate funds of Swiss providers amount to around CHF10bn, bringing the total volume of their real estate funds to around CHF28bn. This fund posted considerable performance gains in 2009 and the market share rose by 5.4% in 2009.
Assets invested in the funds comprising the other funds category stood at CHF46.27bn by end of March, 2012.
In March, 2009, changes to article 31 of the Ordinance on Collective Investment Schemes (CISO) came into effect which removed national regulations known as ‘Swiss Finish’ and brought the Swiss regulatory regime more into step with EU norms.
The Financial Market Supervisory Authority (FINMA) initiated the consultation process about the suppression of the Swiss Finish with the approval of the Federal Department of Finance on September 16, 2008. According to the government the suppression of the Swiss Finish on March 1 should contribute to repositioning the Swiss funds market and promoting Swiss collective investment schemes, making Switzerland an increasingly attractive jurisdiction for hedge funds to domicile. The Federal Council has also initiated changes to the taxation regime to make Switzerland a more attractive location for fund managers both on a corporate and a personal level.