Prudential regulationi Relationship with the prudential regulator
The Swiss banking supervision system is based on an indirect (or dual) supervision model. Banks, foreign banks' branches and financial groups (or conglomerates) subject to Swiss supervision must appoint an external audit company supervised by the Federal Audit Oversight Authority. The auditor assists FINMA in its supervisory functions: it examines annual financial statements, and reviews whether regulated entities comply with their by-laws and with Swiss financial markets regulation and self-regulatory provisions. FINMA requires that financial and regulatory audits be conceptually separated and may require, where appropriate, that these two audits be carried out by different audit firms. The results of the financial and regulatory audits are detailed in annual audit reports that are to be handed over to the supervised entity and to FINMA. FINMA exercises its oversight and ascertains whether the various regulatory requirements are complied with, largely based on these reports. The intensity of the supervision and the direct involvement of FINMA, in particular as regards qualitative aspects of supervision, depend on the category to which a bank or securities dealer is assigned. In this context, FINMA applies a risk-oriented supervision, classifying regulated banks and securities dealers according to their importance (notably in terms of assets under management, deposits and required equity) and risk profile:
- category 1 institutions are extremely large, important and complex market participants, which require intensive and continuous supervision;
- category 2 institutions are deemed very important and complex, and require close and continual supervision;
- category 3 market participants are large and complex to which a preventive supervision model is applied; and
- category 4 and 5 institutions are small to medium-sized participants, for which event-driven and theme-based supervision is generally deemed sufficient.
In addition, auditors are obliged to inform FINMA if they suspect any breach of law or uncover other serious irregularities. Supervised entities also have a general duty to inform FINMA of any event or incident that may be of relevance from a supervisory perspective. Furthermore, banks have special reporting duties: for instance, in cases of changes in the foreign controlling persons (or entities), in the qualified shareholders, and in the status of statutory equity capital, liquidity ratios or risk concentrations. Based on these informational tools, FINMA initiates investigations (if necessary, through an appointed investigator) and, if a breach is ascertained, takes administrative measures aimed at restoring compliance. In cases of serious breach, FINMA can ultimately decide to withdraw a licence. In the event of serious breach (and, in particular, in the event of violation of market conduct rules), FINMA may also order the disgorgement of illegally generated profits. In practice, the most common sanctions that FINMA imposes relate to the forced liquidation of unauthorised securities dealers, insolvency procedures and sanctions following non-compliance with Swiss know your customer rules.
Following the 2008 financial crisis, a more rigorous supervisory regime was put in place for UBS AG and Credit Suisse AG, as the size and complexity of these institutions raise systemic risks. Accordingly, FINMA does not rely exclusively on the reports of the banks' auditors, but carries out its own investigations and maintains close contact with the two banks.
FINMA has generally been more active and interventionist than was previously the case, with these two banks as well as with the other systemically important financial institutions. For several years, and in accordance with its risk-based approach, FINMA has carried out extensive stress tests at Credit Suisse AG and UBS AG to periodically and systemically assess their resilience against sharp deteriorations in economic conditions. Systemic banks are subject to a specific regime in terms of capital adequacy (see Section III.iii) and crisis resistance. In this context, they are required to establish detailed recovery and resolution plans, as well as to implement specific corresponding organisational measures. As an example, both Credit Suisse AG and UBS AG now have a non-operating holding company as group parent, and they have transferred Swiss-based systemically important functions to separate subsidiaries. Further steps will be undertaken in the future, in particular the reduction of the financial and operational dependencies that persist within the groups and the submission to FINMA of a feasible Swiss emergency plan by 2019. Within FINMA, a specific division, the Recovery and Resolution Division, which is in charge of crisis restructuring and insolvency proceedings, monitors and coordinates these emergency and resolution planning efforts.
While FINMA has noticeably heightened its focus over systemic banks, it has also recognised that the increase in normative intensity and complexity that followed the financial crisis represents a considerable challenge for small and micro banks. In recent years, FINMA has been exploring avenues to ease certain quantitative and reporting requirements, simplify procedures and reduce the frequency of regulatory audits for banks in supervisory categories 4 and 5. In July 2018, FINMA began a pilot phase with around 70 small banks to test the new supervisory regime. With the results of this test phase progressively coming in, the topic will remain at the top of the regulator's agenda this year and in years to come.ii Management of banks
The granting of a banking or securities dealer licence is conditional upon the fulfilment of certain organisational requirements. In particular, the articles of incorporation and internal regulations of a bank must define the exact scope of business and the internal organisation, which must be adequate for the activities of the bank. As a general rule, two separate corporate bodies must be in place:
- a board of directors that is primarily in charge of the strategic management of the bank, and the establishment, maintenance, monitoring and control of the bank's internal organisation. The board must comprise at least three members who meet professional qualifications, enjoy a good reputation and offer every guarantee of proper business conduct. Depending on the size, complexity and risk profile of the bank, FINMA may require that the board comprises more than three members. In addition, FINMA expects, as a rule, that a substantial number of the board members have a close relationship to Switzerland in terms of residence, career or education. In practice, FINMA expects at the very least that the chair or vice chair of the board be domiciled in Switzerland. As a matter of principle, the board must be free of any conflicts of interest with the management or with the bank itself. By law, the board of directors of a Swiss bank is non-executive, with a strict prohibition of a double mandate both as director and manager; and
- the executive management, which also implements the instructions of the board of directors. Its members must meet the various professional qualifications and fit and proper tests. As a rule, FINMA requires that a Swiss bank be managed from Switzerland, and senior managers are typically expected to be domiciled in Switzerland.
Under FINMA practice, the strategic management, supervision and control by the board of directors, the central management tasks of the management, and decisions concerning the establishment or discontinuation of business relationships may not be delegated to another affiliated or non-affiliated entity. As a result, a Swiss bank that is a subsidiary of a foreign group must be granted a certain degree of independence in its decision-making process. General instructions and decisions from a foreign parent entity are permitted, however. For the rest, as a general rule, outsourcing of other functions within a Swiss bank to affiliated or non-affiliated service providers both in Switzerland and abroad is generally permitted, subject to the satisfaction of certain requirements, in particular in relation to Swiss banking secrecy and data protection rules. As from 1 April 2018, outsourcing by banks is governed by FINMA Circular 2018/3, which replaced Circular 2008/7 and regulates the way in which banks handle outsourced services. The new Circular retains its principle-based and technology-neutral approach and imposes, inter alia, the following changes in comparison to the previous rules:
- banks must maintain an up-to-date inventory of all outsourced services, including information regarding the outsourced services, the service provider, the service recipient and the responsible unit within the financial institution;
- in the case of outsourcing outside Switzerland, banks have to make sure that all necessary data for reorganisation, resolution and liquidation purposes remain accessible in Switzerland at all times;
- the requirements provided by the Circular are to be complied with regardless of whether outsourcing is within a group, although the intragroup nature of an outsourcing may be taken into account for risk assessment purposes; and
- the requirements for data protection and banking secrecy are not addressed by the new Circular, and banks are now required to assess compliance in light of the relevant statutes governing data protection and banking secrecy.
FINMA Circular 2018/3 applies to all new outsourcing arrangements entered into after 1 April 2018. Outsourcing arrangements that were already in place before 1 April 2018 have a five-year transition period (i.e., until 1 April 2023) to adapt to the new regulatory requirements.
Specific constraints and requirements regarding the organisation of a Swiss bank (e.g., with respect to internal audit, controls, compliance and reporting, segregation between trading, asset management and execution function) vary depending on the actual business and size of the bank.
In this context, FINMA Circular 2010/1 on remuneration schemes, the purpose of which is to increase the transparency and risk orientation of compensation schemes in the financial sector, provides for 10 principles that certain financial institutions must observe. Although these rules do not impose any absolute or relative cap on remuneration, FINMA requires that variable compensations (i.e., any part of the remuneration that is at the discretion of the employer or contingent upon performance criteria) be dependent on long-term sustainable business performance, taking into account assumed risks and costs of capital. FINMA thus expects a significant portion of the remuneration to be payable under deferral arrangements. Furthermore, the compensation policy is to be disclosed annually to FINMA. These rules are mandatory for banks, securities dealers, financial groups (or conglomerates), insurance companies, and insurance groups and conglomerates with capital or solvency requirements in excess of 10 billion Swiss francs. In practice, this concerns UBS AG and Credit Suisse AG. For other financial institutions, the Circular represents guidelines for adequate remuneration policies.
FINMA can, however, deviate from this and require, where appropriate, a determined institution to comply with some or all of the provisions of Circular 2010/1.
Finally, FINMA Circular 2017/1 on corporate governance and revised Circular 2008/21 on operational risks integrate the key principles of corporate governance and risk management recently issued by the Banking Committee on Banking Supervision into Swiss regulation. These circulars consolidate and strengthen several requirements that previously derived from less formal guidance and FINMA practice, notably as regards internal control processes and instances, as well as risk management frameworks and responsibilities.iii Regulatory capital and liquidity
The Swiss regulatory capital and liquidity regimes implement the Basel III recommendations. Capital adequacy and measurement rules are set out in the Capital Adequacy Ordinance (CAO), and the Basel minimum standards are defined therein by reference to the most recent recommendations of the Basel Committee on the calculation of capital requirements. The CAO, therefore, overall implements pure Basel III requirements as regards the minimum capital requirements and their measurement.
As the Basel III capital requirements are minimum requirements and Switzerland has a tradition of imposing more stringent capital requirements on its banks, the CAO provides for an additional layer of capital (additional capital), which requires Swiss banks to have additional capital based on the size and specificities of their business.
The differences from Basel III can be summarised as follows:
- the possibility of a partial waiver of capital instruments in cases of a point of non-viability (PONV);
- particular rules with respect to obligations to Swiss pension funds;
- the possibility of a direct deduction from Common Equity Tier 1 capital as an alternative to a risk-weighting of an asset;
- certain minor deviations with respect to deductions pending clarification of respective international standards; and
- the application of requirements on a stand-alone basis for which Basel III does not make any recommendations.
As regards credit risks, Swiss banks can choose between the standard approach (international standard SA-BIS) and an internal ratings-based approach (IRB in its two variations: foundation IRB or advanced IRB). The CAO no longer provides for the simple Swiss standard, SA-CH, and banks using SA-CH have to move to SA-BIS within a certain transitional period.
As regards operational risks, Swiss banks can choose between the basic indicator and the standard approach as simple methods. A Swiss bank having the necessary resources may also choose the advanced measurement approach and thereby use a tailor-made proprietary risk model approved by FINMA.
As regards market risks, the CAO implements the respective rules developed by the Basel Committee in cooperation with the International Organization of Securities Commissions.
Capital requirements must be met both at the level of the individual institution and at the level of the financial group or conglomerate. Stand-alone reporting is required on a quarterly basis and consolidated reporting on a semi-annual basis.
The required capital is as follows.Minimum capital requirements
The minimum capital requirements (after application of regulatory adjustments) call at all times for an aggregate (Tier 1 and Tier 2) capital ratio of 8 per cent of a bank's risk-weighted assets, with a minimum Common Equity Tier 1 capital ratio of 4.5 per cent and a minimum Tier 1 capital ratio of 6 per cent of such risk-weighted assets. In this context, banks' assets are notably weighted against credit risk, non-counterparty-related risks, market risks, operational risks, risks under guarantees for central counterparties and value adjustment risks in connection with derivative counterparty credit risks.Capital buffer
As of 1 July 2016, banks must have a capital buffer up to the amount of the total capital ratio in accordance with requirements specified in the CAO for each bank category. If the minimum ratio is not met because of unforeseeable events, such as a crisis within the international or Swiss financial system, this does not amount to a breach of the capital requirements, but a deadline will be set by FINMA for replenishing the capital buffer.Countercyclical buffer
The Swiss National Bank can request the Federal Council to order that banks must maintain a countercyclical buffer of up to 2.5 per cent of all or certain categories of their risk-weighted assets in Switzerland in the form of Common Equity Tier 1 capital if this is deemed necessary to back the resiliency of the banking sector with respect to risks of excessive credit expansion or to counter an excessive credit expansion. At present, a countercyclical buffer of 2 per cent applies to loans secured by Swiss residential property.Extended countercyclical buffer
As of 1 July 2016, banks with total assets of at least 250 billion Swiss francs, of which the total foreign commitment amounts to at least 10 billion Swiss francs, or with a total foreign commitment of at least 25 billion Swiss francs, are required to maintain an extended countercyclical buffer in the form of Common Equity Tier 1 capital. An extended countercyclical buffer is calculated on the basis of foreign private sector credit exposures, including non-bank financial sector exposures.Additional capital requirements
In special circumstances and on a case-by-case basis, FINMA may demand that certain banks maintain additional capital, notably to respond to risks that FINMA deems not adequately covered by the minimal capital requirements. The additional capital requirements, with the capital buffer, primarily aim at ensuring that the minimum capital requirements can also be met under adverse conditions.Qualifying capital
To qualify under the capital requirements, equity must be fully paid in or have been generated by the bank. As a rule, it cannot be directly or indirectly financed by the bank, set off against claims of the bank or secured by assets of the bank. All qualifying capital must be subordinated to all unsubordinated claims of creditors in the case of liquidation, bankruptcy or restructuring of the bank. Capital instruments that are not only convertible, or subject to a conditional waiver in the case of an imminent insolvency of a bank, are qualified based on their respective terms prior to conversion or reduction, other than in the context of the requirements for additional capital or convertible instruments of systemic banks.
The capital qualifying under the above general requirements is divided into Tier 1 capital and Tier 2 capital. Tier 1 capital is, in turn, subdivided into:
- Common Equity Tier 1 capital, which consists of the paid-in capital, disclosed reserves, reserves for general banking risks (after deduction of latent taxes unless provided for) and profits carried forward and, with certain limitations, profits for the current business year as shown on audited interim financial statements reviewed in accordance with FINMA guidelines; and
- Additional Tier 1 capital, which consists of perpetual equity or debt instruments with restricted optional repayments and discretionary distributions providing for a conversion into Common Equity Tier 1 instruments (or, in the case of equity instruments without a conversion feature, a waiver of any privilege over Common Equity Tier 1 instruments), or a reduction and write-off to contribute to the restructuring of a bank in the case of its threatened insolvency (PONV). The conversion or reduction must take place no later than at the acceptance of public aid or when ordered by FINMA to avoid insolvency in the case of equity instruments, whereas an additional trigger of breaching a minimum threshold of 5.125 per cent of Common Equity Tier 1 capital is required for debt instruments. Debt instruments with capital reduction may provide for a conditional participation in the benefits of a subsequent recovery of the bank's financial situation. Additional Tier 1 capital issued by a special purpose vehicle, the proceeds of which are immediately and without restrictions passed on to the ultimate holding company or an operative company of the group in the same or higher quality, qualifies as Additional Tier 1 capital on a consolidated basis.
Tier 2 capital consists of equity or debt instruments with a minimum term of five years with restricted optional repayments and discretionary distributions providing for their conversion or reduction at such time as the bank reaches the PONV as for Additional Tier 1 capital. During the last five years before final maturity, the amount of such instruments that qualify is reduced by 20 per cent of their nominal amount for each year. FINMA is to issue guidelines for further elements to qualify as Tier 2 capital.Regulatory deductions
Banks must apply full or threshold deductions to the above capital elements to account for various items, such as losses, unfunded valuation adjustments, goodwill, deferred tax assets and defined benefit pension fund assets in line with the Basel minimum standards.Leverage ratio
Based on the Liquidity Ordinance (LO), which provides for the implementation of a leverage ratio in line with Basel III, FINMA Circular 2015/3 'Leverage ratio – banks' (as last revised on 30 June 2018) defines the methodology for calculating the leverage ratio in line with the Basel III methodology.
The CAO was revised as of 1 January 2018 to introduce a leverage ratio. In accordance with Basel III requirements, the revised CAO requires a risk-weighted capital ratio as well as an unweighted capital adequacy requirement for all non-systemic banks. A safety net in the form of a leverage ratio has been implemented and provides for a minimum core capital (Tier 1) to a total exposure ratio of 3 per cent for all non-systemic banks. The revised FINMA Circular 2015/3 enables banks to also apply the Basel III standard approach for derivatives when calculating the leverage ratio.Risk diversification rules
The maximum risk concentration permissible is 25 per cent of the overall required capital (after application of required deductions). With effect from 1 January 2019, the revised CAO provides that risk concentrations will be measured only against core capital (Tier 1), meaning that supplementary capital (Tier 2) will generally no longer be taken into account. Moreover, banks are allowed only very restricted use of models for determining their risk concentrations, as modelling errors have a major impact when calculating these risks. Further changes concern overruns of the upper limits set out in the CAO (large exposures exceeding 25 per cent of core capital are generally no longer permitted), the weighting of certain assets, as well as the adjustment of some special rules for systemically important banks (see below). The revised risk diversification provisions in the CAO are supplemented by the revised FINMA Circular 2019/1 'Risk diversification – banks'.Liquidity requirements
The LO sets out the quantitative and qualitative requirements for the minimum liquidity for banks and systemic banks. Although FINMA is in charge of the implementation and enforcement of the new LO, it must consult with the Swiss National Bank on any questions relating to its implementation.
With the revision of the LO as of 1 January 2015, the quantitative elements required by the Basel III framework for the liquidity coverage ratio (LCR) were introduced for non-systemic banks and will be gradually implemented until 2019, whereas systemic banks had to adhere to these requirements and the additional Swiss requirements applicable to them as from 2015. The net stable funding ratio (NSFR) was due to be implemented in January 2018 following a test reporting phase. Owing to delays in the introduction of the NSFR on the EU and US financial markets, the Federal Council decided in November 2018 to postpone the implementation of the NSFR, and to reassess the situation and decide on the next steps at the end of 2019. The LO was further revised with effect from 1 January 2018 to relax the LCR requirements for small banks, which are further detailed in the revised FINMA Circular 2015/2 on the liquidity risk for banks, which also entered into force on 1 January 2018.
Banks have to report their LCR as at each month end to the Swiss National Bank, within 20 calendar days for non-systemic banks or within 15 calendar days for systemic banks.
Banks that hold privileged deposits must maintain additional liquid assets to cover their respective obligations, as set by FINMA, based on the amount of privileged deposits reported annually by the bank. Financial groups must maintain adequate liquidity on a consolidated basis. Finally, certain short-term liabilities to one single customer or bank in excess of 10 per cent of the aggregate of short-term liabilities on a gross basis must be reported.Specific regime applicable to systemic banks: capital, liquidity and risk diversification
As regards capital requirements, on 11 May 2016, the Federal Council adopted an amendment to the CAO that sets out the specific capital requirements for SIBs and introduces new requirements for G-SIBs in line with G20 standards. The revised CAO came into effect on 1 July 2016, subject to certain phase-in provisions.
SIBs must have sufficient capital to ensure continuity of their service at times of stress and to avoid state intervention, restructuring or winding up by FINMA (i.e., going concern capital requirement). The going concern requirement consists of a basic and a progressive component, and is set with respect to both the bank's leverage ratio and its risk-weighted assets.
The progressive component is calculated based on the degree of systemic importance of a bank, such as its size and market share. The basic going concern capital requirement of a SIB consists of a base requirement of 4.5 per cent leverage ratio and 12.86 per cent risk-weighted assets, and a surcharge. With the inclusion of the progressive component, G-SIBs will have to comply with a 5 per cent leverage ratio and 14.3 per cent for risk-weighted assets. The size of the surcharge is set with respect to the degree of systemic importance (i.e., the total exposure and the market share of the relevant SIB). The going concern requirement is further split into a minimum requirement component of a 3 per cent leverage ratio and 8 per cent risk-weighted assets that a SIB has to maintain at all times, and a buffer component by which a SIB may temporarily fall short (e.g., in the case of losses and under strict conditions). From 1 January 2018, systemic banks may also be subject to a total exposure ratio up to 10 per cent.
Systemic banks operating at an international level are further subject to an additional capital requirement to guarantee their recovery or the continuation of their systemic functions in an operating unit while liquidating other units without support from the public (i.e., gone concern requirement). By analogy, the gone concern requirement of a G-SIB quantitatively corresponds to its total going concern capital requirement: that is, a minimum 4.5 per cent leverage ratio and a minimum 12.86 per cent risk-weighted assets, plus any surcharges applicable to the relevant G-SIB, to the exclusion of countercyclical buffers. After consultation with the Swiss National Bank, FINMA may lower the level of those requirements, based on the effectiveness of measures taken to improve the global resolvability of the relevant G-SIB group and in consideration with other factors. However, the gone concern requirement must not fall below a 3 per cent leverage ratio or 8.6 per cent risk-weighted assets or, if higher, the applicable international standards, provided that the requirement adjustment does not jeopardise the implementation of the G-SIB's emergency plan. The gone concern requirement is complied with, as a general rule, by means of bail-in instruments such as bonds with conversion rights, subject to the regulator's decision. In February 2018, the Federal Department of Finance initiated a consultation on amendments to the CAO regarding gone concern requirements for the three SIBs (i.e., PostFinance AG, Raiffeisen and Zürcher Kantonalbank). In November 2018, the Federal Council adopted the relevant amendments to the CAO, which entered into force on 1 January 2019. Following the introduction of gone concern capital requirements for the G-SIBs (UBS and Credit Suisse) in 2016, these now also apply to the SIBs. The amended CAO also provides for new rules for the treatment of systemically important banks' stakes in their subsidiaries (see below).
Systemic banks also have to satisfy the countercyclical buffer and extended countercyclical buffer requirements. Capital requirements apply both on a stand-alone and consolidated basis. In this context, FINMA may alleviate the requirements on a stand-alone basis if these would otherwise increase the requirements on a consolidated basis and the financial group has taken appropriate measures to avoid an increase. Both stand-alone and consolidated requirements, as well as any alleviation, have to be disclosed by FINMA with respect to the principles, as well as by the bank or the financial group as part of its regular reporting. Finally, FINMA may, in extraordinary circumstances, require a SIB to hold additional capital or demand that the going concern capital requirement is fulfilled with higher-quality capital.
In addition, systemic banks are subject to more stringent liquidity requirements both on a stand-alone and a consolidated basis, which take into account extraordinary stress scenarios. As a result, systemic banks must be able to cope with all liquidity drains that are to be expected under a particular stress scenario over a period of 30 days. In this context, no liquidity gap, as defined for the relevant period in the LO, may arise on a seven-day and a 30-day liquidity outlook. The particular stress scenario must be based on the assumption that, inter alia, the bank loses access to financing in the markets, and that large amounts of deposits are being withdrawn. Systemic banks must further hold a regulatory liquidity buffer consisting of primary and secondary buffers comprising determined qualifying assets listed in the LO. However, FINMA may modify the list and determine the minimum deductible to establish the sales value of the assets. The percentage of liquidity that can be generated by a sale of assets allocated to the regulatory liquidity buffer qualifying for the primary buffer must amount to at least 75 per cent on a seven-day outlook and 50 per cent on a 30-day outlook. Finally, systemic banks must report monthly on changes in their liquidity position, highlighting and explaining the reasons for the most significant changes.
As regards risk diversification, the maximum risk concentration permissible for systemic banks is 25 per cent of the Common Equity Tier 1 capital (other than Common Equity Tier 1 capital constituting the progressive element) only. The Federal Council requested that the Federal Department of Finance prepare, by the end of February 2018, a proposal on the risk weighting principles applicable to positions held in subsidiaries. The Federal Council adopted in November 2018 an amendment to the CAO providing for new rules for the treatment of systemically important banks' stakes in their subsidiaries. In this context, the same regime now applies to SIBs as to G-SIBs. This regime provides, inter alia, for an abolition of the full deduction of parent companies' positions held in subsidiaries from core equity capital and of the accompanying relief measures allowed for these two large banks and for replacement thereof, after a transition period, by a risk weighting of up to 250 per cent with respect to positions in Swiss-based subsidiaries and 400 per cent with respect to positions in foreign subsidiaries of these two large banks. These requirements relate to parent companies' stand-alone capital ratios, but not the consolidated ratios. Finally, in addition to measures relating to capital, liquidity, organisational and risk diversification requirements, the amendment to the BA also entails provisions that allow the government to order adjustments to the remuneration system of a bank that would have to rely on government funding.Transitional period
The new rules for banks and systemic banks overall not only provide for increased capital ratios, but also significantly vary as to the quality of the capital and deductions that need to be applied to the capital, and smaller banks that used the simplified SA-CH standard approach to measure credit risk will have to move to the SA-BIS.
In light of these changes, very detailed transitional rules are intended to allow banks and finance groups to adjust to the increased requirements over time by building up the required capital and replacing or phasing out capital that no longer qualifies under the new rules.
As regards capital requirements, both the going concern requirement and the gone concern requirement are subject to a phase-in with gradually increasing requirements, and must be fully applied by 1 January 2020.Future developments
The evolution of the standards issued by the Basel Committee on Banking Supervision, changes to the Banking Ordinance and the CAO, as well as amended international accounting standards, have necessitated changes to a number of FINMA circulars (i.e., 2008/6 'Interest rate risks – banks', 2011/2 'Capital buffer and capital planning – banks', 2013/1 'Eligible capital – banks', 2016/1 'Disclosure – banks', 2017/7 'Credit risks – banks'). A consultation was opened until the end of January 2018 for this purpose. FINMA Circular 2008/6 'Interest rate risks – banks' has been replaced by a new FINMA Circular 2019/2 'Interest rate risks – banks', which entered into force on 1 January 2019. FINMA Circulars 2011/2 'Capital buffer and capital planning – banks', 2013/1 'Eligible capital – banks', 2016/1 'Disclosure – banks' and '2017/7 'Credit risks – banks' were all amended in June 2018. The revised versions of these circulars entered into force on 1 January 2019.
Most of the legal and regulatory capital adequacy requirements deriving from the Basel III standards have been gradually implemented into the Swiss regulatory framework. This revision package is one of the last steps in the national implementation of the Basel III standards. The implementation of the NSFR (see above), and the revised standards published by the Basel Committee in December 2017, are still pending. These will be handled under the lead of the Federal Department of Finance via amendments to the relevant Federal Council ordinances and associated FINMA circulars.iv Recovery and resolution
The provisions of the BA dealing with insolvent banks aim at streamlining reorganisation procedures, ensuring prompt repayment of preferential deposits and the continuity of basic banking services. These provisions enhance the flexibility of such proceedings, and confer additional instruments and powers to FINMA with a view to increasing the likelihood of a successful reorganisation. FINMA is, for instance, empowered to order a transfer of all or part of a failing bank's activities to a bridge bank, the conversion of certain convertible debt instruments issued by the bank (CoCos or convertibles), the reduction or cancellation of the bank's equity capital and, as an ultima ratio, the conversion of the bank's obligations into equity.
The FINMA Banking Insolvency Ordinance reflects a quite extensive interpretation of the new instruments and powers of the BA. For instance, it allows FINMA to order, as an ultima ratio to ensure the presence of sufficient equity capital, the conversion of the bank's obligations (third-party funding) into equity capital, with the exception of certain limited claims that would be ranked in privileged classes in the event of a liquidation procedure. This measure could also potentially concern clients' deposits that do not qualify as preferential deposits (being defined as cash deposits of up to 100,000 Swiss francs whose payment would be secured within liquidation proceedings). In addition, FINMA may order a temporary stay of a counterparty's right to terminate agreements with a bank.
Following a revision of the BA that entered into force on 1 January 2016, FINMA's power to order a stay of early termination rights has been considerably broadened: FINMA may now couple a stay with any of the protective or reorganisation measures it may take in the event of insolvency risk (not only, as was formerly the case, in connection with a transfer of the relevant agreements to a bridge bank), and can order a stay in relation to any contractual agreement with the bank (not only in relation to certain financial agreements). In this context, where agreements subject to termination rights in the case of protective or reorganisation measures are governed by non-Swiss law or non-Swiss jurisdiction clauses, the Banking Ordinance generally requires, for enforceability purposes, that Swiss banks and securities dealers only enter into new agreements or agree to the amendment of agreements, provided the counterparty contractually acknowledges and consents to a stay of the termination right. This obligation has now been further specified in the revised FINMA Banking Insolvency Ordinance, which entered into force in April 2017. Finally, FINMA may also order the stay of certain netting, private sale and claim transfer rights that are, in principle, recognised and protected within FINMA insolvency proceedings.
On 15 February 2017, the Federal Council instructed the Federal Department of Finance to prepare a consultation draft with the aim of strengthening the current deposit protection scheme on the basis of the recommendations of the group of experts on the further development of the financial market strategy and the continuing discussions between the State Secretariat for International Financial Matters, FINMA and the Swiss National Bank on this issue. The consultation draft has been published on 8 March 2019 and is subject to a consultation procedure until 4 June 2019. One notable proposal is to require a Swiss bank to pay cash deposits within seven business days of its bankruptcy, which is in line with international standards.
In line with international standards, systemic banks must have both a recovery plan and a resolution plan for identifying risks to the stability of the financial system due to their systemically important nature, and to determine viable ways of dealing with the effects of a crisis. Pursuant to the Banking Ordinance, a systemic bank has to establish a recovery plan that contains the measures that it would implement in the event of a crisis and that would allow it to pursue its activity without requiring government funds. Responsibility for drafting and regularly updating the recovery plan lies at executive board level of the systemic bank and must be embedded in a viable corporate governance framework. The recovery plan and any amendments thereto are subject to FINMA's approval. If the legal requirements are met, FINMA will approve the recovery plan, and then develop a resolution plan itself based on the information provided by the systemic plan. At the time of writing, FINMA considers that the two largest banks, Credit Suisse AG and UBS AG (G-SIBs) have improved their crisis resistance over the years by establishing detailed recovery and resolution plans and implementing the necessary organisational measures. Both banks now have a non-operating holding company acting as their respective group parent and have transferred their Swiss-based systemically important functions to separate subsidiaries. Nevertheless, according to FINMA, further steps are to be undertaken to reduce financial and operational dependencies that persist in the groups. Both banks are due to submit revised emergency plans to FINMA in 2019 that are to address this issue, among others.