On May 15, 2024, FINMA launched a consultation on a new circular (the Draft Circular) outlining its supervisory practice with regard to certain conduct requirements under the Financial Services Act (FinSA) and the Financial Services Ordinance (FinSO). The Draft Circular mainly sets out FINMA's expectations in relation to transparency obligations towards clients. It will apply directly to financial service providers in the sense of the FinSA that are subject to supervision by FINMA or a supervisory organisation within the meaning of Art. 43a of the Financial Market Supervision Act (FINMASA). However, it will also be relevant for other financial services providers in the sense of the FinSA. The consultation period ends on July 15, 2024.
Key provisions
1. Corporate finance and M&A services; placement of financial instruments (Art. 3 para. 3 let. a to c FinSO)
According to Art. 3 para 3 lit. a to c FinSO, (i) the provision of advice on corporate finance and M&A matters, (ii) the placement of financial instruments with or without a firm commitment and (iii) financing in connection with the services listed under (i) and (ii) are not deemed to be financial services within the meaning of the FinSA.
The Draft Circular clarifies that the above exceptions only apply if the relevant services are primarily used for industrial, strategic or entrepreneurial purposes and not for investment or hedging purposes. For underwriting services, this clarification is not needed, as it is already the current practice that such services are only excluded from the scope of the FinSA to the extent that they are provided to the issuer, but the sale to investors as their broker would be classified as a financial service provided to the investors. However, the implementation of the Draft Circular may prove difficult in practice for corporate finance activities. As stated in FINMA's explanatory report, the services listed in Art. 3 para 3 lit. a to c FinSO would fall within the scope of the FinSA if they are provided to clients acting as investors as opposed to the company, its shareholders or an issuer of securities. In particular, buy-side (as opposed to sell-side) M&A advisory services could therefore qualify as financial services in the scope of the FinSA if the clients are considering the transaction primarily for investment purposes. It remains to be seen whether this distinction will be maintained in the final version of the Circular.
2. Information duties (Art. 8 FinSA, Art. 7 FinSO)
The Draft Circular provides guidance on certain information duties under Art. 8 FinSA and Art. 7 FinSO, which are relevant for retail clients and, to the extent not waived, for professional clients:
- Providers of advisory services must inform their client in an appropriate manner (e.g. in writing) at the time their advice is given whether their recommendations take into account the client's entire portfolio (portfolio investment advice) or are only based on individual transactions (transaction advice);
- FINMA wants to introduce specific risk disclosure requirements in connection with complex products offered to retail clients such as contracts for differences (CFDs), which would be modelled on the requirements of the European Securities and Markets Authority (ESMA) in the European Union. When disclosing the risks associated with financial instruments, the provider must inform its clients of (i) the proportion of clients who lose money in connection with CFDs (ii) the potential obligation to make additional payments and the risk of unlimited losses and (iii) leverage, margin rules, counterparty risk and default risk. At this stage, it would remain unclear what products exactly fall into the scope of such obligations. FINMA's explanatory report also mentions rolling spot FX transactions.
- Providers of portfolio management and advisory services must specifically inform their clients on the nature and risks associated with large exposures in their portfolios. According to FINMA, this information must be provided to the clients if a concentration of 10% or more in individual securities or a concentration of 20% or more in certain issuers cannot be excluded. The disclosure obligation will not apply to concentrated positions in collective investment schemes, as the latter are subject to specific risk diversification requirements.
3. Verification of appropriateness and suitability (Art. 11 and 12 FinSA, Art. 16 and 17 FinSO)
According to FINMA, the questionnaires used to determine a client's risk profile do not always contain all data required to verify the appropriateness and suitability in a sufficiently detailed manner. The Draft Circular specifies that financial services providers must inquire about their clients' knowledge and experience for each investment category relevant to the financial service being offered.
4. Use of clients' financial instruments / securities lending (Art. 19 FinSA)
The Draft Circular specifies information obligations that are in line with those contained in the former FINMA Circular 2010/2 on Repo/SLB Transactions, which was repealed upon the entry into force of Art. 19 FinSA, but that continued to be relevant for the interpretation of Art. 19 FinSA.
5. Conflicts of interest (Art. 8 para. 2 let. b and c in conjunction with Art. 25 FinSA, Art. 10 and 24 to 28 FinSO)
The Draft Circular stipulates that clients must be made aware of any conflicts of interest that may arise from the selection by the financial service provider of its own financial instruments. The term "own financial instruments" covers not only products issued by the financial service provider or one of its group companies, but also products issued or offered by third parties with which the financial service provider has economic relationships (e.g. self-managed products, private/white label products, products for which the provider acts as guarantor, as well as third party products for which the provider receives retrocessions). According to FINMA's explanatory report, the conflicts of interest must be disclosed in sufficient detail to enable clients to make an informed decision on whether or not to use the financial services. General statements to the effect that the financial service provider consider both third party products and its own products do not satisfy this requirement. In particular, the provider should indicate how the selection of proprietary products may expose it to conflicts of interest (e.g. double dipping).
Where a financial service provider offers investment solutions consisting exclusively of its own financial instruments, it must inform its clients of this fact, and explain the conflicts of interest and risks involved. Where the provider takes into account third party products, it must take appropriate measures to avoid conflicts of interest, and in particular select these products according to a pre-defined process based on objective criteria customary in the industry.
6. Remuneration received from third parties; retrocesssions (Art. 26 FinSA, Art. 9 FinSO)
Taking into account the case law of the civil courts, FINMA outlines in its Draft Circular the information that must be provided to clients in connection with retrocessions pursuant to Art. 26 FinSA. The Draft Circular stipulates that if the information is included in standardised contracts or forms, it must be visually highlighted (e.g. by using bold letters, a larger font size, or a frame). According to the explanatory report, another possibility is to inform clients by means of a separate letter or notice. If it is not possible to determine the amount of the retrocessions before the financial service is provided, the provider must indicate (i) a range for each different product category and (ii) for portfolio management and investment advice taking into account the client's entire portfolio (but not advice on individual transactions), the range in relation to the value of the portfolio (based on the agreed investment strategy).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.