The New Swiss Fintech License

ZURICH THE NEW SWISS FINTECH LICENSE BACKGROUND AND KEY POINTS In February 2017, the Swiss Federal Council conducted a consultation on Fintech. The initiative included three measures to promote innovations in the financial sector and to reduce barriers to market entry for Fintech companies. The aim was firstly to extend the permissible holding period for settlement accounts in connection with crowdfunding and secondly to create a licensefree innovation space for Fintech companies, the “Sandbox.” These measures came into force on 1 August 2017. In addition, the Federal Council proposed to include a new license category with simplified requirements in the Banking Act. In particular, this should allow younger companies and especially Fintech firms to accept public deposits of up to CHF 100 million as part of their business activities. The legislative proposal of the Federal Council for this new license category was accepted by the Federal Parliament. The new provisions in the Banking Act and Banking Ordinance entered into force on 1 January 2019, and the updated regulatory guidance of FINMA was published on 15 March 2019 for public consultation. The new regulation allows for not only banks to accept deposits from the public on a professional basis, but also holders of the new innovator license or “Fintech License” set out in article 1b of the Banking Act (“Licensees”). However, the new license does not allow Licensees to invest the public deposits or to pay interest on them. These activities remain reserved for banks. The Fintech License is further subject to certain conditions concerning organization, risk management, compliance, accounting and financial resources. Background In 2017, the Federal Council and the Federal Department of Finance (FDF) acknowledged that the financial industry is in a state of transformation due to increasing digitalization. Innovative, up-and-coming, IT-related companies are digitalizing and democratizing financial services and infrastructures. Such Fintech firms can provide bank-like services, but usually do not conduct core banking activities. In particular, there is mostly no reinvestment of any funds collected and no maturity transformation. The services Fintech firms offer are quite heterogeneous and include a wide array of alternative financing options (e.g., crowdfunding), algorithm-based data analyses, infrastructures for banks or payment systems, applications based on blockchain technology as well as activities within the framework of investment advice and asset management. Some of these business models require the acceptance of deposits from the public (so-called deposit-taking business), while they do not intend on entering the lending business at the same time. In principle, such business models would fall within the scope of the Banking Act and require a banking license from the Swiss Financial Market Supervisory Authority (FINMA). However, early-stage Fintech companies are often not able to meet the onerous and costly requirements of a banking license. The Federal Council and the FDF further came to the conclusion that the requirements for a banking license are not tailored to Fintech companies, especially given that many Fintech business models do not make use of the funds received by means of a maturity transformation. Purpose The Fintech License primarily aims at lowering the market entry barriers for Fintech companies that do not conduct business typical of a bank. The previous regulatory framework represented an unnecessarily high barrier to market entry in many cases and restrained innovation, which affected the competitiveness and attractiveness of the Swiss financial market. Companies that operate payment systems or the like, including such systems based on cryptocurrencies or other blockchain applications, do not necessarily THE NEW “FINTECH” LICENSE CATEGORY generate typical bank risks. Such bank risks arise from the deposit and loan business: Banks “borrow short to lend long” and, therefore, incur the risks of maturity transformation. Accordingly, the very strict requirements (liquidity, capital, organizational) applying to banks are considered too onerous and should be alleviated for innovative companies without maturity transformation. This issue was addressed by first introducing the “Sandbox” concept, which is an unregulated space that allows innovators to accept up to CHF 1 million in public deposits. The Fintech License goes further. This new license category allows the Licensee to accept a significantly larger amount of deposits, as long as the deposits do not bear interest and are not reinvested. Scope Although the primary purpose of the new regulation is to lower the barriers to market entry for Fintech firms, the provision is broadly worded and generally applies to all “persons working primarily in the financial sector” (Article 1b(1) Banking Act). Companies outside the Fintech sector can, therefore, also obtain a license in accordance with article 1b of the Banking Act. Despite this openly drafted scope, the focus is clearly on innovative Fintech business models. With the new license, companies are granted the right to accept deposits from the public up to a maximum of CHF 100 million on a commercial basis. The simultaneous operation of a lending or investment business remains reserved for licensed banks. Licensees are, therefore, not permitted to invest or pay interest on the deposits received (article 1b para. 1(b) of the Banking Act). Requirements a. Overview The Banking Act sets out that the requirements for banks apply to the new Licensees mutatis mutandis. In particular, Article 1b(3) Banking Act obliges Licensees to: - describe their business activities in detail and have an organization suitable for their business; - have a risk management with adequate resources and an effective internal control system, which ensures, amongst other things, the compliance with legal and in-house rules; - dispose of adequate financial means; and - ensure that the persons entrusted with directorship and management are of good repute and guarantee an irreproachable business activity. Therefore, Licensees must meet certain requirements with regard to their organization, risk management, compliance and financial resources. They must also have their activities reviewed by an approved auditor. The requirements for the Fintech License are detailed in the revised Banking Ordinance that entered into force on 1 January 2019. Compliance with these provisions is verified by FINMA as part of its ongoing supervision. FINMA is also responsible for enforcements in case of non-compliance. As mentioned, the provisions of the Banking Act are only applicable mutatis mutandis rather than directly, as the Banking Act is specifically tailored to the classical banking business and risks. While the Banking Ordinance provides certain rules, there remains substantial room for interpretation and technical discretion of FINMA with regard to the implementation of the Fintech License. b. Commercial acceptance of deposits as nexus of the Fintech License In general, the acceptance of deposits from the public only requires a license if it is made on a commercial basis. The revised Banking Ordinance defines “non-commercial” as accepting less than 20 public deposits or accepting less than CHF 1 million while not conducting the banktypical interest rate differential business. No additional criteria are set out in the Banking Ordinance. Therefore, the acceptance of deposits below CHF 1 million is considered non-commercial if the deposits are neither reinvested nor used to conduct the banktypical deposits-and-loans business, and the company may profit from the simplifications in the Sandbox. Conversely, the acceptance of more than 20 deposits totaling over CHF 1 million by Fintech firms is generally considered commercial, even if the deposits neither carry interest nor are invested. Accordingly, a Fintech License (or a Banking License) is required for the acceptance of deposits in excess of CHF 1 million. c. Custody of deposits Licensees are primarily obliged to either forward the accepted deposits in accordance with the respective agreements with the customers (e.g., crowdfunding agreement) or, if this is not the purpose of the agreements or not possible, to repay them. However, if a (re-)transfer according to the respective agreements is not possible or not provided for, the company may keep the deposits in custody. This holding of deposits is not subject to any time limits, but to certain conditions. If deposits are held, they must be administered in the interest of customers and may not be invested or accrue interest during this period. The Licensees are, therefore, prohibited from conducting the deposit and loan business reserved for banks and from generating profits from the differential in interest rates. The prohibition of reinvestment furthermore means that the deposits may not be used to purchase yielding assets, whether in one’s own name and account or in the framework of a collective investment. As long as the deposits received from the public are not forwarded as intended or repaid to the customers, they must be either kept separate from the funds of the Licensee or they must be recorded in the Licensee’s accounts in such a way that they are separable from its own funds at all times. However, this mere “accounting separation” requires that the Licensee is subject to an ordinary audit in accordance with Article 727 of the Swiss Code of Obligations. The deposits received have to be kept in custody in such a manner that the risks for the customers are largely excluded until the deposits are forwarded or repaid. The deposits in custody must also be held in a liquid manner, so that they can be forwarded or refunded within a reasonable period of time. One option is to pay the funds into a bank account or to another person entitled to accept deposits, as a sight deposit. Alternatively, the regulations permit to hold the deposits as category 1 high-quality liquid assets (HQLA) within the meaning of article 15a of the Ordinance on Liquidity from 30 November 2012. This HQLA category includes such instruments as certain government bonds. It is also possible to cover the received deposits with a sight deposit with the Swiss National Bank (SNB). However, this would require the Licensee to have a current account with the SNB and to be admitted to the Swiss Interbank Clearing (SIC) payment system. The deposits received have to be held in the same currency as the respective potential repayment claim of the customers. Deposits in cryptocurrencies have to be held in the same manner as originally received. d. Duty to inform customers Licensees may offer a wide range of services. In order for potential depositors to be able to assess the risks of the business, they need to be informed about the business model. Accordingly, Licensees must thoroughly assess the risks associated with their business model as well as the technology used and communicate the result of this assessment to their customers. It is not sufficient for the company to provide technical remarks and assessments that can only be understood by specialists. Rather, the business model must be described in plain language. All the risks of the business model must be described and information regarding specific risks must be fully disclosed. In contrast to banks, Licensees have been exempted from having to join the Swiss deposit guarantee scheme. However, customers must be made aware of the lack of deposit protection in an appropriate manner. The disclosure described above may not merely be included in the general terms and conditions and small print may not be used. Apart from this, Licensees are free to choose the manner in which they will inform their customers. In particular, information by electronic means, subject to certain conditions, is possible. e. Legal form, registered office and effective administration Licensees must be a stock corporation (Aktiengesellschaft), a limited commercial partnership (Kommanditaktiengesellschaft) or a limited liability company (Gesellschaft mit beschränkter Haftung). f. Management Licensees must effectively be managed from Switzerland. Accordingly, the persons entrusted with the management must also be resident in a place from which they can effectively perform their management tasks. Like banks, Licensees must also appoint a corporate body responsible for ultimate supervision and control if this is required by the business purpose or scope of business. This corporate body must comprise at least three members, of whom at least one third must be independent of the executive management. If the body consists of only three members, it is sufficient if one member meets the independence requirements. Compared to banks, these requirements are more lenient. Furthermore, natural and legal persons holding at least 10% of the voting rights or capital of a Licensee, so-called qualified participants, must enjoy a good repute and ensure that their influence does not impair the prudent and sound conduct of business. FINMA has the authority to grant exceptions and impose additional conditions. g. Compliance and Risk Management Licensees have to ensure that the laws and regulatory requirements are complied with and that the effective identification, assessment, management and monitoring of the risks associated with their business (risk management) as well as an effective internal control system are in place. An internal control system is generally structured through a “three lines of defense” approach. However, if and in which form such a three lines of defense approach has to be implemented by Licensees depends on the individual case. The compliance and risk management aspects have to be documented internally and the respective body responsible for the compliance and risk management has to be independent from the profit-orientated business unit. Compliance and risk management can be outsourced. However, the responsibility and liability fully remain with the Licensee. h. Conflicts of Interest Generally, conflicts of interest are regulated in the Financial Services Act, which is set to enter into force on 1 January 2020. These rules will have to be observed by all financial service providers. Licensees have to take appropriate organizational measures to avoid potential conflicts of interest. Some of these measures will likely be explicitly set out in the Financial Service Ordinance. i. Minimum capital requirements Licensees are subject to capital adequacy requirements. The purpose of the minimum capital rules is not only to ensure a certain level of loss-absorbency for the deposits, but also to ensure that the company can finance adequate organizational and technical measures to conduct its business properly. The qualitative and quantitative capital requirements are significantly less strict for Licensees as compared to banks. The capital requirements are set in accordance with the amount of public deposits received. Licensees must at all times maintain capital amounting to 3% of these deposits, but in any case not less than CHF 300,000. For the purpose of capital adequacy, financial assets may only be taken into account to the extent that they are paid-in and held permanently. The minimum capital must be available to serve the purpose of the company. Accordingly, it must neither be lent to qualified participants or related natural or legal persons nor invested in participations controlled by the Licensee. This limitation of investment opportunities is intended to reduce the risk of the company’s assets being depleted. FINMA has the authority to increase the required minimum capital in individual cases where this appears advisable due to increased risks. To this end, FINMA must analyze the business model and the associated risks and specifically justify any increased requirements. THE NEW FINTECH LICENSE IN PRACTICE International Comparison It is anticipated that the revised framework will create favorable conditions for Switzerland to compete with jurisdictions such as the UK, Singapore and Hong Kong, which have also modified their regulations in order to attract innovative Fintech businesses. While the approach taken by the Swiss regulator differs significantly from other jurisdictions, the Fintech License can be an attractive option for Fintech firms, such as payment providers. Naturally, the attractiveness of Switzerland as a place of business also depends on other factors such as the tax environment, which can be described as generally favorable. Application process The process of obtaining a Fintech License is expected to take significantly less than six months to complete, subject to the quality of the application, the complexity of the business model and potential staffing constraints at FINMA. For comparison, an applicant for a banking license will be subject to quite onerous capital, liquidity and organizational requirements and an application will take at least six to nine months, and quite probably longer. Possibilities for licensed banks The revised Banking Ordinance may still provide space for banks to advance into the Fintech sector by making use of the alleviations provided to Fintech Licensees. As the total of accepted deposits is calculated on a consolidated basis, most traditional banking institutions will exceed the CHF 100 million threshold for that license category by far. However, provided that the Fintech company affiliated with the bank is manifestly independent from the banking group’s other business, exceptions from the consolidated view of deposits can be granted by FINMA. Accordingly, banks may also take advantage of the new Fintech License under certain conditions. From our point of view, the hurdles for the exception from the consolidated view should not be set too high in order to ensure a level playing field and to promote competition. Potential of the Fintech License for specific use cases in the blockchain space Fintech Licensees may not only accept fiat currencies, such as Swiss franc or euro, but also cryptocurrencies such as Bitcoin and Ether. However, according to the practice of FINMA, credit resulting from the acceptance and safe custody of cryptocurrencies that are still directly held by individual customers on the blockchain at all times (and not in the company’s own accounts) are generally not regarded as deposits. An example for this are wallet providers. Generally speaking, coins in a wallet are not deposits taken by the wallet provider if the power of disposing of them remains with the customer at all times and even in the insolvency of the wallet provider. Such acceptance and safekeeping of cryptocurrencies can, therefore, be made irrespective of having a Fintech License or banking license. Furthermore, companies with a Fintech License are generally free to keep tokens qualifying as securities in custody for clients without requiring an additional license as a securities dealer or investment firm (in accordance with the Financial Institutions Act) for the pure safekeeping of such securities tokens. Therefore, not all contact with (crypto-)currencies or other blockchain-based assets of customers requires a license. In the past, companies considering an initial coin offering (ICO) usually had to take into account that they might fall under the regulations of the Banking Act and had to take precautions in order to steer clear of the licensed area under the Banking Act. Now companies envisaging an ICO might also consider obtaining a Fintech License in order to streamline the ICO process, given the possibility for holders of a Fintech License to accept and hold deposits in the form of tokens without obtaining a license. However, the attractiveness of the new Fintech License in connection with ICOs still has to be shown in practice and will strongly depend on the business model pursued by the ICO organizer. With regard to the trading of asset tokens on the secondary market, Licensees can also be admitted as participants in licensed trading infrastructures if they meet the requirements set out in the Financial Market Infrastructure Act. Furthermore, the Federal Council intends to examine in due course whether the operation of an organized trading system should also be opened up to Licensees. However, the Federal Council has advocated a new license category for a blockchain-based trading platform to which retail customers should have access as well, which could render the discussion obsolete. Conclusion As a general conclusion, the regime of the new Fintech License currently appears sufficiently flexible to be able to react appropriately to future developments. However, the suitability and attractiveness of the new category for blockchain-based business models will only become apparent once this new license category has been put to the test and certain practices of FINMA are established. It will be necessary to monitor carefully whether the framework conditions for the Fintech License take market developments sufficiently into account and whether there is a need for further regulation, e.g., a clearer definition of the provisions of the Banking Act which apply analogously to institutions with a Fintech License and the provisions which do not. Furthermore, the regulations should stay flexible to allow amendments where necessary—only the future will tell whether the Fintech License in its present form can establish the desired level playing field in the area of Fintech firms. www.bakermckenzie.com © 2019 Baker McKenzie. All rights reserved. Baker & McKenzie International is a global law firm with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner or equivalent in such a law firm. Similarly, reference to an “office” means an office of any such law firm. This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome. Baker McKenzie helps clients overcome the challenges of competing in the global economy. We solve complex legal problems across borders and practice areas. Our unique culture, developed over 65 years, enables our 13,000 people to understand local markets and navigate multiple jurisdictions, working together as trusted colleagues and friends to instill confidence in our clients. For further information on the Fintech License, please contact our Zurich financial services team: Dr. Marcel Giger Partner Tel: +41 44 384 13 16 marcel.giger @bakermckenzie.com Dr. Ansgar Schott Partner Tel: +41 44 384 12 51 ansgar.schott @bakermckenzie.com Dr. Yves Mauchle Associate Tel: +41 44 384 14 12 yves.mauchle @bakermckenzie.com Jan Nussbaumer Associate Tel: +41 44 384 15 30 jan.nussbaumer @bakermckenzie.com