The Swiss Banking Sector


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The Swiss Banking Sector

  1. 1. Compendium Edition 2004 The Swiss Banking Sector
  2. 2. Preamble This compendium aims to provide an overview of structures, processes and institutions in the Swiss banking and financial centre. In our activity report ( we provide comprehensive information about the key events of the past year. In the compendium we focus primarily on the global structures and institutions of the banking sector and their development, and we only address those events of the past two years which were relevant to these issues. The compendium is intended for readers outside the industry who seek to gain a general understanding of the banking sector, as well as professional bankers with an interest in obtaining accurate informa- tion on a specific subject. The compendium may also serve as sup- port literature for university level lectures and as a general reference. The 2004 edition is an expanded update of the 2001 version. The compendium is updated bi-annually. The author looks forward to receiving your comments and sugges- tions on his e-mail address: Basel, October 2003 Swiss Bankers Association PO Box 4182 4002 Basel Switzerland 2
  3. 3. Contents Page 2 Preamble 3 Contents 6 Index of Acronyms Chapter 18 Economic Function of the Financial System Inter-Temporal Exchange 8 Allocation of Funds 9 Allocation of Risks 9 Supply of Liquidity 9 Information and Monitoring 10 Difference Between Banks and Industrial Companies Chapter 2 11 Banks in the Overall Economy High Output and Productivity 12 Important Employer, Above-Average Salaries 12 An Important Taxpayer 12 Asset Management is a Core Competence Chapter 3 14 Development of Select Business Areas Lending Business – Profitable and Crucial to the Economy 15 Investment Funds 15 Self-Regulation in Fund Business 16 Mortgage Business 16 Mortgage Business in a Process of Change 17 Investment Banking 18 Payments 18 Swiss Interbank Clearing AG 3
  4. 4. 18 Swiss Euro Clearing Bank 19 Continuous Linked Settlement (CLS) 19 Investment Advice and Asset Management 20 Safe Custody of Securities and Valuables 21 Global Custody 21 Draft for a Securities Custody Act 22 Fiduciary Business 22 Derivative Financial Instruments Chapter 4 23 Economic Challenges for the Banks Additional Synergy and Savings Potential Exists 24 The Choice of Business Model is Decisive 25 New Challenges in Wealth Management 26 Continued Success Thanks to Standardisation and Disintegration Chapter 5 27 Supervision and Regulation of Banks The Federal Banking Commission (FBC) 27 Banking Regulation: Purpose and Basis 28 Reform of Financial Market Regulation 29 Banks, Banking Commission and Auditors 29 Impeccable Business Conduct as Requirement for Banking Licence 29 Auditors as Instruments of the FBC 30 Reform of Bank Audit 30 Compliance 30 Business Activity Requirements 30 Equity 31 New Basel Capital Accord (Basel II) 31 Risk Monitoring 31 Liquidity 32 Depositor Protection 32 Amendment of the Bank Insolvency Law 33 Amendment of the Depositor Protection Agreement 33 Annual Statement and Balance Sheets 34 FBC Guidelines on Accounting Regulations (FBC GAR) 34 Self-Regulation and Code of Conduct 34 Code of Conduct with Regard to the Exercise of Due Diligence (CDB 03) 35 Swiss Banking Ombudsman 36 International Co-Operation among Supervisory Authorities 36 Administrative Co-Operation and In Situ Monitoring 37 Consolidated Supervision 37 Bank Customer Confidentiality 38 Swiss Tax System 38 Direct Withholding Tax as a Correlation 38 Taxation of Savings Interest Earnings in the EU, Tax Retention in Switzerland 39 Anti-Money Laundering Measures 39 Public Law and Penal Code 40 International Mutual Legal Assistance in Criminal Matters 40 Self-Regulation 4
  5. 5. Chapter 6 41 The Banks’ Joint Organisations Position and Significance of the Joint Organisations 42 Swiss Financial Services Group AG (SIS) 42 SIS SegaInterSettle AG 42 SIS x-clear AG 42 Telekurs Group 43 Telekurs Multipay AG 43 Telekurs Card Solutions AG 43 Swiss Interbank Clearing 43 PayNet (Schweiz) AG 43 Telekurs Financial AG 43 Telekurs Services AG 43 Stock Exchanges 44 SWX Swiss Exchange 44 Swiss Value Chain 45 SWX Group Chapter 7 46 The Swiss National Bank The Monetary Concept 47 Monetary Control 47 Repurchase Agreements 48 Other Duties of the SNB 48 Cash Supply 48 Non-Cash Payment Transactions 49 Creating Currency Reserves 49 Monitoring of the System Stability 49 International Co-Operation 49 Advisor and Banker to the Federal Government Chapter 8 50 SwissBanking – The Swiss Bankers Association Safeguarding Interests and Self-Regulation as Primary Objectives 50 Membership List Includes Auditors and Securities Traders 51 General Assembly, Board of Directors and Office Chapter 9 52 Categories of Banks Categories of Banks as per SNB Banking Statistics 52 The Cantonal Banks 53 The Big Banks 53 Regional Banks 54 Raiffeisen Banks 54 Private Bankers 55 Other Banks 55 Non-Bank Financial Intermediaries 56 Selection of Basic and Advanced Literature 59 Internet Addresses 5
  6. 6. Index of Acronyms Art. Article SBL Federal Act on Banks and Savings Banks (Swiss Banking Law) SESTA Federal Act on Stock Exchanges and Securities Trading FSO Federal Statistics Office BIS Bank for International Settlement CBOT Chicago Board of Trade CHF Swiss franc CS Credit Suisse i.e. that is (id est) FBC Swiss Federal Banking Commission fed. Federal EU European Union EUREX EURopean EXchange ECB European Central Bank f./ff. Following page/following pages (folio/folios) FATF Financial Action Task Force on Money Laundering GAAP Generally Accepted Accounting Standards MLA Federal Act on the Prevention of Money Laundering in the Financial Sector 6
  7. 7. Psr. Publisher IAS International Accounting Standards Intersettle Swiss Corporation for International Securities Settlements SME Small and Medium-sized Enterprises DD Direct Debit m. million bn. billion MROS Money Laundering Reporting Office Switzerland Nasdaq National association of securities dealers automated quotation system NYSE New York Stock Exchange OTC Over-the-Counter p.a. for the year, annual (per annum) Repo Repurchase Agreement CR Circular (FBC) SBA Swiss Bankers Association FDCB Federal Act on Debt Collection and Bankruptcy SEC Securities and Exchange Commission SECB Swiss Euro Clearing Bank GmbH Frankfurt SECOM SEga COMmunication System SFS Swiss Financial Service Group SIC Swiss Interbank Clearing SIS SegaInterSettle AG SNB Swiss National Bank SPC Swiss Penal Code SWX SWiss eXchange (Swiss stock exchange) TARGET Trans European Automated Real-Time-Gross-Settlement-Express-Transfer-System i.a. including, among other things (inter alia) CDB Agreement on the Swiss banks’ code of conduct with regard to the exercise of due diligence e.g. for example (exempli gratia) 7
  8. 8. 1 Economic Function of the Financial System Inter-Temporal Exchange All financial business is conducted on the basis of contracts. These agreements form the basis of and regulate the exchange of payments at different intervals between two or more parties. The lender makes cash or cash-like equivalents available to the borrower on a given day and receives a promise from the borrower that he or she will repay the loan in the future. This voluntary exchange has advan- tages for both sides: the borrower has the opportunity to make pur- chases or investments which he or she would otherwise have to post- pone or abandon altogether; to obtain this advantage, the borrower is prepared to pay an interest on the capital borrowed. In return, the interest payment compensates the lender for agreeing not to use his or her funds immediately. Allocation of Funds Investment capital is always limited. Consequently, a selection of projects to be considered is necessary. The decision is driven primarily by the price: the advantage is with the borrowers who are willing and able to pay the prevailing market rate of interest. Thus the decision depends on the expected return on the investment to be financed. At this initial stage, any possible risk to the lender is abstracted. The very existence of such risk means that we need to check and monitor (see below). 8
  9. 9. Allocation of Risks The risks (and opportunities) are distributed differently for bank loans and private equity financing. Different levels of risk and opportunity are inherent in bank loans and private equity financing. In the case of a bank loan, the lender has a legal right to claim repayment and interest irrespective of the success of the project to be financed. However, in practice, the bor- rower may be unwilling (lack of repayment discipline) or unable (lack of credit worthiness) to meet his liabilities. In the case of private equity financing, the lender participates in the success or failure of the project. Individual risks can be eliminated by the law of large numbers; systematic risk cannot. Conservative lenders will only assume such risk if they receive compensation in the form of a risk premium. The rapid development of financial derivatives has rounded out the market system: using Lenders will only assume derivatives, risks can often be isolated more risk if they receive com- accurately and thus transferred; as a result pensation in the form of the opportunities for risk allocation have increased. Derivatives are based on various a risk premium. combinations of three basic types of financial contract: forwards/- futures, swaps and options. Depending on the underlying instruments, a distinction is made between rate, currency and index derivatives. Supply of Liquidity Liquidity describes the ability to settle a payment commitment on time. An asset is deemed liquid if it can be sold, and thus converted into legal tender (money), at any time in any volume, without a price loss vis-à-vis the market rate. Banks help their customers to cover themselves against the risk of unexpected funding requirements. This is one of the reasons why secondary markets exist. An asset’s level of liquidity also depends on the market in which it is traded, as well as the system of that market and the quality and reliability of information about the product (asymmetric information may be an indication for non-liquidity). Information and Monitoring The borrower is usually better informed than the lender on the risks and opportunities of the project the latter finances (asymmetric information). This means the borrower is in a position to influence the chances of success of the investment through his or her action (behavioural risk). After all, the loan he or she has promised to repay is equally dependent on the occurrence of random events (e.g. a recession). There are various ways for the lender to hedge against these risks: he or she can procure additional information about the borrower ex ante (creditworthiness check, financial analysis), continuously monitor his or her exposure, demand equity and collateral from the borrower in order to cover his or her secondary liability and, finally, demand compensation for the risk incurred in the form of a premi- 9
  10. 10. um on the rate of interest. Financial intermediation is another source of information part of which is made available to the public (e.g. when a company is admitted to the stock exchange). Difference Between Banks and Industrial Companies In contrast to industrial companies, banks do not provide physical goods but services. These consist of liquidity, information and trans- formation services (see above) The credit risk of a bank corresponds to the investment risk of a company; the liquidity risk corresponds to the capital structure risk. The bank is also subject to interest rate risk (due to maturity transformation, a bank risks having to refinance its long-term loans at rates which exceed the rate of interest on the loan if the interest rate structure changes). The insolvency of a bank can have a significant external impact on the overall economy; potentially more serious than if an industrial company were to go bankrupt. If, for example, there is a run on a bank, there might be a chain reaction, resulting in the collapse of other banks (systemic risk). Because of this danger, banks are generally more heavily regulated than industrial concerns. 10
  11. 11. 2 Banks in the Overall Economy High Output and Productivity With a net output of almost CHF 57bn or 14% of gross domestic product, the financial sector was among the key sectors in Switzerland again in 2002. Banks contributed CHF 44.4 bn to the real net output, which corre- sponds to 11% of GDP. Insurances contributed CHF 11 bn or 2.7% of GDP and other financial services companies CHF 1.2 bn or 0.3% of GDP. 1 These figures vary 200,000 employees work in the financial sector – i.e. 5.3% of the slightly, depending total workforce, of which 3.3% work for banks, 1.7% for insurance on the source; we companies and 0.3% for other financial intermediaries. 1 use the data provid- ed by BAK Basel Economics AG; The importance of the banking sector in Switzerland is also very these data differ high by international standards, its contribution to the overall net marginally from those provided by output being around twice the size of banks in Germany, France or the Federal Statis- the USA. tics Office (FSO). In relation to other businesses, labour productivity (real net output divided by the number of employees) in the financial sector is above average. 5.3% of the total work force work in the financial sector and deliver 14% of the overall net output, in other words – the pro- ductivity per employee is about triple the average. 11
  12. 12. The Financial Sector and Other Important Industries in 2002 Percentage Percentage Labour productivity * of workforce net output nominal Financial Sector 5.3 14 264 Banks 3.3 11 333 Insurance 1.7 2.7 159 Other 0.3 0.3 100 Commerce 16.4 11.4 70 Hotels and Restaurants 5.8 3 52 Construction 7.3 5.2 71 Equipment 8 8.1 101 Pharmaceutical Industry 1.6 3.3 206 Food and Beverages 1.6 1.7 106 * average = 100 Source: BAK CH-Plus, April 2003 Real productivity per hour (real net output divided by total number of man-hours worked) narrowed by around 10% over the past two years. Calculations by BAK Basel Economics show that this decline has been a result of a 5 per cent decline in real net output combined with an increase of man-hours worked by 5 per cent. The latter indi- cates that the unfavourable market conditions took the banks by surprise and the banks therefore failed to reduce their staff in pace with the declining net output. Important Employer, Above-Average Salaries Around 200,000 people are employed in the financial sector, more than half of them work for banks and almost half of the bank staff are employed with the big banks. More than Around 200,000 people half of all insurance staff work for accident and work in the financial damage insurances, followed by life insurances sector, more than half which employs around one-eighth of all insur- ance staff. of them in banks. In the year 2000, the median monthly gross salary in the banking sector was CHF 7,190, thus exceeding the Swiss median by about one-third (as the distribution is skewed right, the arithmetic mean should be somewhat higher). The respective figure in the insurance business was CHF 6,505 and in other financial services companies CHF 6,937. These figures reflect, i.a., the high level of labour pro- ductivity. An Important Taxpayer Banks are one of the most important taxpayers in Switzerland. The total sum of taxes paid annually by banks, their employees and shareholders amounts to CHF 13 bn (including withholding tax and stamp duty) which represents more than 13% of the total federal, cantonal and municipal tax revenues. Asset Management is a Core Competence Banks make a significant contribution to Switzerland’s prosperity. The asset management business is particularly important, as it gen- erates more than half of the banks’ combined net output, and more than 80% of that is achieved with private customers. Swiss banks 12
  13. 13. are global leaders in cross-border asset management (i.e. with cus- tomers domiciled abroad) with a relevant world market share of around 33%. At the end of 2002, security assets held in customer accounts with domestic banks (parent bank without foreign branches), fell by 13% from the previous year to CHF 2,945 bn. This decline was mainly due to the weaker valuation of stocks. 47% of total deposits were held by institutional investors, 42% by private customers and 11% by corporate customers. 56% of all securities were held by foreign investors, and 47% of all securities were denominated in Swiss francs. Securities Holdings in Customer Accounts with Domestic Banks Year* All customers Foreign customers Domestic customers Allocation in CHF CHF bn. in % (by all customers) 1999 3,438 1,847 1,591 – 2000 3,717 2,056 1,661 49 2001 3,400 1,901 1,498 47 2002 2,945 1,659 1,286 47 * at year end Source: Swiss National Bank Last but not least, the comparatively low rate of interest in Switzer- land is a direct consequence of this strong market position in asset management and has advantages for the country’s entire economy. Such low interest rates represent a significant competitive advantage at the international level, which primarily benefits the Swiss labour market. 13
  14. 14. 3 Development of Select Business Areas Lending Business – Profitable and Crucial to the Economy Traditional loans are of great importance to the economy. The domestic market for construction loans amounts to about CHF 600 bn., of which 60% are attributed to private households, 30% to businesses and 10% to other financial services companies and the public sector. With a share of 78%, mortgages are the predominant form of lending. Bank loans are a major, if not the single, source of outside financing for many companies, especially small and medi- um-sized businesses (SME). The profitability and sustainability of an individual bank’s loan business depends to a large extent on the implementation of an ade- quate risk policy by the bank. In compensa- The profitability and tion for its risk, the lending bank has the sustainability of a bank’s right to claim a form of risk premium, i.e. a loan business depends commensurate rate of interest and appropri- to a large extent on its risk ate lending terms. Supervision and regula- tion, including rules on equity and liquidity, policy. are crucial in this context. The Swiss National Bank’s stability-oriented monetary policy materi- ally supports the banks in defining their risk policy and establishing terms and interest rates. The guiding principle is to use a reliable monetary policy to contain inflationary expectations. The ultimate objective is to preserve Switzerland’s autonomy in terms of interest rate policy and thus enable the banks to supply the market with favourable loans. 14
  15. 15. The banks’ retail business, particularly loans to SME, remains very important. Private and business loans as well as mortgage lending continue to be vital to vast parts of the banking sector. Investment Funds Investment funds consist of assets which the fund management solicits publicly from investors for the purpose of collective investment. The fund management manages these assets usually on the principle of risk diversification on behalf of the investors. The fund management company acts on the basis of a collective investment agreement, managing the investment fund independently and in its own name for the account of the investors. It makes deci- sions about purchase and sale of investments, keeps the accounts and publishes the financial statements for the investment funds. The fund management company has to represent the interests of the investors. In most cases, fund management firms are subsidiary com- panies of banks. As an independent legal entity, the fund assets are classed as preferential debt: if the bank or fund management declares bankruptcy, these assets are excluded from the bankruptcy estate. A manager of a Swiss investment fund as well as the custodian bank where the fund assets are held, both need to be licensed by the FBC. Furthermore, the fund prospectus, issued jointly by the fund man- agement company and the custodian bank, is subject to FBC appro- val. The fund management as well as the investment fund are supervised by the FBC Switzerland ranks ninth and audited by an independent auditing worldwide in terms firm which is recognised by the FBC. Pro- of fund assets under fessional fund distributors also require an management. FBC licence. The investment fund business is significant domestically as well as by international comparison. In terms of volume of fund assets under management, Switzerland ranks ninth worldwide. Banks con- tinuously expand their investment fund services. Above and beyond the mere investment funds range, this applies also to related services such as fund portfolios, fund accounts or fund savings schemes. Self-Regulation in Fund Business To promote self-regulation, the Swiss Funds Association (SFA) has drawn up the following rules of professional ethics to supplement existing legal provisions: – Code of conduct for the Swiss fund industry (30th August, 2000). In effect since 1st January 2001, the Code of Conduct specifies minimum standards in terms of the fund management companies’ duty to exer- cise due diligence, act in good faith and provide fair information. – Guidelines on the calculation of net asset values and the handling of valuation errors in the case of securities funds (11th June, 2001) – Guidelines on fund distribution, including provisions for fund dis- tributors (22nd October 2001, in effect since middle of 2002). – Guidelines on the calculation and disclosure of the Total-Expense- Ratio (TER), approved by the FBC in June 2003 15
  16. 16. Funds have to publish their TER for the first time in their annual or semi-annual financial statements closing as from end of 2003. The TER expresses the costs and commissions charged to a fund’s assets as a percentage of the fund assets. In the past, many investment funds reported only their management and subscription fees. The TER includes also costs charged to the fund assets on an ongoing basis such as expenses covering the production of the annual and semi-annual financial statements, communication to investors, auditing fees and fees for supervision of the fund. Some banks go beyond these requirements and report not only the TER of their funds, but also the all-in fee. The latter includes all expenses related to the fund management company and the management of the investments. Excluded are only foreign stamp duty and costs incurred on the purchase or sale of investments outside Switzerland. Mortgage Business Switzerland has a substantial mortgage lending market. The average of mortgage lending per capita amounts to CHF 72,000 (by compari- son, average bank savings amount to CHF 44,000 per capita). Mort- gage loans are not only provided by banks, but also by insurance companies, pension funds, public institu- The continuous growth in tions, private enterprises and private indi- mortgage lending is an viduals. Banks command a market share of important growth factor for about 85%. Although other forms of loan the construction industries. shrank over the period from 1998 to 2002 by 1.1% p.a., the volume of mortgage loans provided by banks grew during the same period by an average of 2.1% p.a. The continuous growth in mortgage lending is an important growth factor for the primary and secondary construction industries (the secondary construction industry includes plumbing, carpentry etc.). Mortgage Business in a Process of Change Over the past ten years, banks have introduced a large variety of new mortgage types, and the variety of mortgage types continues to expand. With these new products, banks offer their customers customised financing solutions to a much greater extent than in the past. Fixed-rate mortgages account for more than half of the new mortgages in the present day. The interest rate on such mortgages is fixed and remains non-variable for a period agreed between the bank and its customer (usually two to five years). The number of money market mortgages is also growing rapidly. Banks refinance this type of mortgages in the Euromarket and charge the variable refinancing cost to their customers. This enables the banks to bor- row close to the market and at matched maturities. Most banks have ceased to offer the traditional variable mortgage with its inherent lack of pricing transparency, or they might only do so on specific demand. Mortgage pricing is being based increasingly on a single interest rate (instead of the dual interest rates for first and second mortgages). The single interest rate correlates to the loan-to-value ratio and the borrowers’ credit. The customer benefits from a more transparent pricing structure and is in a position to take individual precautions against general interest rate fluctuations. By fixing the mortgage for 16
  17. 17. a certain period, the customer can avoid the effects of interest rate fluctuations completely. In the case of currently inexpensive money market mortgages, the banks offer instruments for minimising the effects of interest rate fluctuation or fixing the maximum mortgage rate. Mortgage Debt in Switzerland in CHF bn. Creditor 1998 1999 2000 2001 2002 Banks 488 501 506 522 541 Insurance companies 31 31 32 32 – Pension funds 26 26 25 25 – Federal government 3 3 3 3 3 Total 548 561 566 525 – Source: SNB. Die Banken in der Schweiz 2002, S. 47 Asset securitisation, i.e. the substitution of loans for marketable securities, is gaining in importance with regard to the mortgage busi- ness. In this process, the bank sells part of its loan claims to a com- pany that is established specifically for this purpose and which refi- nances itself by issuing asset-backed securities (ABS). Asset securitisation was first applied in the USA in the 1970s and spread on a wider scale in the 1990s. In the USA the volume multi- plied from USD 400 bn to more than USD 2,000 bn between 1991 and 2001. At USD 300 bn, the volume was clearly lower in Europe in 2001. In 1998, the former Swiss Bank Corporation was the first bank in Switzerland to securitise domestic mortgage loans. The next transaction was carried out in 2001 by the ZKB and is described in detail below, as a model transaction. It remains to be seen whether ABS will establish itself in Switzerland as it has in the USA or some parts of Europe. Major banks in Switzerland are at any rate showing efforts to acquire the skills and competence necessary for engaging in ABS transactions on a larger scale. Investment Banking Investment Banking essentially consists of new issues, securities and currency trading, money market and treasury business as well as mergers & acquisitions consulting for large companies. These services require particularly specialised know-how on the one hand, but gen- erate a strong output on the other hand. Nowadays, it is no longer possible to look at investment banking form the perspective of a single financial centre. In other words, it is a highly globalised business operating 24 hours a day. Most services are now provided mainly out of only one very large financial centre per time zone; Investment banking is a this is the financial centre with a market highly globalised busi- size and concentration of customers suffi- ness operating 24 hours cient to accommodate an adequately spe- cialised community of service providers, and a day. with a dynamic labour market for a large number of indispensable specialists (e.g. corporate finance specialists, lawyers). London is currently the undisputed investment banking centre in Europe. The Swiss domestic market for investment banking services is relatively limited. 17
  18. 18. Providers of investment banking services typically have a global structure. This enables banks to form bespoke groups of specialists and expert teams to deal with individual transactions on a world- wide level as and when required. Networking, i.e. the simultaneous availability of various resources, is at the heart of such operations and crucial to success. Therefore, fairly large corporate size is typical for businesses engaging in investment banking. Asset securitisation plays a special role in investment banking. Several banks have already securitised mortgages, for instance. These transactions are normally complex in financial as well as legal terms and the costs are still quite high. Consequently, the profitability of a securitisation transaction still depends on the vol- ume of critical mass. Payments Swiss Interbank Clearing AG Swiss Interbank Clearing AG operates the interbank payments system in Swiss francs (SIC). sic is a real-time gross settlement system which processes payments online via the participants’ giro accounts with the SNB. Swiss Post has also been settling its money market trans- actions through SIC since November 2000. The SNB supervises and controls the flow of funds. More than 700,000 payments a day with a daily turnover of around CHF 180 bn were processed in 2002. At the end of 2002, 329 banks were members of SIC. Until 1997, access to SIC was restricted to banks domiciled in Switzerland. Since 1998, the SNB has been granting remote SIC access to international joint organisations and clearing organisa- tions as well as their bank members. 81 banks outside Switzerland are currently using SIC. Since the end of 2002, PostFinance has been holding 25% of shares in Swiss Interbank Clearing Ltd. as a member. This participation strengthens the existing cooperation between PostFinance and the Telekurs Group. Swiss Euro Clearing Bank EuroSIC, the clearing system for euro denominated payments in Switzerland and abroad, processed more than 1.6 million payments in 2002, 650,000 of which were cross-border payments. In terms of number of transactions, euroSIC ranks sixth among the 16 clearing systems connected to TARGET. As per end of December 2002, 122 financial institutions were connected to euroSIC. The SECB controls and supervises euroSIC. As a special-purpose bank, the SECB is exclusively in charge of euro denominated pay- ments. Furthermore, it provides all cash and collateral management services related thereto. Via SECB, euroSIC is connected to the Ger- man euro clearing systems EAF (Euro Access Frankfurt) and ELS (Euro Linking Settlement), as well as to TARGET via ELS. The mem- bers of euroSIC in Switzerland thus benefit from all essential access facilities to and from “Euro-land”. 18
  19. 19. Continuous Linked Settlement (CLS) The launch of the CLS system in the autumn of 2002 has been a mile- stone in the control of credit risks in currency trading. With head- quarters in New York, the CLS bank provides a system for eliminat- ing settlement risks in currency trading known as the Herstatt risks. In the past, the two sides of a currency transaction were processed at a time shift. In a purchase transaction of dollars against Swiss francs, the Swiss francs had to be delivered during European trading hours, whereas the corresponding dollar amount was credited only several hours later during American trading hours. In the meantime, there was a credit risk for several hours. Were one of the banks to be closed down in this period, the counter-party would incur a poten- tially enormous dollar loss. The CLS bank now processes currency transactions in the major currencies according to the “payment ver- sus payment” principle which eliminates the settlement risk for such payment transactions. 42 Settlement members are currently linked to the system and use CLS to process their currency payments in seven different currencies, including the Swiss franc. Three Swiss banks – UBS, CS and ZKB – are members of CLS. Two other financial institutions – HSBC and Bank of America – also settle their Swiss franc currency transactions via CLS. These five institutions enter a total of 1,400 payments at CLS per day worth CHF 20 bn. The settlement is processed through a direct link between the Swiss Interbank Clearing System (SIC) and the CLS bank. These five banks resort to intraday liquidity to cover their Swiss franc delivery commitments. The SNB provides intraday liquidity through interest-free repo business. CLS currently process- es around 35,000 transactions per day, worth a total of ca. USD 400 bn. CLS helps eliminate the settlement risk and contributes thus to the safety of the international financial infrastructure. Investment Advice and Asset Management According to a survey carried out by Merrill Lynch and Gemini Con- sulting, assets invested by wealthy private individuals world-wide as at the end of 2002 was estimated at USD 27,200 bn. (up 2.3% year-on-year). Wealthy private individuals are defined as persons with a net dispos- Swiss banks are global able income in excess of USD 1 million. leaders in managing There are around 7 million such individuals private and institutional world-wide; 2.2 million in North America, 2.6 million in Europe (including Eastern assets. Europe), 1.8 million in Asia and 0.3 million in Latin America. According to the survey, around 175,000 wealthy individuals lived in Switzerland as per end of 2002. Nearly one-third of global private assets, i.e. USD 7,900 bn, can be attributed to the wealthiest segment with a net disposable income of at least USD 30 million; there are an estimated 58,000 such individuals world-wide. An estimated 80% of the assets of wealthy private individuals are managed by asset managers domiciled in the beneficiary’s domestic market (= onshore); the remaining 20% of those assets are managed and invested by trustees resident in foreign jurisdictions (= offshore). Swiss institutions are among the global leaders in terms of management of private as well as institutional assets. An estimated 30% of internationally invested private assets world-wide are man- aged in Switzerland. 19
  20. 20. As at the end 2002, the value of securities held in customer accounts with all Swiss banks amounted to CHF 2,945 bn; foreign customers accounted for CHF 1,659 bn (or 56%). This figure does not include life insurance, customer assets in bank balance sheets and fiduciary deposits. The banks’ contribution to gross output and the creation and pre- servation of jobs in the overall economy is mainly due to the high level of productivity in the banking sector. The productivity also reflects the banking sector’s competitiveness on an international scale. Asset management plays a crucial role in this respect, as it gen- erates more than half of the banks’ total output. That is CHF 25 bn or 6% of GDP. Private customer business accounts for an estimated 80% of this output. In recent years, a moderate trend towards concentration has been observed in private banking. Nonetheless, private banking remains a widely fragmented business area at both the domestic and the glob- al level: for instance, UBS AG, the global market leader, controls a market share of 2% of the financial assets managed on behalf of “high net worth individuals” world-wide (the world top ten together manage approximately 8%). The banks’ success in asset management is attributed to their long- standing tradition in the business, traditionally stable legal and political conditions, a stable currency, the high efficiency and relia- bility of the banks and last but not least a good long-term perform- ance of investments. Performance is a crucial factor especially for institutional investor, although private customers are taking an increasing interest in performance, too. The big banks have expressed their intention to strengthen their onshore private banking activities, i.e. to service customers at their domiciles. Asset management has a strong positive impact on the securities and underwriting business in Switzerland. Thanks to the volume of assets they manage, the banks in particular have substantial placement power, which translates into an important competitive advantage in the underwriting business: approximately half of all new Eurobond issues are placed in customer portfolios managed by Swiss banks. Safe Custody of Securities and Valuables Safe custody of securities and valuable items (jewellery, documents etc.) is one of the original bank services. With a view to rationalising the custody of securities, banks began establishing external collective custodies (SEGA) some thirty years ago. An increasing demateriali- sation of securities has resulted from the banks’ efforts to further simplify safe custody. Although shareholders in listed companies are still entitled to hold physical shares, such physical shares are issued only on explicit request (deferred printing of securities). 20
  21. 21. Global Custody Large institutional investors typically hold securities in several countries. Big banks specialising in the securities business hold such securities in safe custody, and they monitor and manage them irre- spective of the place of custody. This service is known as “global custody”. Above and beyond safe custody, it includes settlement, collection of interest and dividend payments, providing information on corporate policies (e.g. capital increases) and tax returns. Further- more, added value services such as securities lending and various information services (portfolio analyses, performance calculation, fund accounting etc.) are gaining in importance. Safe custody, and especially global custody, is a fast growing business. However, global competition is causing a decline in margins and a growing cost squeeze. Moreover, growing customer expectations are giving rise to continuous costly investments in processing systems which can only be justified by sufficiently high business volumes. Providers of financial services are also attracted to Switzerland by the efficiency of its capital market logistics, which facilitate the smooth settlement of securities transactions. The joint organisations of the banks and stock exchange are the main providers of logistics. The banks in Financial services pro- Switzerland are thus well equipped to par- viders are also attracted ticipate successfully in the global custody to Switzerland by the market. efficiency of its capital Draft for a Securities Custody Act market logistics. At the initiative of the SBA, and in co-operation with the Swiss Federal Banking Commission (FBC) and the Swiss National Bank (SNB), a draft for a Securities Custody Act was submitted to the Swiss Federal Department of Finance (SFDF) in early 2003. The FDF manages the current revision of this draft. The final draft is expected to be submitted for consultation in 2004. The new law is devised as a supplement to existing securities laws, and reflects global developments in securities trading. There is a global trend towards dematerialisation and away from physical circulation of conventional securities. The association of ownership right and certificate, typical of conventional securities, is becoming increasingly fictional. This is manifested in the fact that securities are no longer held directly by the beneficiaries but centrally in col- lective custody and that securities are replaced by stock rights, i.e. non-certificated rights equivalent to securities. The Swiss Securities Act has not been amended since 1936. There is a need for clear reg- ulation with regard to securities held in collective custody. Moreover uncertainties in the transfer of stock rights need to be eliminated. The new Securities Custody Act aims to close the existing loopholes and thus enhances the legal basis for the securities business. It governs in particular the collective custody of securities and global certificates which comprise several securities. In addition, it provides clear regulation of stock rights, which become inscribed stock by entry in the public central registry of a central custody organisation. Stock rights thus obtain a qualitative status that exceeds the status 21
  22. 22. of a common receivable, and become equivalent to securities held in collective custody. Moreover, the draft also provides standards for the transfer of rights to securities, global certificates and inscribed stock in collective custody, as well as for the appointment of security interest. Fiduciary Business Fiduciary business includes investments, loans and equity interests which the bank holds or grants in its own name, but for the account and at the risk of a customer, on the basis of a written agreement. The instructing customer bears the full currency, transfer, price and collection risks on the one hand, and is the exclusive beneficiary of all accruals from such transactions on the other hand. The bank charges a commission for its services. Fiduciary business is still very important. The volume of assets under fiduciary contracts totalled CHF 339 bn as per end of 2002. Over the past ten years, about four-fifths of all fiduciary money has come from outside Switzerland. About 40% of fiduciary deposits originated from European countries. Banks invested 90% of fiduciary deposits in Europe. The largest investments were made in the UK, followed by Belgium, Luxemburg, the Netherlands and France. Less than 1% of fiduciary deposits were invested in Switzerland. Derivative Financial Instruments Derivative financial instruments are financial contracts whose prices are derived from the market value of their underlying instruments. Nowadays, however, the derivatives market often dominates that market for underlying instruments, i.e. the derivatives market deter- mines the prices in the underlying market. One of the reasons is that turnover volume in many derivative markets far exceed those in the underlying markets. Derivatives are based on various combinations of three basic types of financial contracts: Forwards/futures, swaps and options. The underlying instruments are subdivided into interest rate, currency and index derivatives. Derivative contracts are further categorised as exchange-traded contracts and over-the-counter (OTC) contracts. 22
  23. 23. 4 Economic Challenges 1 This chapter is also published in the SBA Annual Report for the Banks 1 2002/2003 As a result of the economic downturn and the protracted bear market, the banks have suffered a decline – in some cases considerable – in fee and commission income over the past two years. Investment banking and wealth management houses have seen their revenues contract. In addition, some banks incurred considerable losses from their proprietary equity holdings. The overall picture is nuanced slightly by the fact that despite lower revenues from asset manage- ment, trading and securities underwriting as well as losses on pro- prietary equity holdings, income from traditional interest activities, especially in the retail segment, continues to be relatively strong. Retail-oriented banks achieve comparatively stable results, particu- larly if they have their credit risks under control. This is the case for the overwhelming majority of players in the sector, not least due to the lessons learned from the painful experiences of the nineties. Additional Synergy and Savings Potential Exists The continued stagnation also raises questions about proportionate capacity. Wealth management and investment banking are areas which were expanded rapidly in the nineties. As stock prices and business volumes rose, so, too, did the personnel capacities in a number of the banks – to a level that in many cases is unsustainable over the medium term. Moreover, we must assume that employment cannot be maintained at present levels even if revenues stagnate. Technological progress has a “labour-saving” effect, albeit not to the same degree in all areas. The greatest potential for synergies and savings lies in back-office processing and IT where there is a high fixed 23
  24. 24. cost component. However, fully exploiting this potential generally requires some form of cooperation between the banks. Faced with the twin pressures of rising costs and falling margins, the banks are striving to reduce recognised overcapacities in a targeted manner. In most cases, this is impossible without reducing headcount. Between the end of 2001 and the end of 2002, Swiss banks cut a net total (i.e. taking into account newly-created positions) of around 2,000 jobs, a fall of 2%. This in a sector which for decades had been a job creator; a sector, moreover, which employs people with superior qualifications and remunerates them accordingly – a development unprecedented in the annals of Swiss economic history. The banks are reacting to the unfavourable environment by manag- ing costs more closely, concentrating on their core business and in some cases cutting jobs. Necessary though these measures may be, they are rarely sufficient in their own right. In order to get back on a more stable course over the medium term, it is also necessary in some cases to adapt business models, rethink value chains, open up structures and rationalise processes. The Choice of Business Model is Decisive The difficult situation currently facing the banks is due in large part to the ongoing stagnation of the overall economy. At the same time, structural challenges are also evident. For the individual bank, or rather its Board of Directors and Management, the key issue is to identify the medium-term business model most adequately suited to securing the bank’s long-term earnings power. Every bank seeks to create and maximise cost advantages and economies of scope by choosing a business model that best matches its particular strengths and resources, for example by fostering a high level of integrity (economies of trust) as a value proposition in the wealth manage- ment business, through the quality and scope of the products and services it offers (economies of scope), by bundling large volumes for processing and/or providing superior back-office execution (economies of scale) – or through a combination of these strategies. In principle, a bank can narrow or widen the focus of its business activity. In the late nineties, for example, a model in which banking operated as part of a broadly diversified financial conglomerate that also encompassed insurance was considered to have massive potential. In part due to the negative performance of the stock markets, which had a marked impact on the insurance sector and led to a drastic reduction in the equity component of investment portfolios, the banc assurance option is now viewed with a good deal more caution. 24
  25. 25. In recent times, the traditional model of a universal bank has come more to the fore, complemented and extended by the philosophy of what is known as “open architecture”. The idea, taken originally from fund distribution, involves a bank also delivering funds from third-party Universal banks providers, provided that such funds satisfy with “open architecture” defined quality requirements. The concept have come more to can be extended not only to other banking services like mortgages, but also to internal the fore. bank processes such as the processing and settlement of securities transactions. Taken to its logical conclusion, the philosophy leads to a banking model whose value is based primarily on its reputation as a hub for sales, quality assurance and customer service, with the majority of the products and services sold actually being bought in. The core competences of a networked bank of this kind would include branding, product range policy and of course advisory ser- vices. In the case of companies concentrating on product manufac- ture (not necessarily banks), however, the core competencies would include the quality of process management, cost leadership and sim- ilar. Larger universal banks in particular are probably in a position to act not only as providers of products and services to other banks but also as buyers from them. The majority of banks are likely to act as providers, complementing their product range by offering target- ed third-party products and outsourcing some internal processes to external service providers, some of whom may be other banks. New Challenges in Wealth Management Various and at times conflicting developments are also evident at individual business level, for example in asset management, which is the largest sector for the Swiss banks and accounts for 50% of their output. This business is still highly fragmented throughout the world, although a trend toward concentration has been evident for some time. In general, the financial markets in the industrialised nations are highly information-efficient, and this makes it difficult to outperform a benchmark over the long term and on a risk-adjust- ed basis. As a result of this, and for reasons of cost efficiency, some investors are increasingly favouring passive investment strategies, whereby the asset managers wholly or partially replicate the returns of a prescribed index portfolio (index tracking). An index tracking strategy tends to favour the big asset managers, as they are better able to spread the costs of such a strategy over the assets under man- agement. In the United States, for instance, one-third of pension fund assets is managed passively. Large asset management firms are likely to benefit more from index tracking strategies, as they are more in a position to spread the cost of such strategies (economies of scale). There is also a tendency towards specialisation. This can be traced back to the fact that the number of asset classes and invest- ment instruments is growing constantly and also includes a large number of non-traditional or alternative vehicles such as hedge funds, private equity, real estate or high-yield bonds. The manage- ment of these investments generally requires a great deal of time and effort, which encourages increased focus and specialisation on the 25
  26. 26. part of providers. Only a relatively small band of providers are in a position both to implement the economies of scale afforded by pas- sive investment strategies and to realise specialisation gains with regard to the marketing of alternative investments. Continued Success Thanks to Standardisation and Disintegration In view of the foregoing, what can we expect from the Swiss banks over the next few years in terms of the development of their service offering and their market behaviour? For one thing, an increased standardisation of products, services and processes, primarily with a view to further improving cost efficiency. The accompanying disin- tegration of the production structure, in other Competition among words an increased tendency towards spinning banks for profitable cus- off parts of the business and instead buying in tomers and good risks products and services (outsourcing), will enable banks to take full advantage of any is set to increase. economies of scale. The trend already evident today towards customising pricing to individual customers on the basis of risk, creditworthiness and membership of a specific segment does not stand in contradiction to this. Competition among banks for profitable customers and good risks is set to intensify further in the future, and banking regulation (notably the Basel II capital ade- quacy requirements) has a clear role to play in this process. Finally, systems and processes (built for instance around common platforms) as well as the range of products and services offered are likely to be increasingly opened up to attractive third-party providers. 26
  27. 27. 5 Supervision and Regulation of Banks The Federal Banking Commission (FBC) As an independent federal administrative agency, the FBC supervises banks and financial markets. Its supervisory authority also covers investment funds, central mortgage bond institutions, stock exchanges, brokers as well as the disclosure of holdings and public offers. The FBC safeguards the rights of creditors and investors, and guar- antees the proper functioning of banking and securities markets. Furthermore, it supervises compliance with legal regulations and passes all necessary ordinances and decrees to this effect. The combat of money laundering also falls to the FBC. It is responsible for monitoring the prevention of money laundering and ensuring that underlying financial intermediaries comply with the Anti-Money Laundering Act. At the international level, the FBC is member of the Basel Committee on Banking Supervision, a body founded by central banks and banking supervisors in 1975. Banking Regulation: Purpose and Basis Swiss banking law does not provide an explicit definition of pur- pose. However, individual articles as well as the inception and prac- tice of the supervisory authority clearly stipulate that the primary function is to protect the banks’ creditors, in particular depositors. Over the past years, great attention has been awarded not only to the protection of individual customers, but also to overall functions. The latter include protecting the system (avoiding chain reactions) as well as confidence. Both the protection of individual customers and functions ultimately serve to maintain the stability of the finan- cial system (institutions and markets). 27
  28. 28. Banking legislation pursues primarily public interests. It protects bank customers (industrial protection) and ensures in part the fulfil- ment of constitutional economic assignments; most provisions form part of public law. Banking legislation consists of the following: – Federal Act on Banks and Savings Banks (Swiss banking law, SBL) – Federal Investment Fund Act (Investment fund law, IFL) – Federal Act on Stock Exchanges and Securities Trading (Stock exchange law, SESTA) – Central Bank Act (CBA) – Currency and Means of Payment Act. (CMP) These are complemented by relevant ordinances and a growing number of special laws (on consumer lending, bonds, money laundering). Banks must also observe the circulars issued by the FBC, the Code of conduct issued by the SBA, and in particular the Swiss Banks’ Code of Conduct with Regard to the Exercise of Due Diligence (CDB), as well as the regulations of the Swiss Stock Exchange and the Swiss Stock Exchange Admission Board. Reform of Financial Market Regulation The “Zufferey” group of experts, commissioned by the Swiss Fed- eral Department of Finance, published their summary report in November 2000. In it, the experts proposes that insurance and banking supervision be merged into one supervisory authority. The Swiss Federal Council subsequently appointed another group of experts headed Prof. Ulrich Zimmerli. This panel had the task of preparing the legal grounds for the proposed integration of the financial market regulation. In July 2003, the Zimmerli group of experts submitted their first partial report on financial market regulation and their draft for the relevant federal law to the Swiss Federal Department of Finance (FDF). This set of documents will be submitted for consultation in autumn 2003. The legal message to parliament should follow in 2004. The draft of a new Federal Law on Financial Market Regulation (“FINMAG”) provides for the creation of a federal financial market regulator (“FINMA”) as a public legal entity. The FINMA is intended to assume the tasks which are carried out The tasks at present carried at present independently by the FBC and out by the FBC and Federal the Federal Office of Private Insurance. Office of Private Insurance Apart from containing structural provi- sions, the bill also standardises the sanc- are to be integrated. tioning instruments of the future regulato- ry body. Material supervisory regulations will, however, remain in effect, in due consideration of the specific sector requirements. Stan- dard regulation will also apply to the co-operation with domestic and foreign authorities. The future integration of the Money Laun- 28
  29. 29. dering Control Authority within the new regulatory body remains yet to be decided. The question whether independent wealth managers, securities and foreign exchange dealers should also be regulated by this authority, is to be examined in greater detail, as well. Banks, Banking Commission and Auditors Impeccable Business Conduct as Requirement for Banking Licence The exercise of banking activities is subject to a licence issued by the FBC. Banks must meet legal requirements in order to obtain the licence. Accepting money from the public and the management of such money in one’s own name on a professional business scale is subject to a licence on principle. Professional business is defined as any activity that involves more than 20 customers. The term bank- ing business is applicable, if the money accepted is used to extend loans to third parties. Investment funds are subject to a licence, because they accept money from the public on a professional basis for the purpose of collective capital investment under the manage- ment of a third party. The principal requirement for a licence is the assurance of a perma- nently impeccable business conduct. Otherwise, the FBC has the authority to withdraw the licence. In this case, thus inevitably causing the bank to be liquidated. Auditors as Instruments of the FBC Banks and their corporate bodies must primarily ensure that regulations are observed internally. The law has also provided for an additional means of supervision consisting of the FBC and external auditors. In contrast to most other countries, banks in Switzerland are super- vised by external auditors and not by the FBC directly. The supervi- sion by statutory bank auditors is the principal means of protection for bank customers. Swiss auditing associations and fiduciary com- panies are deemed eligible statutory auditors. They must be entirely independent from their clients, in economic as well as personnel terms, and they have to be adequately qualified. The FBC authorises and supervises the auditors. Within the annual audit, the auditor usually examines the compli- ance of the layout and contents of the annual report with legal and statutory regulations, general compliance with the bank law and the banking ordinance as well as compliance with other bank licence requirements. The auditing report is initially sent to the body responsible for overall management, supervision and control, i.e. the Board of Directors or, in the case of cantonal banks, the banking council. The body in turn forwards the report to the FBC. The auditors thus act as the extend- ed arm of the FBC (dual supervision). The auditor’s report furnishes the FBC with a detailed view of the bank’s overall condition. The FBC is also entitled to demand further information and documents from the bank as well as the auditor, and to impose extraordinary audits. 29
  30. 30. Reform of Bank Audit In the year 2000, the FBC appointed a panel of experts chaired by Prof. Peter Nobel, to elaborate a comprehensive reform of the audit system. While the experts gave good ratings to the system of dual supervision, they recommended reforms in many other areas. An FBC commission is currently elaborating the specific measures to this effect. The report by the Zimmerli panel of experts (financial markets regulation) also proposes improvements in this area. The FBC is already in the process of building an administration unit within the banking commission, who will be in charge of supervising the auditors. Moreover, all banks and securities traders, except the big banks, will be examined in future at regular intervals by an auditor other than their regular auditing firm (second audit). Clearly defined areas of the big banks will also be audited in greater depth at least once per year. Compliance The FBC supervises the banks with regard to their economic stability and management integrity. However, banks are autonomous in terms of their business policies: within the perimeters of due dili- gence, every bank is free to choose its business. Neither does the SBL define the contractual relationship between banks and their cus- tomers. This area is governed by private law. The supervisory bodies of the bank supervise compliance with all the relevant laws as well as the articles of association, the regulations and directives, and they ensure that a bank always acts in accordance with the applicable regulations and its internal guidelines. The regulatory bodies include in particular the internal controlling department, internal audit and supervision by the Board of Directors. Business Activity Requirements The pursuit of banking activities is subject to a licence issued by the FBC. Banks must meet the legal requirements in order to obtain this licence. Such requirements relate in particular to minimum capital, the bank’s internal structure and the integrity of management. Other prerequisites pertain to business activities, in particular equity, liquidity, diversification of risk, market risks, netting and reporting. Equity The balance sheet of a bank differs substantially from that of an industrial company. The assets of a bank are typically 95% financial assets, while liabilities are primarily deposits and borrowed funds (the majority of which are short term); the bank’s equity capital accounts for only around 10% of the balance sheet total. The SBL requires that banks provide enough equity capital to ensure they can cover substantial losses before creditor claims are impaired. Equity is then used as a buffer to cover any losses. The weighted (with various rates) assets on the balance sheet that involve risk, certain off-balance sheet transactions, as well as open securities positions, foreign exchange and derivative transactions must be covered by 8% equity. The size of the rates is inversely proportionate to the securi- ty of the positions to be covered. The capital adequacy requirements must be met both individually and on a consolidated basis. Statutory 30
  31. 31. equity capital covers the market and credit risks of the banks. Since 1998 banks have been able to choose between the standard proce- dure and their own model when covering their market risks. The lat- ter requires the approval of the FBC. New Basel Capital Accord (Basel II) Today’s national equity capital provisions for banks are based on the “Basel Capital Accord” of 1988 which is currently being revised (Basel II). The objective of the revision is in particular to increase the risk awareness, i.e. the equity capital requirements for banks will reflect the individual bank’s own risk structure more strongly than they do at present. Basel II will thus have a significant impact on the banks’ risk management. Chronology Basel II 1988 July Publication of Basel Capital Accord (Basel I) 1992 End Entry into force of Basel I 1996 January Basel market risk paper 1999 June First consultative paper on revising the Capital Accord (Basel II) 2001 January Second consultative paper on Basel II 2003 May Third consultative paper on Basel II 2003 Autumn Publication of the new Capital Accord 2006 End Entry into force of Basel II The Basel Capital Accord is based on a concept made up of three pillars: There has been no change to the first pillar which continues to stipulate the minimum capital require- ments for banks. Previous equity require- A new feature is that ments based on credit and market risks are banks can choose complemented in future by the obligation between various proce- to provide additional equity cover for cer- dures for assessing risks. tain operative risks. A new feature is that banks can now choose between various procedures for the assess- ment of risks (i.a., external ratings may be applied to the assessment of credit risks if certain conditions are met). The second pillar tight- ens up national supervision procedures. This aims to improve condi- tions that will allow any irregularities to be identified at an early stage. The third pillar aims to improve market discipline by requir- ing banks to disclose specific information. The publication of the final “New Basel Capital Accord” is sched- uled for end of 2003. As an international “soft law”, “Basel II” will subsequently need to be implemented on a national scale by the respective supervisory authorities and legislative bodies. The imple- mentation is expected to be concluded by end of 2006. In Switzerland, the implementation is being prepared by a mixed task force headed by the FBC. Risk Monitoring Banks should be prevented from building up excessive risk which could harm depositors (and taxpayers). Among the measures aimed at ensuring this are regulations governing concentrations of risks (lump risks) and loans to bank directors and senior bank executives (intergroup loans, to prevent a conflict of interests). Liquidity By using short-term deposits to grant long-term loans, banks “trans- form” maturities. The varying lengths of interest rate lock-down periods for the loans extended and amounts due in make banks vul- 31
  32. 32. nerable to changes in interest rates. Banks also have a direct liquidity risk, however, if an unexpected number of customers withdraw their assets at the same time, subsequently forcing the bank to liquidate a part of its assets early, a move which may result in a loss for the bank. The SBL therefore prescribes a reasonable ratio between, on the one hand, tangible assets and assets that can be readily sold and, on the other hand, the short-term liabilities owed to the banks. Depositor Protection In the event of bankruptcy, bank creditors’ claims are satisfied in an order of ranks fixed by law. Claims protected by pledge, are acquitted first through the liquidation of the pledge. Other claims are cate- gorised in three ranks of creditor claims. Claims by 1st rank creditors have first priority, followed by 2nd and 3rd rank creditors, always depending on the availability capital stock. Claims by 3rd creditors, which usually account for the largest part of claims, may be satisfied only in part. However, in deviation from the ranks provided by the Swiss Bankruptcy Act, SBL provisions stipulate that certain claims up to an amount of CHF 30,000 per creditor have to be categorised in a rank between the 2nd and 3rd rank of creditors. These claims have priority versus (other) 3rd rank creditor claims (considering strict equity capital requirements, such claims are virtually guaran- teed). Bank depositors are more privileged to the effect that their deposited assets are treated as preferential claims in the case of bankruptcy, i.e. such assets are excluded a priori from the bankruptcy estate and paid out directly to the depositors. Amendment of the Bank Insolvency Law In November 2002, the Federal Council drew up a legal message to the parliament concerning changes to banking legislation in the area of reorganisation and liquidation of banks and the protection of depositors. The draft awards a broader authority to the FBC in the reorganisation and liquidation of banks. If the The liquidation FBC has “legitimate reasons to assume” that a procedure following a bank has a debt overload, liquidity problems or bankruptcy should does no longer meet equity capital requirements become simpler, faster despite warnings, the FBC should have the authority to impose measures of protection, and less expensive. reorganisation procedures or the liquidation. The draft also contains proposed measures for system protection in payment transfers and securities trading, in particular the irre- versibility of system entries. In the case of a “legitimate prospect for reorganisation”, the FBC may impose reorganisation proceedings. The liquidation procedure as a result of a bank’s bankruptcy should become simpler, faster and less expensive. To this effect, the power of decision (hitherto split between the FBC and the civil courts) will be assigned entirely to the FBC. 32
  33. 33. Amendment of the Depositor Protection Agreement Last but not least, a mandatory deposit protection is to be intro- duced. It should be arranged internally by the banks within their self-regulation area and require FBC approval. In future, the prefer- ential treatment in the event of bankruptcy will be extended above and beyond savings, deposit, salary and pension accounts, to all bank deposits. Experience has proved that there is usually sufficient cover for a bank’s preferential liabilities – not least due to the equity capital requirements stipulated in the Banking Ordinance. To ensure prompt payment of preferential deposits to bank creditors in the event of a bank’s collapse, there needs to be a system which will advance the liquidity for such payments. The SBA Depositor Protection Agreement was established for this purpose in Switzerland. If a signatory bank files for insolvency pro- ceedings or bankruptcy, the SBA will ensure expeditious remittance of protected assets to the respective customers. When a case arises, the SBA will apply an agreed quota to raise contributions from the signatories of the Agreement. Since this assessment system takes time, the SBA may borrow the funds required for interim financing. For the remaining part of the liquidation procedure, the SBA assumes the role of the creditors for the amount it remitted. The maximum amount under the Depositor Protection Agreement is currently set at CHF 1 bn. In the revised SBL this amount should be raised to CHF 4 bn. Banks will have to hold additional liquidity for half of that amount. Annual Statement and Balance Sheets Banks are primarily involved with other people’s money. Their financial statements are therefore particularly important for creditors (and owners) as a reporting instrument. Moreover, regulations gov- erning financial reporting are an essential part of the protection afforded to functions. Although banks have to comply with the accounting standards set out in company law (art. 662–670 Swiss Code of Obligations), they are governed primarily by the provisions of the SBL (art. 6) and the related Implementing Ordinance (art. 23–28) which, as a “lex specialis”, take precedence over company law. More detailed infor- mation on accounting requirements can be found in the FBC Guide- lines on Accounting Regulations and the FBC circulars. Banks with global operations increasingly use international account- ing standards (specifically IAS). The FBC permits this practice, but requires an explanatory statement, in the form of notes, drawn up in accordance with Swiss law. The annual financial statement consists of a balance sheet, a state- ment of income and notes. The statement is complemented by an annual report setting out detailed information on all important events that occurred after the balance sheet date. Banks disclosing total assets of CHF 100 million or more and involved in balance sheet transactions to a significant extent also have to issue a cash flow statement as part of their annual statement requirements. 33
  34. 34. FBC Guidelines on Accounting Regulations (FBC GAR) The new FBC Guidelines on Accounting Regulations (FBC GAR) were enacted at the end of 2002. However, they become only bind- ing for annual statements closing as from 31st December 2003. For the most part, the revision of the FBC GAR is “technical”. Among other things, it includes the incorporation of the fundamental provi- sions of the Swiss GAAP FER 19. The listing regulations of the SWX require listed banks which publish a consolidated annual statement to publish also individual accounts established on the basis of the true-and-fair-view principle. Banks whose gross income consists to at least one-third of commission and services business, have to pres- ent the managed and deposited assets. Self-Regulation and Code of Conduct The banking, stock exchange and anti-money laundering laws are minimum standards which leave scope for specification by the code of conduct. The code of conduct forms part of the banks’ and securities traders’ system of self-regulation and plays an Self-regulation of banks important role in the Swiss banking sector. The and securities traders essential advantages of self-regulation lie in the plays an important role fact that they relate closely to business practice, they are established by regulators with profes- in the Swiss banking sional expertise and they are more readily sector. accepted and implemented. The SBA passes the code of conduct and the FBC enforces it in its capacity as a public supervisory authority. This sovereign enforce- ment ensures that the SBA code of conduct is binding for all banks. For the purposes of the FBC, compliance with the code of conduct is equal to the “assurance of impeccable business conduct” and thus forms part of the banking licence requirements that financial servic- es companies have to fulfil permanently. This private code of con- duct thus ranks in fact as a public standard and is therefore subject to sanctions by banking law. The FBC currently recognises 14 guide- lines and agreements as part of the code of conduct; auditors have to examine the banks’ and securities traders’ compliance with these guidelines and agreements. Code of Conduct with Regard to the Exercise of Due Diligence (CDB 03) The Code of Conduct with regard to the Exercise of Due Diligence is of particular importance. The 6th version (CDB 03) entered into force on 1st July 2003. The identification of contracting parties and Identification of con- the establishment of the beneficial owners are still the core elements of the CDB. The CDB tracting parties and esta- contains detailed instructions as to the identi- blishing the beneficial fication procedures and document verifica- owners are still core ele- tion duties. The CDB also includes provisions on mandatory records. The CDB further pro- ments of the CDB. hibits active assistance by the banks in the flight of capital in countries with restrictions with regard to invest- ments abroad. In the same vein, the CDB prohibits active assistance by the banks in tax evasion and similar acts by issuing incomplete certifications. An independent supervisory commission monitors and sanctions violations against the CDB, and may impose fines of up to CHF 10 m. 34
  35. 35. Some provisions regarding customer identification have been tight- ened in the 2003 version of the CDB. For instance, in establishing the beneficial owners, banks must require also require information on the date of birth and citizenship, in order to facilitate any future identification of persons and exclusion of neutral third parties. Fur- thermore, the verification of the identity of legal entities not listed in the Commercial Register must include the identity verification of the persons opening the account. If an account is opened through corre- spondence, mere exchange of correspondence is no longer sufficient as a method of identification, but the bank must obtain a certified copy of the contracting person’s passport or identity document. The identity verification option “known personally” has been cancelled. Proof of identity is mandatory also for individuals personally known to the bank staff. Overview of Key SBA Codes of Conduct Agreement on Due Diligence (CDB). The CDB obliges banks to know their customers, to identify the beneficial owners, and to provide no assistance in tax evasion or illegal export of capital. Directives on the Independence of Financial Research. Reduction and elimination of possible conflicts of interest in financial research and analysis. Agreement on depositor protection. Guarantee to bank’s creditors (depositors) for expeditious repayment of up to CHF 30,000 should the bank collapse. Code of conduct for securities traders. Basic regulation governing all securities traders under the Stock Exchange Law, specifying their responsibility with regard to disclosure, due diligence and loyalty. Guidelines for the management of country risk. Minimum requirements for banks with regard to internal structures and processes for managing country risk. Guidelines for risk management in trading and the use of financial derivatives. Formulation of internal guidelines with regard to risk management. Guidelines on portfolio management agreements. Principles of customer portfolio management. Guidelines for the treatment of dormant assets. Avoiding instances where assets become dormant, re-establishing contact with the customer, the banks’ duties with regard to dormant assets, procedures for tracing dormant assets. Swiss Banking Ombudsman The SBA established the “Swiss Bank Ombudsman Foundation” in the fall of 1992. The Ombudsman acts as an impartial mediator between banks and their customers. He can be called upon by every bank customer, in particular those little acquainted with the banking business, e.g. private individuals or SMEs. The Ombudsman suggests solutions on the basis of statements he receives from both parties. His recommendations are highly respected although they are not legally binding. This forum enables dissatisfied bank customers to settle disputes with their banks in an efficient and unbureaucratic manner, and dispenses of the necessity to take tedious and costly legal action. The Ombudsman is also a port of call for people with enquiries regarding assets which became dormant subsequent to 1945. Assets are deemed dormant if the respective customer contact has ceased 35
  36. 36. and cannot be established despite the bank’s active search efforts. The SBA has issued guidelines on this subject. International Co-Operation among Supervisory Authorities Legal co-operation governs the co-operation between judicial author- ities, whereas administrative co-operation governs the co-operation between administrative and supervisory authorities. Statutory guar- antees warrant in both instances the safeguarding of justified cus- tomer interests. Administrative Co-Operation and In Situ Monitoring On principle, the FBC may furnish foreign supervisory authorities with information which falls within official confidentiality and is not available to the public. The release of such information (admin- istrative co-operation) is subject to three statutory conditions: – Information may be conveyed exclusively for the purpose of direct supervision of banks and other authorised financial institutions. Administrative assistance to tax authorities is prohibited. – The foreign authority seeking co-operation must be bound by offi- cial and professional discretion and it must be the direct recipient of the information. – The foreign authority seeking co-operation is not permitted to convey information to other authorities or public supervisory bodies, other than by the FBC’s prior consent or a general treaty authorisation. Information may not be conveyed to pros- The foreign authority ecution authorities if legal co-operation in seeking co-operation must criminal cases is restricted. This is to pre- be bound by official and clude an evasion of prosecution assistance requirements. professional discretion. The revised SBL enacted on 1st October 1999 provides a legal basis which enables in situ monitoring in Switzerland by foreign supervision authorities. Such monitoring is restricted to information which is necessary to ensure a consolidated supervision of the banks con- cerned. Moreover, the monitoring is subject to the provisions on mutual administrative assistance. Investigations into issues pertaining directly or indirectly to assets managed on behalf of individual customers or deposits, can only be carried out by the FBC. Such investigations are governed by the Fed- eral Act on Administrative Proceedings. Bank customers have a right to appeal against an injunction issued by the FBC, at the Swiss Feder- al Court. Both, the FBC and the Federal Court must grant bank cus- tomers a fair hearing and access to the relevant documents. The Swiss Federal Court takes these requirements very seriously. It has forestalled administrative assistance interaction between the FBC and the SEC on several occasions, because the SEC is governed by American laws and therefore does not fully comply with the Swiss requirements for official confidentiality and the principle of speciality. Particularly with a view to the combat of terrorism and money laun- dering, international understanding has prevailed that monitoring of due diligence compliance in terms of customer identity verification constitutes an element of supervisory authority responsibilities. This also comprises in situ monitoring, i.e. the examination of customer documents by authorities of the bank’s country of origin. The FBC 36
  37. 37. deems current Swiss provisions in this context too restrictive to be applied in a meaningful manner in practice. Therefore, the FBC has taken the initiative to amend the Swiss laws governing administrative assistance. The SBA fundamentally supports this initiative. Conse- quently, a mixed task force of FBC and SBA representatives has elab- orated a proposal for a solution. In cases where customer related information is transferred abroad, it is crucial from our perspective that legal protection remains warranted to the parties concerned (applicability of administrative procedure). Consolidated Supervision Due to the international orientation of the Swiss financial centre, many foreign banks have long established their branches and sub- sidiaries in Switzerland. The principle of consolidated supervision of such foreign banks by authorities in their countries of origin is granted under the condition that such supervision is conducted in accordance with Swiss law. Subject to compliance with certain requirements, banks may convey to their foreign head offices any such information and documents as may be necessary for the pur- pose of consolidated supervision. Consolidated supervision by banks in the country of origin is thus warranted. Bank Customer Confidentiality The banking secret is not a secret in relation to the bank but to the bank’s customers. It is therefore more appropriately called the bank customer confidentiality. The Swiss bank customer confidentiality differs from that of other countries most notably in that it is strictly protected not Banking secrecy is not only by civil law but also by penal law. The secrecy in relation to the protection of privacy strongly fosters the bank but to the bank’s customers’ confidence in their banks. This customers. protection constitutes a fundamental right within the Swiss legal system. It also reflects the citizens’ right to personal freedom – a traditional and treasured fundamental right. The bank customer confidentiality also pursues the principle of equality by granting equal protection to Swiss and foreign cus- tomers. Contrary to common belief, anonymous accounts do not exist in Switzerland. Though customers may hold a so-called numbered account, the bank must invariably establish the customer’s identity. The purpose of a numbered account is only to restrict access to the information about the holder’s identity to a limited number of bank employees, thereby offering an additional protection against a viola- tion of confidentiality provisions. However, numbered accounts and ordinary named accounts are equal in all legal aspects. Therefore, for instance in the course of criminal investigations, the relevant court is entitled to demand information from the bank. The Swiss bank customer confidentiality is not and has never been absolute. The SBL explicitly reserves the federal and cantonal provi- sions about the banks’ duty to report and testify to authorities. The duty to report is in particular part of the civil law, the law of civil proceedings, debt collection law and bankruptcy law. The duty to report to the relevant investigation authorities is especially part of the criminal proceedings law and legal co-operation treaties. 37