Approval procedure for portfolio managers and trustees: Status and first practical experiences
With the entry into force of the Law on Financial Institutions (LEFin) and the Law on Financial Services (LSFin) on January 1, 2020, new regulations apply regarding the authorization requirements and conditions for the provision of services by portfolio managers and trustees. Since then, independent portfolio managers and trustees need authorization to operate.
The deadline for submitting an authorization application, December 31, 2022, is approaching and the authorization process has already started for some applicants. FINMA recently published information on its first experiences in the authorization process with portfolio managers and trustees. The aim of this legal update is to provide an overview of the status of authorizations granted and authorization requests filed, but also to share the first practical experiences acquired concerning new authorization requests. For more information on the authorization conditions for independent portfolio managers, please refer to our legal update of December 1, 2020.
Status of the authorization process
To date, FINMA has received 95 license applications and authorized 36 portfolio managers, of which only one license has been granted to an independent portfolio manager. All other licensees are group companies under FINIA. In accordance with art. 74 par. 2 and par. 3 LEFin, independent portfolio managers and trustees who were already carrying out their activities in this capacity before the entry into force of the LEFin had to report to FINMA by June 30, 2020. Independent portfolio managers who have started their activities before the end of 2020 had to report to FINMA at the start of their activities. On the basis of these notifications, it is possible to roughly estimate the number of additional authorization requests that will be submitted. According to FINMA, this should be 2,521 portfolio managers and trustees.
The vast majority of notifications were made by portfolio managers who were already active before the entry into force of FinLa. Overall, authorization requests are submitted later than expected, which is why FINMA expects that the majority of requests will not be processed before 2023. FINMA therefore tries to anticipate the flow of requests expected at the end of 2022 and proactively inform the industry.
Findings and practical experience of the approval process
According to FINMA, only complex and risky models are examined in depth; thus, a risk-based approach is adopted when examining the application for authorization. FINMA uses different criteria to determine whether a business model is associated with increased risks and thus decide on the depth of the review. The criteria include the type, number and domicile of clients; the volume of assets under management; investment strategies and products used; and the number and types of services offered. It is not excluded that business models with increased risks are not approved. These include, without limitation, the following business models:
- Involvement of foreign custodian banks
- Foreign client structures
- Use of investment instruments with potential conflicts of interest
- Compensation for third parties (retrocessions, etc.)
FINMA has published its expectations for pursuing risky business models. For example, the involvement of foreign custodian banks must be explainable or make sense. FINMA expects the risks associated with this involvement to be addressed in directives and controls. In addition, the risk and compliance functions should be separated from the operational areas.
The above three requirements should also apply mutatis mutandis in the case of foreign client structures. In addition, client advisers who are also involved in foreign client structures must have relevant experience and appropriate professional qualifications and receive regular training.
If investment instruments with potential conflicts of interest are used, FINMA expects, among other things, that internal rules regarding the prevention and disclosure of conflicts of interest are created and that the exclusive investment instruments are limited in percentage in accordance with the investment strategy. Any multiple fee settlements must be disclosed and their treatment defined. In addition, portfolio managers and trustees should implement a segregation of risk and business unit compliance.
If third parties are compensated, this compensation must comply with the requirements of art. 26 FinSA. FINMA also expects related risks to be addressed in the directives.
Our experience in supporting authorization requests
In addition to the above remarks on FINMA’s conclusions, our experience in supporting clients in authorization requests is as follows.
Organizational regulations in an official language
As is generally known, the request for authorization must be accompanied by an organizational regulation which defines the implementation of the organizational requirements for the applicant. These organizational regulations must be submitted in an official language. Organizational regulations exclusively in English are therefore not sufficient.
Individual signing authority for “small” applicants
Particularly in the case of applicants with a lean organizational structure, the question often arises as to whether a person authorized to represent the applicant can also sign alone. Art. 23 par. 1 The Ordinance on Financial Institutions (OFIN) assumes in principle that two people must sign jointly, subject to art. 20 par. 2 FINIA. If the applicant has chosen the legal form of a public limited company (SA), the only member of the board of directors may also be the only qualified managing director.
In such cases, the question also often arises as to whether it is appropriate to separate management and governance. In addition, it should be noted that the exercise of a mandate of board of directors and of an executive management mandate in personal union could be rejected by FINMA if the candidate has ten or more full-time positions or gross annual income of more than CHF 5 million. and the nature and scope of its activities require a separation of these two tasks (art. 23 para. 3 LFIO). In this case, therefore, individual signing authority is not possible.
In summary, in our experience, nothing prevents the provision of individual signing authority, provided that the requirements set out here are met.
Reporting of all delegations of tasks
With regard to the delegation of important tasks and the corresponding reporting obligation to FINMA, our experience is that, contrary to the wording of the law in Art. 64 par. 1 FINMA, all outsourced activities must be declared to FINMA, including “intangible” activities. FINMA then decides on a case-by-case basis whether it considers outsourcing to be significant or not. In particular, in our experience, FINMA considers the outsourcing of compliance and risk management to be “relevant” outsourcing, even in the case of portfolio managers.
Overall, the FINMA circular on outsourcing can be applied in a similar way to the outsourcing of the activities of portfolio managers and trustees. We therefore recommend complying with the FINMA standard for all outsourced activities in accordance with the circular and declaring all outsourced activities to FINMA when submitting the request.
Information on the domicile of the contracting party and the beneficial owner
In addition, as part of the information on commercial activities, the applicant must indicate whether he has only Swiss or also foreign customers and, in the case of foreign customers, also indicate their region of domicile. However, the region of domicile or the domicile of the client may be different from the domicile of the beneficial owner, which must be identified within the framework of the obligations of the AML Anti-Money Laundering Law).
For the authorization request as such, these two domiciles must be treated separately, the domicile of the beneficial owner having to be previously indicated in the LBA section. However, we recommend addressing both regions of domicile in the geographical description in the organization regulations.
conclusion and perspectives
The above remarks as well as the presentation of FINMA showed that the legal basis as well as the explanations of the authorities in individual cases do not provide conclusive answers to the open questions, and that the practice for new forms of authorization is still emerging in some respects. This uncertainty may also explain why many existing independent portfolio managers and trustees are still waiting to apply. However, given the figures released by FINMA, which suggest an influx of applications at the end of 2022, the authorization process should be launched as soon as possible. Otherwise, applicants may wait longer than expected for their application to be reviewed.