## EXECUTIVE SUMMARY

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### INTRODUCTION
- Focused review of the effectiveness of the regulation and supervision of asset management activities as part of the 2019 FSAP.
- Review draws on discussions in Switzerland from October 31 to November 14, 2018, and from January 23 to February 6, 2019.
- Prepared by Nobuyasu Sugimoto (IMF, Monetary and Capital Markets Department).
- Key legislative changes:
  - Revisions to the Financial Services Act (FinSA) and Financial Institution Act (FinIA) approved in June 2018, entering into force in January 2020.
  - FinIA brings a multitude of small independent asset managers within the regulatory perimeter.
  - FinSA sets out cross-sector rules for the offer and distribution of financial services and financial instruments, including funds.
- Analytical inputs: authorities’ questionnaire responses, self-assessment of 17 IOSCO Principles, limited legal/regulatory review, and discussions with authorities, self-regulatory bodies, and market participants.

### MARKET DEVELOPMENT
- Official reporting does not cover the entire asset management and fund industry in Switzerland due to definitional differences and lack of regulation for independent asset managers managing assets under discretionary mandates.
- Swiss funds and foreign funds distributed in Switzerland:
  - Total AuM: CHF 1,087 billion (160 percent of GDP) at end-2017.
  - Year-over-year increase: 17.7 percent.
- Assets managed under discretionary mandates (unregulated independent asset managers):
  - Estimated AuM: over CHF 900 billion (134 percent of GDP) in 2017.
  - Estimated growth: 12 percent annual growth (IFZ/AMP Asset Management Study, June 2018).
  - These managers will be supervised starting in 2020 under FinIA.
- Market drivers in 2017:
  - Equity funds grew mainly due to positive market performance.
  - Bond funds grew due to market appreciation and higher inflows.
  - Other funds experienced outflows and market depreciation (negligible impact on market size overall).
- Money Market Funds (MMFs): Constant NAV per share MMFs (C-NAV MMFs) are not allowed in Switzerland, though Swiss asset managers manage some foreign domiciled C-NAV MMFs.
- Recent market stress and cross-border supervision:
  - In H2 2018, funds focusing on underperforming asset classes (emerging market bonds, commodities) suffered material outflows and required prompt liquidation of illiquid instruments (e.g., exotic derivatives).
  - A Switzerland-based large asset management group had to liquidate bond funds domiciled in Luxembourg, Ireland, and the Cayman Islands; the funds were managed by foreign asset managers in the U.K. and Ireland, limiting FINMA’s direct supervisory powers.
  - Experience underscores the importance of group supervision and cross-border cooperation.

### MAIN FINDINGS — A. Supervisory Resources and Capacity
- Staffing and allocation:
  - FINMA staff allocated to asset management and fund regulation and supervision: 55 Full Time Equivalent (FTE) at end-June 2018.
  - FINMA enforcement staff for the entire financial sector: 61 FTE at end-June 2018.
  - FINMA plans to increase resources to cope with indirect supervision of many small independent asset managers from 2020 via a new independent supervisory organization authorized by FINMA.
- Quality and organization:
  - Creation of a dedicated Asset Management (AM) Division (separated from the Market Division in 2014) improved supervisory quality and commitment.
  - Market participants reported positive views on FINMA staff quality and capability.
- Staff turnover:
  - High turnover in 2011 (overall over 14 percent; Market Division 21 percent) has improved; turnover has reduced to low levels over the last five years.
- IT systems and data granularity:
  - FINMA’s current IT system limits analytical capacity: reports are received largely in paper format; early warning and alert systems rely on annual data and quarterly SNB statistics that lack microprudential granularity.
  - FINMA is upgrading its internal IT system with a unified online platform (EHP) to allow online submissions and improved data interactions.
  - Data gaps and insufficient granularity impede quantitative and detailed analysis of risks (liquidity, maturity mismatches, leverage) at both firm and industry levels.
  - Increased data collection and IT capability are particularly important ahead of indirect supervision expansion in 2020.

### MAIN FINDINGS — B. Systemic Risk and Regulatory Perimeter
- Market size and systemic relevance:
  - Combined Swiss funds and foreign funds distributed in Switzerland: CHF 1,087 billion (160 percent of GDP) at end-2017.
  - Assets under discretionary mandates (not previously regulated): over CHF 900 billion (134 percent of GDP).
- Leverage and stability:
  - Leverage of Swiss regulated funds is low and stable since 2013, including alternative investment funds.
  - FINMA monitors leverage via ad-hoc supervisory data collection and official statistics since 2018.
  - Leverage measurement: derivative positions converted to underlying assets using appropriate sensitivities; securities financing transactions considered when collateral reinvestment generates returns in excess of the risk-free rate. Value at Risk (VaR) methods allowed only upon FINMA approval and granted to few funds.
- Concentration risks:
  - Most Swiss funds face concentration limits (e.g., 10 percent per single entity), but higher concentration limits apply to counterparty credit risks via certain derivative transactions (e.g., total return swaps for index funds).
  - Concentration concerns include ETFs’ swap counterparties and group custodian bank exposures to ETFs, which may trigger runs when a group is under stress.
  - Recommendation: better monitoring of concentration risk to prevent undue concentration; concentration via ETFs’ swap counterparties warrants heightened supervision and potentially regulation.
- Liquidity risks:
  - FINMA’s semi-annual Risk Barometer identified increased liquidity risks in the asset management industry.
  - Publicly available data and large Swiss asset managers’ disclosures show some funds—particularly those focused on underperforming asset classes—suffered material outflows, notably in Q4 2018.
  - Idiosyncratic risk management at asset managers does not capture sector-wide risks such as undue concentration; industry-wide liquidity stress testing is necessary.

### MAIN FINDINGS — C. Selected Regulatory and Supervisory Issues
- Supervisory cooperation:
  - FINMA should continue enhancing cooperation with foreign supervisors to effectively monitor and supervise internationally active asset managers; FINMA’s decision to expand supervisory scope beyond regulated entities is welcome.
- Enforcement powers:
  - FINMA lacks the power to impose administrative fines. Current powers include seizing profits from serious regulatory violations and revoking licenses.
  - The inability to impose administrative fines could pose challenges, especially when supervising many small independent asset managers from 2020.
  - Within current legal constraints, FINMA should use existing enforcement tools more actively and comprehensively disclose individual enforcement actions and license revocations.
- Valuation safeguards:
  - Close monitoring of the effectiveness of valuation safeguards is required to address potential conflicts of interest within banking groups.

### DATA GAPS, REPORTING, AND STRESS TESTING
- Data gaps and reporting coverage:
  - SNB collects quarterly data from domestic regulated asset managers and funds on behalf of FINMA, but the data "is not granular enough" to analyze risks notably on credit (such as investment by credit ratings) and liquidity (such as investors’ profile—wholesale or retail investors, and other information about liabilities).
  - Reporting does not cover foreign funds managed by Swiss regulated entities or distributed to Swiss investors.
  - FINMA collects annually industry-wide information on asset management activities.
  - Small independent asset managers (totaling an estimated AuM of up to CHF 500 billion) are unregulated until 2020 and thus their investment activities are not subject to any reporting requirement.
  - FINMA occasionally closes data gaps by collecting and analyzing information on an individual entity basis.
- Recommendations on reporting and supervisory data:
  - Revise the template to enable analysis of trends of key risk characteristics (such as credit risk taking, maturity and liquidity mismatches) more precisely.
  - Expand coverage to other relevant players, including domestic asset managers managing foreign funds under the de-minimis threshold and foreign funds distributing to Swiss investors, in close cooperation with relevant foreign supervisors as necessary.
  - FINMA should continue to improve its IT system and further enhance analytical capacity; allocate sufficient budget resources to IT and analytical capability ahead of 2020 indirect supervision expansion.
- Stress testing:
  - Authorities should conduct industry-wide liquidity stress tests of the asset management and fund industry.
  - Simple industry-wide stress tests would help identify the most critical data gaps and concrete features of the IT system more clearly.
  - Once granular reporting information with upgraded IT system become available, authorities could conduct more sophisticated industry-wide stress tests without undue additional cost.
  - In the medium term, this would help identify and address risks in a forward-looking manner without material market impact.

### CONCENTRATION LIMITS AND OTC DERIVATIVES REFORMS
- Standard concentration restrictions for funds:
  - Securities funds and other funds for traditional investments: may invest no more than a 10 percent in a single entity, and the total value of securities in which more than 5 percent of the fund’s assets are invested may not exceed 40 percent of the fund’s assets.
  - Real estate funds: required to invest in more than ten properties and the market value of a single property may not exceed 25 percent of the fund’s assets.
  - An overall limit (20 percent of the total NAV) across different instruments applies to exposures of all entities within the same group in accordance with international accounting standards.
  - Certain limits (such as 20 percent of the total NAV) apply to the collateral of a single issuer.
  - Alternative investments are not subject to those concentration restrictions.
- Limits may not be effective for counterparty credit risk:
  - Swiss funds actively use OTC derivatives for hedging; concentration limits are relaxed for certain products (such as index funds) and apply to total NAV rather than total OTC derivatives’ counterparty exposures, so limits may not effectively require funds to diversify counterparties.
- OTC derivative reforms and Swiss implementation:
  - FMIA and FMIO implemented margin requirements (IM and VM) effective January 2016 with transition periods as laid out in BCBS and IOSCO margin requirements.
  - Asset managers and funds generally do not qualify for intra-group exemptions and are therefore subject to IM and VM requirements; small funds may qualify for an exemption if under applicable thresholds, but large funds with material derivative exposures (such as synthetic ETFs) are subject to IM and VM requirements.
  - IM and VM requirements mitigate group concentration risk to some extent by restricting admissible collateral.

### VALUATION SAFEGUARDS
- NAV valuation rules:
  - NAV of all open-ended Swiss CISs is calculated at market value on each day units are issued or redeemed.
  - Investments listed on a stock exchange or another regulated market open to the public are valued at the price paid on the main market.
  - Other investments with no current price must be valued at the price that would probably be obtained in a diligent sale at the time of valuation.
  - SFAMA guidelines are recognized as minimum standards by FINMA.
  - For real estate funds, independent valuation experts are required (at least two natural persons or one legal person), subject to FINMA approval.
- Responsibilities and safeguards:
  - Fund management companies, custodian banks, and auditors must ensure fair and reliable valuations: fund managers ensure transparent financial statements; custodian banks verify calculation of NAV and issue/redemption prices; an audit firm examines funds’ annual accounts.
  - FINMA should closely monitor effectiveness of valuation safeguards to address potential conflicts of interest within a banking group.
- Reporting of valuation errors:
  - Significant valuation errors must be reported immediately to FINMA.
  - Limits for assessing the significance of valuation errors were reduced by about half in the SFAMA guidelines, which came into force in July 2016.
  - FINMA conducted several onsite visits at most fund managers and custodian banks focusing on risk management and internal controls on valuation and errors.

### MANAGING REDEMPTION RISKS AND LIQUIDITY TOOLS
- FINMA approval and redemption frequency:
  - FINMA approval is required on redemption terms; FINMA requires adequate redemption terms based on specific investment strategy and underlying investments.
  - FINMA approves securities funds only with daily redemption; weekly or monthly redemption is possible for other funds for traditional or alternative investments.
  - Investors in real estate funds may request redemption at the end of each financial year with twelve months’ prior notice.
- Tools available to fund managers to address redemption shocks:
  - Gates
  - Side pockets
  - Anti-dilution levy
  - Redemption fees
  - Redemption in-kind
  - Suspension of redemptions
  - Swing pricing
  - Short-term borrowings
- FINMA powers and limits:
  - In exceptional cases, FINMA may require asset managers to limit deferral of a redemption in the interest of all investors and coordinate measures with relevant foreign supervisory authorities.
  - FINMA does not have the power to impose on an individual asset manager or the entire industry to defer/suspend redemptions: the decision to defer/suspend redemptions needs to be made by each individual fund.
- Regulatory mapping of liquidity tools (summary of regulatory status):
  - Gates: yes.
  - Side pockets: yes (subject to prior approval).
  - Anti-dilution levy: yes.
  - Redemption fees: yes.
  - Redemption-in-kind: yes.
  - Suspensions of redemptions: yes.
  - Swing pricing: yes.
  - Short-term borrowings: yes.
  - Mandatory liquidity buffers: no.
  - Side letters: no.
  - Other measures: yes — FINMA may require other/additional liquidity management measures on a case-by-case basis.

### LIQUIDITY RISK MANAGEMENT, LEVERAGE, AND CUSTODY
- Liquidity risk management:
  - FINMA requires risk management, including of liquidity risk, both at the asset manager and individual fund levels.
  - FINMA has conducted several offsite inspections and 12 onsite inspections in 2018 at asset managers; some inspections included liquidity and other risk management in their scope.
  - Limitations: inspections may not capture sector-wide risks such as undue concentration; recommendation for industry-wide stress testing.
- Use of leverage:
  - Leverage limits vary by fund type:
    - Securities funds and real estate funds: overall exposure may not exceed 200 percent of the fund’s total net assets.
    - Other funds for traditional investments: limit of 225 percent.
    - Other funds for alternative investments: limit of 600 percent.
  - Collateral and pledging limits:
    - Securities funds may pledge or transfer ownership as collateral of up to 25 percent of the fund’s net assets.
    - Other funds for traditional investments: pledge/cede limit 60 percent of fund net assets.
    - Other funds for alternative investments: pledge/cede limit 100 percent of fund net assets.
  - Security financing activities must be included in the leverage calculation if collateral is reinvested and such reinvestment results in higher return over the risk-free interest rate.
  - May 2017 FINMA deep-dive: at end-March 2017, market value of securities lent amounted to just under CHF 25 billion, equivalent to 2.6 percent of the AuM.
- Custody and safe keeping:
  - Fund management companies and custodian banks can be related parties; they must be separate entities but can be related parties.
  - Safeguards to avoid conflicts of interest: separation of directors; external auditors assess compliance.
  - FINMA authorization required for every amendment within the custodian bank’s organization and changes within the Fund Management Company’s Board of Directors or Executive Committee.
  - Partial revision of CISA in 2013 implemented additional regulations on outsourcing of custody, requiring that financial instruments be transferred only to regulated custodians, etc.

### LIMITED QUALIFIED INVESTMENT FUNDS (L-QIFs)
- Proposed L-QIF characteristics:
  - Would be exempted from FINMA authorization and prudential supervision.
  - Could invest in diverse assets.
  - Would be managed by a Swiss fund management company licensed and supervised by FINMA.
  - Would be subject to the same statistical data reporting as any other Swiss funds.
- Risk considerations:
  - L-QIFs could bring higher risk to Swiss qualified investors, particularly institutional investors, and need careful monitoring.
  - Authorities should ensure L-QIFs are subject to appropriate statistical data reporting and proper risk management requirements, proportionate to their potentially higher risk-taking activities.

### SUPERVISION, REGULATORY ACTIONS, AND SANCTIONS
- Supervisory tools and activity:
  - FINMA supervisory tools: offsite monitoring, onsite inspection, supervisory audits, and since 2017 “offsite inspections” (desk reviews).
  - Offsite inspections: 12 desk reviews in 2017, and 9 in 2018.
  - With on- and offsite inspections, FINMA aims to cover about 10 percent of supervised entities each year.
  - Supervisory measures increased from about 100 in 2016 to over 250 in 2018.
- Number of Supervisory Measures (as presented in source):
  - 2016*: Number of supervisory measures 112; Supervisory reviews and deep dives 18; Recommendation with obligation 31; Restoration of compliance with the law 4; Intensive supervision 2; Escalation to Enforcement 5; Other measures (not categorized) 57.
  - 2017: Number of supervisory measures 237; Supervisory reviews and deep dives 24; Desk reviews 12; Supervisory meetings 33; Supervisory letters 48; Intervention in audit procedure 24; Supplementary audit 4; Recommendation with obligation 54; Restoration of compliance with the law 7; Intensive supervision 1; Escalation to Enforcement 2; Other measures (not categorized) 25.
  - 2018: Number of supervisory measures 255; Supervisory reviews and deep dives 23; Desk reviews 9; Supervisory meetings 32; Supervisory letters 77; Intervention in audit procedure 30; Supplementary audit 3; Recommendation with obligation 40; Restoration of compliance with the law 3; Intensive supervision 3; Escalation to Enforcement (blank in table); Other measures (not categorized) 33.
  - Note: FINMA *A consistent categorization of measures is available as from 2017.
- Auditors and investigating agents:
  - Auditors mandated by FINMA conduct supervisory audits of asset managers and funds.
  - Number of irregularities and recommendations identified by auditors was constant at about 700 per year between 2015 and 2018.
  - FINMA can appoint an investigating agent to address major regulatory breaches; during 2015–18 FINMA conducted one major enforcement proceeding in connection with an asset manager and appointed an investigating agent.
- Enforcement policy and limits:
  - FINMA adopted a revised enforcement policy in 2014 and started to publish a yearly enforcement report.
  - FINMA intensified enforcement actions, taking action against individuals responsible for serious violations and increasingly publicly discloses individual enforcement cases.
  - FINMA does not have the power to impose pecuniary administrative fines.
  - Extreme sanction: FINMA can revoke licenses of regulated entities, resulting in liquidation of regulated entities and associated funds.
  - FINMA can ban professionals from working in leading positions and is authorized to disgorge profits made through a serious violation.
  - For criminal violations, either Legal Services of the FDF or the Attorney General’s Office can impose criminal charges including fines.
  - Relevance: the absence of administrative fines means one of the strongest incentives for supervised entities to comply is missing; this tool will become more important as FINMA will supervise indirectly a large number of small independent asset managers from 2020.

### POLICY RECOMMENDATIONS AND KEY ACTIONS
- Identified recommendations with responsible authorities, timing, and priority:
  1. Increase the coverage and granularity of data reporting requirements (FINMA; paragraphs: 13–14).
     - Timing: ST
     - Priority: H
  2. Conduct industry-wide liquidity stress tests of the asset management and the fund industry (FINMA; SNB; paragraph:16).
     - Timing: MT
     - Priority: M
  3. Update FINMA’s IT system to improve its analytical capacity (FINMA; paragraphs:12 and 15).
     - Timing: MT
     - Priority: M
  4. Empower FINMA to impose administrative fines (FDF; paragraphs: 40–41).
     - Timing: MT
     - Priority: M
  5. Monitor concentration risk of regulated funds and prevent undue concentration (FINMA; paragraphs: 21–23).
     - Timing: ST
     - Priority: H
  6. Enhance international cooperation with foreign supervisors on internationally active asset managers (FINMA; paragraph: 8).
     - Timing: ST
     - Priority: H
  7. Subject limited qualified investment funds to intensive monitoring of the key risks (size, leverage) and proper risk management requirements through asset managers (FDF, FINMA; paragraph: 35).
     - Timing: MT
     - Priority: M
  8. Closely monitor the effectiveness of valuation safeguards to address potential conflict of interests within a banking group (FINMA; paragraphs: 26–27).
     - Timing: ST
     - Priority: M
- Timing legend reproduced from source:
  - C = Continuous; I = Immediate (within one year); ST = Short Term (within 1–2 years); MT = Medium Term (within 3–5 years)
- Priority legend:
  - H = High; M = Medium; L = Low

*Source: IMF staff summary of the "EXECUTIVE SUMMARY" chapter.*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### INTRODUCTION
- This note is a focused review of the effectiveness of the regulation and supervision of asset management activities and is part of the 2019 FSAP. The review draws on discussions in Switzerland from October 31 to November 14, 2018, and from January 23 to February 6, 2019.
- The review covers both regulated and unregulated entities and was prepared by Nobuyasu Sugimoto (IMF, Monetary and Capital Markets Department).
- Key legislative changes: revisions to the Financial Services Act (FinSA) and Financial Institution Act (FinIA) approved in June 2018, entering into force in January 2020. FinIA brings a multitude of small independent asset managers within the regulatory perimeter. FinSA sets out cross-sector rules for the offer and distribution of financial services and financial instruments, including funds.
- Analytical inputs: authorities’ questionnaire responses, self-assessment of 17 IOSCO Principles, limited legal/regulatory review, and discussions with authorities, self-regulatory bodies, and market participants.

### MARKET DEVELOPMENT
- Official reporting does not cover the entire asset management and fund industry in Switzerland due to definitional differences and lack of regulation for independent asset managers managing assets under discretionary mandates.
- Swiss funds and foreign funds distributed in Switzerland:
  - Total AuM: CHF 1,087 billion (160 percent of GDP) at end-2017.
  - Year-over-year increase: 17.7 percent.
- Assets managed under discretionary mandates (unregulated independent asset managers):
  - Estimated AuM: over CHF 900 billion (134 percent of GDP) in 2017.
  - Estimated growth: 12 percent annual growth (IFZ/AMP Asset Management Study, June 2018).
  - These managers will be supervised starting in 2020 under FinIA.
- Market drivers in 2017:
  - Equity funds grew mainly due to positive market performance.
  - Bond funds grew due to market appreciation and higher inflows.
  - Other funds experienced outflows and market depreciation (negligible impact on market size overall).
- Money Market Funds (MMFs):
  - Constant NAV per share MMFs (C-NAV MMFs) are not allowed in Switzerland, though Swiss asset managers manage some foreign domiciled C-NAV MMFs.
- Recent market stress and cross-border supervision:
  - In the second half of 2018, funds focusing on underperforming asset classes (emerging market bonds, commodities) suffered material outflows and required prompt liquidation of illiquid instruments (e.g., exotic derivatives).
  - A Switzerland-based large asset management group had to liquidate bond funds domiciled in Luxembourg, Ireland, and the Cayman Islands; the funds were managed by foreign asset managers in the U.K. and Ireland, limiting FINMA’s direct supervisory powers.
  - The experience underscores the importance of group supervision and cross-border cooperation.

### MAIN FINDINGS

#### A. Supervisory Resources and Capacity
- Staffing and allocation:
  - FINMA staff allocated to asset management and fund regulation and supervision: 55 Full Time Equivalent (FTE) at end-June 2018.
  - FINMA enforcement staff for the entire financial sector: 61 FTE at end-June 2018.
  - FINMA plans to increase resources to cope with indirect supervision of many small independent asset managers from 2020 via a new independent supervisory organization authorized by FINMA.
- Quality and organization:
  - Creation of a dedicated Asset Management (AM) Division (separated from the Market Division in 2014) improved supervisory quality and commitment.
  - Market participants reported positive views on FINMA staff quality and capability.
- Staff turnover:
  - High turnover in 2011 (overall over 14 percent; Market Division 21 percent) has improved; turnover has reduced to low levels over the last five years.
- IT systems and data granularity:
  - FINMA’s current IT system limits analytical capacity: reports are received largely in paper format; early warning and alert systems rely on annual data and quarterly SNB statistics that lack microprudential granularity.
  - FINMA is upgrading its internal IT system with a unified online platform (EHP) to allow online submissions and improved data interactions.
  - Data gaps and insufficient granularity impede quantitative and detailed analysis of risks (liquidity, maturity mismatches, leverage) at both firm and industry levels.
  - Increased data collection and IT capability are particularly important ahead of indirect supervision expansion in 2020.

#### B. Systemic Risk and Regulatory Perimeter
- Market size and systemic relevance:
  - Combined Swiss funds and foreign funds distributed in Switzerland: CHF 1,087 billion (160 percent of GDP) at end-2017.
  - Assets under discretionary mandates (not previously regulated): over CHF 900 billion (134 percent of GDP).
- Leverage and stability:
  - Leverage of Swiss regulated funds is low and stable since 2013, including alternative investment funds. FINMA monitors leverage via ad-hoc supervisory data collection and official statistics since 2018.
  - Leverage measurement: derivative positions converted to underlying assets using appropriate sensitivities; securities financing transactions considered when collateral reinvestment generates returns in excess of the risk-free rate. Value at Risk (VaR) methods allowed only upon FINMA approval and granted to few funds.
- Concentration risks:
  - Most Swiss funds face concentration limits (e.g., 10 percent per single entity), but higher concentration limits apply to counterparty credit risks via certain derivative transactions (e.g., total return swaps for index funds).
  - Concentration concerns include ETFs’ swap counterparties and group custodian bank exposures to ETFs, which may trigger runs when a group is under stress.
  - Recommendation: better monitoring of concentration risk to prevent undue concentration; concentration via ETFs’ swap counterparties warrants heightened supervision and potentially regulation.
- Liquidity risks:
  - FINMA’s semi-annual Risk Barometer identified increased liquidity risks in the asset management industry.
  - Publicly available data and large Swiss asset managers’ disclosures show some funds—particularly those focused on underperforming asset classes—suffered material outflows, notably in Q4 2018.
  - Idiosyncratic risk management at asset managers does not capture sector-wide risks such as undue concentration; industry-wide liquidity stress testing is necessary.

#### C. Selected Regulatory and Supervisory Issues
- Supervisory cooperation:
  - FINMA should continue enhancing cooperation with foreign supervisors to effectively monitor and supervise internationally active asset managers; FINMA’s decision to expand supervisory scope beyond regulated entities is welcome.
- Enforcement powers:
  - FINMA lacks the power to impose administrative fines. Current powers include seizing profits from serious regulatory violations and revoking licenses.
  - The inability to impose administrative fines could pose challenges, especially when supervising many small independent asset managers from 2020.
  - Within current legal constraints, FINMA should use existing enforcement tools more actively and comprehensively disclose individual enforcement actions and license revocations.
- Valuation safeguards:
  - Close monitoring of the effectiveness of valuation safeguards is required to address potential conflicts of interest within banking groups.

### POLICY RECOMMENDATIONS AND KEY ACTIONS (Table 1)
- The following recommendations were identified with responsible authorities, timing, and priority:

1. Increase the coverage and granularity of data reporting requirements (FINMA; paragraphs: 13–14).
   - Timing: ST
   - Priority: H

2. Conduct industry-wide liquidity stress tests of the asset management and the fund industry (FINMA; SNB; paragraph:16).
   - Timing: MT
   - Priority: M

3. Update FINMA’s IT system to improve its analytical capacity (FINMA; paragraphs:12 and 15).
   - Timing: MT
   - Priority: M

4. Empower FINMA to impose administrative fines (FDF; paragraphs: 40–41).
   - Timing: MT
   - Priority: M

5. Monitor concentration risk of regulated funds and prevent undue concentration (FINMA; paragraphs: 21–23).
   - Timing: ST
   - Priority: H

6. Enhance international cooperation with foreign supervisors on internationally active asset managers (FINMA; paragraph: 8).
   - Timing: ST
   - Priority: H

7. Subject limited qualified investment funds to intensive monitoring of the key risks (size, leverage) and proper risk management requirements through asset managers (FDF, FINMA; paragraph: 35).
   - Timing: MT
   - Priority: M

8. Closely monitor the effectiveness of valuation safeguards to address potential conflict of interests within a banking group (FINMA; paragraphs: 26–27).
   - Timing: ST
   - Priority: M

- Timing legend reproduced from source:
  - C = Continuous; I = Immediate (within one year); ST = Short Term (within 1–2 years); MT = Medium Term (within 3–5 years)
- Priority legend:
  - H = High; M = Medium; L = Low

*Source: IMF staff summary of the "EXECUTIVE SUMMARY" chapter.*

### 13.   Particularly, the authorities are suffering from a lack of granularity in important data

### 13.   Particularly, the authorities are suffering from a lack of granularity in important data

### Data gaps and reporting coverage
- SNB collects quarterly data from domestic regulated asset managers and funds on behalf of FINMA, but the data "is not granular enough" to analyze risks notably on credit (such as investment by credit ratings) and liquidity (such as investors’ profile—wholesale or retail investors, and other information about liabilities).
- Reporting does not cover foreign funds managed by Swiss regulated entities or distributed to Swiss investors.
- FINMA collects annually industry-wide information on asset management activities.
- Small independent asset managers (totaling an estimated AuM of up to CHF 500 billion) are unregulated until 2020 and thus their investment activities are not subject to any reporting requirement.
- FINMA occasionally closes data gaps by collecting and analyzing information on an individual entity basis.

### Recommendations on reporting and supervisory data
- Reporting requirements for the asset management and fund industry should be enhanced:
  - Revise the template to enable analysis of trends of key risk characteristics (such as credit risk taking, maturity and liquidity mismatches) more precisely.
  - Expand coverage to other relevant players, including domestic asset managers managing foreign funds under the de-minimis threshold and foreign funds distributing to Swiss investors, in close cooperation with relevant foreign supervisors as necessary.
- FINMA should continue to improve its IT system and further enhance analytical capacity:
  - Current IT system is in the process of being upgraded but "there is still room for improvement".
  - From 2020, a significant number of independent asset managers will come under FINMA’s indirect supervision, warranting a material upgrade of the IT system.
  - FINMA is recommended to allocate sufficient budget resources to its IT system and enhance the analytical capability of supervisors of the asset management and fund industry.

### Stress testing
- Authorities should conduct industry-wide liquidity stress tests of the asset management and fund industry:
  - Simple industry-wide stress tests would help identify the most critical data gaps and concrete features of the IT system more clearly.
  - Once granular reporting information with upgraded IT system become available, authorities could conduct more sophisticated industry-wide stress tests without undue additional cost.
  - In the medium term, this would help identify and address risks in a forward-looking manner without material market impact.

### Systemic risk monitoring and regulatory perimeter
- FINMA performs a semi-annual assessment of major macroeconomic capital market and structural risks (the “risk barometer”) to highlight key macro-financial risks and operational consequences for supervisory activities; assessments and possible supervisory measures are reported to FINMA’s Executive Board and shared internally; FINMA provides its systemic risk assessment to the SNB for its annual Financial Stability Report.
- The early 2018 risk barometer highlighted a potential risk of liquidity pressure in the asset management and fund industry that began in niche products and a small number of funds and became more wide-spread later in 2018, prompting intensified supervision of liquidity management and needs.
- Authorities adjust the regulatory perimeter when necessary:
  - Independent asset managers were not subject to prudential regulation and supervision; in June 2018, Parliament approved revisions of the FinIA and FinSA, which will enter into force in January 2020.
  - FinIA includes licensing requirements and other prudential requirements (e.g., risk management, internal control, minimum capital and own funds) for independent asset managers.
  - Implementation of the two acts will create uniform conditions for financial intermediaries and improve consumer protection.
- Authorities participate in FSB shadow banking work:
  - An inter-agency shadow banking analysis group involves SIF, FINMA, and the SNB to monitor non-bank financial intermediation and improve statistics, gather ad-hoc data, exchange information, and discuss analysis summaries (such as heat maps).
  - A case study on the Swiss non-banking sector was provided to the FSB in 2014 and published as part of the “Global Shadow Banking Monitoring Report” in October 2014.

### Concentration limits and counterparty concentration risk
- Standard concentration restrictions for funds:
  - Securities funds and other funds for traditional investments: may invest no more than a 10 percent in a single entity, and the total value of securities in which more than 5 percent of the fund’s assets are invested may not exceed 40 percent of the fund’s assets.
  - Real estate funds: required to invest in more than ten properties and the market value of a single property may not exceed 25 percent of the fund’s assets.
  - An overall limit (20 percent of the total NAV) across different instruments applies to exposures of all entities within the same group in accordance with international accounting standards.
  - Certain limits (such as 20 percent of the total NAV) apply to the collateral of a single issuer.
  - Alternative investments are not subject to those concentration restrictions.
- Limits may not be effective for counterparty credit risk:
  - Swiss funds actively use OTC derivatives for hedging; similar concentration limits apply to OTC derivatives’ counterparty exposures but are relaxed for certain products (such as index funds) and apply to total NAV rather than total OTC derivatives’ counterparty exposures, so limits may not effectively require funds to diversify counterparties.
- Recommendation:
  - FINMA should monitor concentration risk of regulated funds and prevent undue concentration, particularly where funds managed by a banking group may have significant concentration to their parent bank, creating run, reputation, and contagion risks if the parent bank faces financial stress.
  - Sample analysis suggests some funds and ETFs managed by banking groups tend to have material concentration risk through derivatives; while current size of such exposures (after netting against collateral) may not be significant enough to pose systemic risk, they may create run risks and material conflicts of interest in market turmoil.

### Box: Application of OTC Derivative Reforms to the Asset Management and Fund Industry
- Background:
  - In March 2015, BCBS and IOSCO finalized margin requirements for non-centrally cleared derivatives as part of the G20 reform program initiated in 2009.
  - G20 reform elements agreed in 2009 included: (i) trade standardized OTC derivatives on exchanges/electronic platforms where appropriate; (ii) clear standardized OTC derivatives through central counterparties; (iii) report OTC derivatives to trade repositories; (iv) subject non-centrally cleared derivatives to higher capital requirements; in 2011, the G20 added margin requirements on non-centrally cleared derivatives.
- Swiss implementation:
  - Since 2015, Switzerland enacted the Financial Market Infrastructure Act (FMIA) and the Financial Market Infrastructure Ordinance (FMIO) to implement OTC derivatives reforms.
  - Margin requirements, including initial margin (IM) and variation margin (VM), became effective in January 2016 with transition periods as laid out in BCBS and IOSCO margin requirements.
  - FMIA and FMIO determine conditions and compliance dates for counterparties regarding IM and VM; admissible collateral for IM and VM are specified by FMIO (cash deposits, government securities, etc.).
- Intra-group exemptions:
  - International standards allow discretion on intra-group exemptions; FMIA grants exemption from margin requirements for certain intra-group OTC derivatives transactions that meet four conditions: (i) two counterparties included in same full consolidation basis; (ii) counterparties subject to appropriate centralized risk evaluation, measurement and control procedures; (iii) no legal or factual impediments to the prompt transfer of own funds or repayment of liabilities; (iv) transactions do not aim to circumvent duty to exchange collateral.
  - Asset managers and funds generally do not qualify for the intra-group exemption and are therefore subject to IM and VM requirements; even asset manager and funds within a banking group are not recognized as “intra-group transactions” and thus not eligible for the exemption.
  - Small funds may qualify for an exemption if under applicable thresholds, but large funds with material derivative exposures (such as synthetic ETFs) are subject to IM and VM requirements.
- Effects:
  - IM and VM requirements mitigate group concentration risk to some extent: collateral eligible for IM and VM are limited to cash, high quality bonds, covered bonds, shares of a major index, gold, MMFs, etc.; collateral with wrong way risk (such as bonds issued by a parent bank or its competitors) are not allowed.

### Valuation of assets and valuation safeguards
- NAV valuation rules:
  - NAV of all open-ended Swiss CISs is calculated at market value on each day units are issued or redeemed.
  - Investments listed on a stock exchange or another regulated market open to the public are valued at the price paid on the main market.
  - Other investments with no current price must be valued at the price that would probably be obtained in a diligent sale at the time of valuation.
  - SFAMA has established guidelines recognized as minimum standards by FINMA.
  - For real estate funds, the fund manager needs to appoint at least two natural persons or one legal person as independent valuation experts, subject to FINMA approval; valuation experts must conduct valuation with the due diligence and expertise required of a valuation expert.
  - Thematic reviews addressed valuation processes and independence for real estate funds, including implementation of changes in valuations of buildings under construction.
- Responsibilities and safeguards:
  - Fund management companies, custodian banks, and auditors must ensure fair and reliable valuations: fund managers ensure transparent financial statements; custodian banks verify calculation of NAV and issue/redemption prices; an audit firm examines funds’ annual accounts.
  - FINMA should closely monitor effectiveness of valuation safeguards to address potential conflicts of interest within a banking group, since asset managers within banking groups often use group custodian banks and funds may have material derivative positions on parent banks; significant derivatives may be categorized as either level 2 or level 3, making valuation not readily available in the market and more difficult in stressed markets.
  - Current regulation imposes safeguards such as separation of management between asset managers and custodian banks, but growth of asset management revenue in large banks raises risk these safeguards may not work as intended.
- Reporting of valuation errors:
  - Significant valuation errors must be reported immediately to FINMA.
  - To address a 2014 FSAP recommendation, limits for assessing the significance of valuation errors were reduced by about half in the SFAMA guidelines, which came into force in July 2016.
  - FINMA conducted several onsite visits at most fund managers and custodian banks focusing on risk management and internal controls on valuation and errors.

### Managing redemption risks and liquidity tools
- FINMA approval and redemption frequency:
  - FINMA approval is required on redemption terms; FINMA requires adequate redemption terms based on specific investment strategy and underlying investments.
  - FINMA approves securities funds only with daily redemption; weekly or monthly redemption is possible for other funds for traditional or alternative investments.
  - Investors in real estate funds may request redemption at the end of each financial year with twelve months’ prior notice, although many real estate funds are tradable on a secondary market.
- Tools available to fund managers to address redemption shocks (as listed in the source):
  - Gates
  - Side pockets
  - Anti-dilution levy
  - Redemption fees
  - Redemption in-kind
  - Suspension of redemptions
  - Swing pricing
  - Short-term borrowings
- FINMA powers and limits:
  - In exceptional cases, FINMA may require asset managers to limit deferral of a redemption in the interest of all investors and coordinate measures with relevant foreign supervisory authorities.
  - FINMA does not have the power to impose on an individual asset manager or the entire industry to defer/suspend redemptions: the decision to defer/suspend redemptions needs to be made by each individual fund.

### Liquidity risk management tools (regulatory mapping)
- Overview of tools and their regulatory status in Switzerland (as reported):
  - Gates: yes — Redemption gates in Swiss CIS have been approved by FINMA following an "e maiore minus" approach based on Article 81 of Collective Investment Scheme Act (CISA); explicit provision in CISO regarding redemption gates might be introduced in 2020.
  - Side pockets: yes — FINMA news publication on January 23, 2009 informed side pockets for Swiss Funds of Hedge Funds were admissible, subject to prior approval of FINMA and guidance on requirements.
  - Anti-dilution levy: yes — Article 38 paragraph 1 of CISO states investors may be charged all-in incidental costs incurred by issue, redemption or conversion of units.
  - Redemption fees: yes — Article 80 of CISA and Article 38 of CISO set out rules on redemption prices including fees or commissions.
  - Redemption-in-kind: yes — Pursuant to Article 78 paragraph 4 of CISA, FINMA may allow derogation from duty to make payments in and out of the fund in cash.
  - Suspensions of redemptions: yes — Article 81 of CISA in conjunction with Article 110 CISO set out rules for deferment of repayment of units.
  - Swing pricing: yes — Based on Article 83 paragraph 3 of CISA the Swiss Federal Banking Commission (SFBC) in 2007 permitted the application of Swing Pricing (SFBC Annual Report 2007, p. 53).
  - Short-term borrowings: yes — Provisions per fund type regarding borrowing set out across CISA and CISO articles for securities funds, real estate funds, other funds for traditional investments, and other funds for alternative investments.
  - Mandatory liquidity buffers: no — n/a.
  - Side letters: no — n/a.
  - Other tools/measures: yes — In the approval process of Swiss CIS, FINMA may require on a case-by-case basis other/additional liquidity management measures (adequate redemption frequency, notice period, limiting illiquid assets, holding sufficient liquid assets etc.), taking into consideration suitable fund type, eligible investors and investment strategy.
- Source for the table: FINMA.

*Source: 1cheea2019008 - 13.   Particularly, the authorities are suffering from a lack of granularity in important data (PDF chapter).*

### 30.   FINMA requires risk management, including of liquidity risk, both at the asset

### 30.   FINMA requires risk management, including of liquidity risk, both at the asset

### Liquidity risk management
- FINMA requires risk management, including of liquidity risk, both at the asset manager and individual fund levels.
- During the approval process of Swiss CISs, FINMA ensures necessary liquidity management measures are in place (examples listed in source): adequate redemption frequency, notice period, limiting illiquid assets, holding sufficient liquid assets, borrowing, redemption in kind, redemption gates, deferred payment, side pockets.
- FINMA has conducted several offsite inspections of asset managers focusing on liquidity risk management and is following up industry practices closely.
- FINMA conducted 12 onsite inspections in 2018 at asset managers; some inspections included liquidity and other risk management in their scope.
- Limitations: such inspections may not capture sector-wide risks, such as undue concentration in specific segments, sectors, or entities.
- Recommendation: industry-wide stress testing would help the authorities capture those risks quantitatively.

### Use of leverage
- Leverage limits vary by fund type:
  - For securities funds and real estate funds, overall exposure may not exceed 200 percent of the fund’s total net assets, including exposure associated with derivative financial instruments.
  - Other funds for traditional investments: limit of 225 percent.
  - Other funds for alternative investments: limit of 600 percent.
- Provisions on loans or guarantees are generally prohibited; securities lending is subject to limitations.
- Collateral and pledging limits:
  - Securities funds may pledge or transfer ownership as collateral of up to 25 percent of the fund’s net assets.
  - Provisions of loans or guarantees are prohibited for securities funds.
  - Other funds for traditional investments may pledge or cede as collateral no more than 60 percent of fund net assets.
  - Other funds for alternative investments may pledge or cede as collateral no more than 100 percent of fund net assets.
- Security financing activities must be included in the leverage calculation if collateral is reinvested and such reinvestment results in higher return over the risk-free interest rate.
- An ordinance specifies minimum criteria of eligible collateral and management of collateral (such as diversification).
- FINMA requires collateral value to amount to at least 100 percent of the market value of the loaned securities at all times.
- May 2017 FINMA deep-dive on securities lending:
  - At end-March 2017, market value of securities lent amounted to just under CHF 25 billion, equivalent to 2.6 percent of the AuM.
  - Exercise revealed differences in materiality of securities lending, collateral agreements, and risk management; FINMA followed up to improve firms’ risk management.

### Custody and safe keeping
- Fund management companies and custodian banks can be related parties; fund management company and custodian must be separate entities but can be related parties.
- Safeguards to avoid conflicts of interest: separation of directors; external auditors assess compliance with these requirements.
- FINMA authorization required for:
  - Every amendment within the custodian bank’s organization.
  - Any changes within the Fund Management Company’s Board of Directors or Executive Committee.
- Partial revision of CISA in 2013 implemented additional regulations on outsourcing of custody, requiring that financial instruments be transferred only to regulated custodians, etc.

### Limited Qualified Investment Funds (L-QIFs)
- Government working on a proposal to amend the CISA introducing a new fund category (L-QIFs) available only to qualified investors.
- L-QIFs characteristics from source:
  - Would be exempted from FINMA authorization and prudential supervision.
  - Could invest in diverse assets.
  - Would be managed by a Swiss fund management company licensed and supervised by FINMA.
  - Would be subject to the same statistical data reporting as any other Swiss funds.
- L-QIF set-up follows the Alternative Investment Fund Managers Directive and similar products such as the reserved alternative investment fund from Luxembourg.
- Risk considerations:
  - L-QIFs could bring higher risk to Swiss qualified investors, particularly institutional investors, and need careful monitoring.
  - Authorities should ensure L-QIFs are subject to appropriate statistical data reporting and proper risk management requirements, proportionate to their potentially higher risk-taking activities.

### Supervision, regulatory actions, and sanctions
- FINMA supervisory tools: offsite monitoring, onsite inspection, supervisory audits, and since 2017 “offsite inspections” (desk reviews).
- Offsite inspections:
  - 12 desk reviews in 2017, and 9 in 2018.
  - Topics covered include outsourcing, pricing errors, securities lending, and collateral management.
- Coverage goal: With on- and offsite inspections, FINMA aims to cover about 10 percent of supervised entities each year.
- Supervisory measures increased substantially from about 100 in 2016 to over 250 in 2018.
- Table 4: Number of Supervisory Measures (as presented in source)
  - 2016*: Number of supervisory measures 112; Supervisory reviews and deep dives 18; Recommendation with obligation 31; Restoration of compliance with the law 4; Intensive supervision 2; Escalation to Enforcement 5; Other measures (not categorized) 57.
  - 2017: Number of supervisory measures 237; Supervisory reviews and deep dives 24; Desk reviews 12; Supervisory meetings 33; Supervisory letters 48; Intervention in audit procedure 24; Supplementary audit 4; Recommendation with obligation 54; Restoration of compliance with the law 7; Intensive supervision 1; Escalation to Enforcement 2; Other measures (not categorized) 25.
  - 2018: Number of supervisory measures 255; Supervisory reviews and deep dives 23; Desk reviews 9; Supervisory meetings 32; Supervisory letters 77; Intervention in audit procedure 30; Supplementary audit 3; Recommendation with obligation 40; Restoration of compliance with the law 3; Intensive supervision 3; Escalation to Enforcement (blank in table); Other measures (not categorized) 33.
  - Source note: FINMA *A consistent categorization of measures is available as from 2017.
- Onsite inspections increased significantly over the last four years; majority focused on particular cases and themes (examples: risk management, real estate funds, valuation, mortgage funds, outsourcing to foreign groups, custody control, market conduct).
- Auditors and investigating agents:
  - Auditors mandated by FINMA conduct supervisory audits of asset managers and funds.
  - Number of irregularities and recommendations identified by auditors was constant at about 700 per year between 2015 and 2018.
  - FINMA can appoint an investigating agent to address major regulatory breaches; during 2015–18 FINMA conducted one major enforcement proceeding in connection with an asset manager and appointed an investigating agent.
  - FINMA concluded the asset manager had severely violated duty of loyalty and due diligence, violating requirement of proper business conduct.
- Enforcement policy:
  - FINMA adopted a revised enforcement policy in 2014 and started to publish a yearly enforcement report.
  - FINMA intensified enforcement actions, taking action against individuals responsible for serious violations.
  - FINMA established a database to assess compliance with proper business conduct requirements.
  - Increasingly, FINMA publicly discloses individual enforcement cases (“naming and shaming”).
- Enforcement limitations:
  - FINMA does not have the power to impose pecuniary administrative fines.
  - Extreme sanction: FINMA can revoke licenses of regulated entities, which results in liquidation of regulated entities and associated funds (not recognized as a very useable enforcement tool).
  - FINMA can ban professionals from working in leading positions in the Swiss financial market.
  - FINMA is authorized to disgorge profits made through a serious violation and has used this power.
  - For criminal violations, either Legal Services of the FDF or the Attorney General’s Office can impose criminal charges including fines.
  - FINMA cannot impose administrative fines on supervised entities; this means one of the strongest incentives for supervised entities to comply with regulations is missing.
  - Relevance: This tool will become more important in asset management supervision as FINMA will supervise indirectly (through the two mandated industry organizations) a large number of small independent asset managers from 2020.

### Policy recommendations and suggested actions
- Conduct industry-wide stress testing to capture sector-wide liquidity and concentration risks quantitatively.
- Ensure L-QIFs are subject to appropriate statistical data reporting and proper risk management requirements proportionate to their potentially higher risk-taking activities.
- Equip FINMA with more comprehensive enforcement powers, including the power to impose administrative fines.
- Within current legal constraints, FINMA should:
  - Increase resources of the enforcement division.
  - Enhance further enforcement actions, including through more comprehensive disclosure of individual enforcement cases.

*Source: IMF staff summary of FINMA and Swiss CIS supervision (extracted from provided content).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1cheea2019008.pdf_