Fintech in Switzerland: Legal Framework and Trends
Contributed by Daniel Flühmann, Peter Ch. Hsu and Rashid Bahar of Bär & Karrer AG
Switzerland continues to be an attractive base for cutting-edge technological innovators. According to the Global Innovation Index 2018 published annually by Cornell University, INSEAD and the World Intellectual Property Organization (WIPO), Switzerland is the world's most innovative country. It is therefore not a surprise that it is a welcoming jurisdiction for fintech companies and a favoured choice for many initial coin offerings ("ICOs"). Switzerland hosted six out of the fifteen largest ICOs since 2016, representing more than one billion USD in funds raised. In particular, the region around the city of Zug has established itself as a centre for innovation in the areas of blockchain and cryptocurrencies. Fintech businesses, such as payment service providers, crowdfunding and crowdlending platforms as well as insurtech companies, are thriving in Switzerland.
From a legal perspective, Switzerland's principle-based approach to financial market regulation supports the strong position in fintech, blockchain and coin offerings. In particular, it provides for much-needed flexibility in addressing rapid market developments. Furthermore, the Swiss regulatory framework is generally designed to be technology-neutral. In practice, this not only means that the same rules apply to all market participants, but also that production and delivery of financial services using technological means is not specifically restricted or hindered. As an example, while payment services are highly regulated in the EU under PSD/PSD2, Swiss law does not provide for any specific, comprehensive regulation in this area. Rather, payment service providers are, in most cases, subject to general anti-money laundering ("AML") regulation only, regardless of whether their services are provided via electronic channels or otherwise. Conversely, there are no specified, hardcoded duties of financial institutions vis-à-vis third party payment service providers in respect of access to account information or execution of account transfers under Swiss law. Overall, the Swiss approach enables innovation without a need to change laws and ordinances.
Building on the favourable legal framework, the Swiss regulators and supervisors encourage innovation in the financial market and aim to lower the market entry barriers for fintech providers and blockchain-based businesses. For example, starting in 2016, the Swiss Federal Council and Swiss Parliament aimed to offer relief from requirements of Swiss financial regulation to fintech providers (as well as traditional financial businesses). The last set of measures in this context, a specific type of licence for financial innovators with reduced requirements compared to a traditional, fully fledged banking licence, stands to come into force by the beginning of 2019 (see further below). Furthermore, in early 2018, the State Secretariat for International Financial Matters established a working group to review the legal framework governing financial sector-specific applications of blockchain technology (including ICOs) to identify any need for action and, in particular, any unnecessary legal hurdles to digitalisation. The working group has since recommended amendments to and further development of Swiss securities law to facilitate the trading of rights on a blockchain.
The Swiss Financial Market Supervisory Authority FINMA ("FINMA") undertakes significant efforts on an ongoing basis to apply an innovation-friendly and technology-neutral approach to its regulatory and supervisory activities. As part of this strategy, it has amended several circulars to remove obstacles for innovative business models. FINMA representatives have declared on various occasions that they regard innovation as key to ensuring the competitiveness and long-term success of the Swiss financial centre. FINMA also established a dedicated fintech desk tasked with addressing enquiries by established and upcoming fintech businesses and ICO organisers. It regularly organises fintech roundtable events, and some of its representatives have held public speeches on this topic.
Regulatory Landscape for Crypto and ICOs in Switzerland
Switzerland has not enacted any specific, comprehensive regulation of blockchain- or cryptocurrency-focused businesses, nor is there any specific regulatory licence type for such activities. Projects in this area in general, and ICO projects in particular, must be reviewed on a case-by-case basis taking into account the gamut of existing Swiss financial market regulation, most importantly the Federal Act on Stock Exchanges and Securities Trading ("SESTA"), the Federal Financial Market Infrastructure Act ("FMIA"), the Federal Act on Banks and Savings Banks ("BankA"), the Federal Act on Collective Investment Schemes and the Federal Act on Combating Money Laundering and Terrorist Financing ("AMLA"), as well as new regulations scheduled to enter into force in the near future (see further below). It is often a prudent (and common) step for startups and ICO organisers to present their projects to FINMA and apply for no-action letter or confirmation of the applicable regulatory framework before launching them in the Swiss market (and applying for the relevant licences, if required).
To streamline the process, FINMA published on 16 February 2018 guidelines for enquiries regarding the regulatory framework for ICOs ("ICO Guidelines"). The ICO Guidelines set out the minimum information required by FINMA to assess regulatory enquiries in connection with planned ICOs and provide some guidance on how FINMA applies Swiss financial market regulation in this context. FINMA accepts enquiries from market participants either in an official Swiss language or in English. The latter is a rather liberal offer by FINMA since, as a general principle, official submissions to FINMA have to be filed in German, French or Italian, and a novelty to account for the fact that ICO organisers often come from all over the world.
The ICO Guidelines provide some legal guidance for ICO organisers and confirm that Switzerland continues to be "open for business" for ICOs. It is particularly important to note that FINMA applies a "substance over form view" taking into account the underlying economic functionality of tokens. On this basis, FINMA differentiates between three main categories of economic token functionalities:
i) Payment tokens, i.e. tokens intended to be used, now or in the future, as a means of payment for the acquisition of goods or services or as a means of money or value transfer (synonymous with pure "cryptocurrencies"). Payment tokens do not contain or represent any claims against the issuer. For example, Bitcoin and Ether are considered payment tokens;
ii) Utility tokens, i.e. tokens intended to provide access to a digital application or service provided on or using a blockchain infrastructure;
iii) Asset tokens, i.e. tokens representing assets such as debt or equity claims against the issuer. They promise for example a share in future earnings of a company or future capital flows. With regard to their underlying economic function, asset tokens can be analogous to equities, bonds or derivatives. Furthermore, tokens that are intended to make physical assets tradable on a blockchain fall in this token category.
The "three buckets" concept is not exclusive and leaves room for hybrid forms of tokens (for example asset tokens that also qualify as payment tokens).
Depending on the type of tokens, various Swiss financial laws may apply. First, a key question of many ICO organisers is whether the tokens to be issued qualify as "securities" (Effekten) in the sense of Swiss financial regulation and what the consequences of such qualification might be.
Under Swiss law, "securities" are standardised certificated securities (Wertpapiere), uncertificated securities (Wertrechte), derivatives (Derivate) and intermediated securities (Bucheffekten) that are suitable for mass trading (art. 2 lit. b FMIA). An instrument is deemed standardised and suitable for mass trading if it is publicly offered for sale in the same structure and denomination or placed with more than 20 clients (except where it has been created specifically for individual counterparties; art. 2 para. 1 of the Financial Market Infrastructure Ordinance).
In its ICO Guidelines, FINMA expressed the view that payment tokens are not securities. The same applies to utility tokens if the following two requirements are fulfilled cumulatively: (i) the sole purpose of the utility tokens in question is to confer digital access rights to an application or service and (ii) the utility tokens can actually be used in such manner at the point in time of issuance. Otherwise, utility tokens may qualify as securities. Generally speaking, a token is likely to qualify as a security if, at the point in time of the ICO or at a later point in time, it serves an "investment purpose" in the broad sense (regardless whether the token is exclusively used for investment purpose or whether it comes in addition to another use as a means of payment or another functionality). On this basis, FINMA generally treats asset tokens as securities. Also, if a pre-sale is conducted, FINMA treats the claims to acquire tokens in the future as securities.
That said, tokens may change their regulatory classification over the course of their lifetime (for example utility tokens may initially qualify as securities while the platform on which they are to be used is developed or in beta stage, but may later lose the quality of securities once the platform becomes operational).
Currently, the regulatory consequences of tokens qualifying as securities for the primary market issuer are limited. As a general principle, the creation and public offering by an issuer of its own security tokens on the primary market is not subject to a Swiss securities dealer licence requirement. An exception is the issuance on a professional basis of tokens qualifying as derivatives, i.e. the activity as a derivative house (art. 10 SESTA in conjunction with art. 3 para. 3 of the Federal Ordinance on Stock Exchanges and Securities Trading; "SESTO"), for example if an ICO organiser were to issue (asset) tokens the value of which is linked to the performance of an underlying asset such as a share or index. Such activity may require a licence as a securities dealer/derivative house.
While there may be no regulatory licence requirement, an ICO organiser issuing security tokens is from a Swiss civil law perspective required to publish a prospectus with the minimum content prescribed by the Swiss Code of Obligations, if the issuance is public and the tokens represent shares or bond instruments. However, the current prospectus rules under Swiss law are very lean by international standards as long as the securities are not listed on an exchange. Similarly, there is currently no requirement to have the prospectus vetted by any governmental or other authority.That said, on 15 June 2018, the Swiss parliament adopted the new Financial Institutions Act ("FinIA") and Financial Services Act ("FinSA"), which stand to introduce an entirely new Swiss financial regulatory framework. This includes new regulations on prospectus requirements for security offerings. Subject to various exemptions, the obligation to prepare a prospectus will be triggered under the new law, if a person in Switzerland makes a public offer to subscribe or purchase securities or seeks the admission of securities to trading on a Swiss trading venue (art. 35 para. 1 FinSA). The FinSA further provides for an obligation to prepare a key information document in connection with the offering of certain financial instruments to retail investors. The new laws and implementing ordinances are expected to enter into force on 1 January 2020, with an additional transitional period.
A second challenge for ICO organisers is compliance with Swiss AML regulation, mainly consisting of the AMLA, its implementing ordinances and accompanying self-regulation. As a general principle, the AMLA applies to so-called financial intermediaries (Finanzintermediäre). These include in particular certain prudentially regulated and licensed entities such as securities dealers or banks (art. 2 para. 2 AMLA) as well as any person professionally accepting or holding on deposit assets belonging to others or assisting in the investment or transfer of such assets (art. 2 para. 3 AMLA). An ICO organiser acting in or from Switzerland may fall within the scope of this regulation, if it provides a payment service or issues payment instruments. This will generally be the case if it offers payment tokens or hybrid tokens with a payment component, since tokens that can be readily transferred by technical means on a blockchain infrastructure are characterised as payment instruments if they can be used to settle a payment obligation.
In terms of regulatory consequences, financial intermediaries are required to join a recognised Swiss self-regulatory organisation for AML purposes ("SRO"; the previous option for direct supervision by FINMA is in practice no longer available and will be repealed when the new FinIA comes into force) and are subject to typical duties of due diligence and know-your-customer principles. However, in the context of ICOs, FINMA considers that such registration duty can be avoided by the ICO organiser if all funds from ICO participants are accepted via a registered financial intermediary that is already subject to the AMLA and fulfils the due diligence requirements of the ICO organiser on its behalf.
Investment Fund Regulation:
Separately from securities regulation and AML compliance, practical experience with ICOs has shown that, in many projects, tokens are prone to qualify as units in collective investment schemes from a Swiss investment fund regulation perspective. This is generally the case if the funds raised in an ICO are pooled and in some way or other managed on behalf of the tokenholders, even for a limited time period, rather than used for the purpose of building and maintaining an operative business. In practice, the complex Swiss investment fund regulation raises a challenging regulatory hurdle for ICO organisers or even constitute a show-stopper. In order to improve Switzerland's competitiveness as an investment fund location, the Swiss Federal Council recently instructed the Swiss Federal Department of Finance to draw up a legislative revision that would introduce a new category of funds for qualified investors. These would not be subject to approval and could be placed on the market more quickly and cost-effectively.
Finally, tokens (that is, the liabilities represented by them) may qualify as public deposits and trigger the application of Swiss banking regulation, if they represent liabilities or other types of repayment obligations by the issuer towards the tokenholders, such as promises to return moneys with a guaranteed return. In particular, if tokens are qualified as public deposits, a banking licence (or, under new regulation (see further below) and up to a certain amount, a new "financial innovator" licence) will be required. Certain limited exemptions are available, notably in the context of the issuance of debt instruments accompanied by a prospectus fulfilling the minimal requirements of Swiss law. In this context, FINMA publicly announced in July of 2018 that it had launched an investigation against an ICO organiser suspected of having professionally accepted deposits from the public without a Swiss banking licence.
Exchange and Trading of Existing Tokens and Cryptocurrencies in SwitzerlandActivities in the secondary market, including the offering of professional services in connection with the exchange and trading of tokens qualifying as securities or payment instruments, may trigger Swiss regulatory licence or registration requirements.
Financial Market Infrastructure Regulation:
In particular, while there are no active providers in the market yet, Swiss-based crypto exchanges allowing for multilateral trading of tokenised securities may qualify as trading venues pursuant to Swiss financial infrastructure regulation. In particular, a crypto exchange might qualify as a multilateral trading facility (MTF) and, as such, require a licence from FINMA (art. 4 in conjunction with art. 2 lit. a no. 1 and 2 FMIA). Trading venues domiciled abroad must have obtained recognition from FINMA before granting FINMA supervised Swiss participants direct access to their facilities (art. 41 FMIA).
In contrast to regulated trading venues, so-called organised trading facilities ("OTF") are not themselves subject to a regulatory licence requirement. However, the operator of an OTF needs to be licensed and regulated as a bank, securities dealer or domestic trading venue or have obtained the status of recognised foreign trading venue (art. 43 para. 1 FMIA). A crypto exchange might conceivably qualify as an OTF if the multilateral trading of tokenised securities is based on discretionary rules or if it only allows for bilateral trading. Moreover, a crypto exchange might qualify as an OTF even if the tokens traded do not qualify as securities but as so-called "other financial instruments" (art. 42 FMIA).
The FMIA does not itself define the term "financial instruments", but FinSA (expected to enter into force on 1 January 2020) provides more guidance on the term. According to the new law, equity securities, debt securities, (Swiss and foreign) units in collective investment schemes, structured products, derivatives, deposits whose redemption value or interest is risk- or price-dependent (excluding those whose interest is linked to an interest rate index) and bonds will be considered financial instruments (art. 3 lit. a FinSA). Consequently, if for example an over-the-counter derivative does not fulfil the requirements for a qualification as security (because it is not standardised and suitable for mass trading), it may still qualify as a "financial instrument" and an exchange offering secondary trading in such instruments may be considered an OTF.
Securities Dealer and Banking Regulation:
Depending on their business activities, Swiss-based firms participating in the secondary market in blockchain tokens may require a Swiss securities dealer licence (for example as a client dealer; art. 3 para. 5 SESTO) or even, separately or additionally, a Swiss banking licence. The banking licence requirement might for example be triggered if the exchange of money in an official currency (fiat) against Bitcoin or another payment token does not take place immediately in the form of delivery against payment (Zug um Zug). This could be the case if a professional payment token trader/exchange accepts funds from its customers on deposit in order to facilitate future trades.
Furthermore, Swiss AML regulation may apply to crypto exchanges. Among other activities, currency exchange (for example the purchase and sale of payment tokens such as Bitcoin or Ether against official currencies or other cryptos in a two-party relationship) or, in the case of an involvement in the payment process, the operation of a trading platform on a professional basis is regarded as a financial intermediation activity subject to the AMLA if conducted in or from Switzerland (art. 5 para. 1 lit. a of the Federal Ordinance on Combating Money Laundering and Terrorist Financing).
There are currently several Swiss-domiciled crypto exchanges that are not prudentially regulated by FINMA but are members of an SRO for AML supervision purposes only (for example Bity and Swiss Crypto Exchange, pursuant to their public statements). Such platforms may, in principle, only offer trading in payment tokens or certain utility tokens that do not qualify as securities or other financial instruments. To date, we are not aware of any professional crypto exchange in Switzerland for the trading of security tokens. However, on 6 July 2018, SIX Group announced that SIX Swiss Exchange is creating a crypto-asset trading platform under the label SIX Digital Exchange for the purpose of digitally tokenising and trading securities and other financial products. According to SIX Group, this would be the first market infrastructure in the world that offers fully integrated end-to-end trading, settlement and custody service for digital assets. SIX Swiss Exchange is regulated by FINMA as a stock exchange and expects that SIX Digital Exchange will enjoy the same standard of supervision and regulation. The initial offering of services is aimed for mid-2019.Regulatory Relief for Fintech and Insurtech Businesses
In 2016, the Swiss Federal Council started various projects for regulatory changes to reduce the market entry barriers for emerging fintech businesses, in particular in the area of Swiss banking regulation. These regulatory reliefs rest on three pillars, two of which were already implemented in 2017: (i) an extended maximum holding period for monies on settlement accounts and (ii) an innovation sandbox. The third pillar, a new licence type for financial innovators, is expected to become available in 2019.
Furthermore, the Swiss Federal Council recently initiated a consultation on a partial revision of the Insurance Supervision Act ("Draft ISA"). Under certain conditions, the Draft ISA allows for an exemption of insurance undertakings with innovative business models from the Swiss insurance supervision requirement.
• Fintech Licence
In the course of the deliberations on the FinIA and FinSA, based on a proposal of the Swiss Federal Council, parliament included a provision for "promoting innovation" in the BankA (art. 1b revBankA). The new provision introduces a licence category below the traditional, fully fledged banking licence, colloquially referred to as "banking licence light" or "fintech licence". FINMA will be competent for granting such licences and for supervising holders.
As mentioned above, Swiss law has so far limited professional deposit-taking activities to banks, which are subject to onerous prudential regulation. However, many emerging fintech businesses, such as payment services providers, have a need to accept and hold customer funds for extended periods of time, without engaging in a typical commercial banking business and being exposed to the risks arising out of this type of business. Therefore, a new type of licence was created for financial innovators (and other potentially interested businesses) in order to lower the barrier to entry for market participants that do not follow a banking model involving lending customer deposits. The fintech licence will allow its holders to accept, on a professional basis, deposits from the public in an amount of up to CHF 100 million, provided that (a) no interest is paid on the accepted deposits and (b) they are not invested.
Holders of a fintech licence will be subject to ongoing supervision by FINMA, but will have to fulfil less stringent regulatory requirements than fully fledged banks, in particular in terms of organisation, accounting, minimum capital, own funds and liquidity. In contrast to deposits held by banks, the deposits held by a fintech licence holder will not be covered by the Swiss depositor protection scheme. The depositors will have to be informed accordingly before any deposits are accepted (art. 1b para. 4 lit. d revBankA). Otherwise, where no specific rule applies, the provisions of the BankA will apply mutatis mutandis to fintech licence holders (art. 1b para. 1 revBankA).
The provisions on the new fintech licence are expected to enter into force on 1 January 2019, together with an amended Federal Ordinance on Banks and Savings Banks ("BankO").
• Exemption from Supervision for Insurance Undertakings with Innovative Business Models
According to the Draft ISA, FINMA shall be granted the right to exempt insurance undertakings with innovative business models from Swiss insurance supervision if (a) this serves the sustainability of the Swiss financial market and (b) the interests of the insured are safeguarded (art. 2 para. 3 lit. b Draft ISA). An implementing ordinance will further concretise the requirements for this exemption (art. 2 para. 4 lit. c Draft ISA). However, it is expected that FINMA will have broad discretion in reviewing and deciding upon applications.
The consultation on the Draft ISA will last from 14 November 2018 until 28 February 2019.
• Maximum Holding Period for Settlement Accounts
As a general principle, persons accepting or soliciting the acceptance of deposits from the public on a professional basis require a banking licence. The term "deposits from the public" covers a very broad range of liabilities towards third parties, subject to limited exemptions. In particular, companies that have a need – due to their business model – to hold third-party funds for limited periods of time may profit from the exemption for so-called settlement accounts, i.e. non-interest bearing accounts established for the sole purpose of settlement of client transactions. As long as a maximum holding period is respected, client funds on such accounts do not qualify as deposits from the public. With effect as of 1 August 2017, this maximum holding was extended from 7 to 60 days (art. 5 para. 3 let. c BankO). This exemption enables, for example, crowdfunding platforms to run longer campaigns or payment service providers to process payments in batches. Furthermore, it provides payment service providers with much more flexibility in structuring their business model. However, the exemption does not apply to forex traders and cryptocurrency traders engaging in similar activities.
• Innovation Sandbox
Together with the extended maximum holding for settlement accounts, a sandbox space was created for fintech and other emerging businesses to test their business models in a licence-free environment. The sandbox allows any person, without the prior approval or review by the regulator, to accept deposits from the public in an amount of up to CHF 1 million, regardless of the number of depositors, without needing a banking licence (art. 6 para. 2 BankO). This exemption is, however, available only if the deposits are neither interest-bearing nor invested (with the exception of financing a mainly commercial or industrial activity). In addition, as a mitigating measure, the deposit-taker must inform the depositors – before accepting any of their monies – that it is not supervised by FINMA and that the deposits are not covered by the Swiss depositor protection regime.
The existing principle-based and technology-neutral Swiss financial regulation provides an attractive legal framework for fintech businesses and initial coin offerings. That said, there are still areas of the law that might be amended to pave the way for further innovation, such as investment fund regulation and form requirements of Swiss civil law as to the transfer of claims. However, recent developments show that the relevant authorities take a dynamic approach and are supportive of the needs of the fintech market. Switzerland is set to further strengthen its position as a stable and welcoming base for the financial business models of the future.
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