Switzerland: What U.S. And Other Non-Swiss Portfolio Managers Need To Know About Managing Assets Of Swiss Occupational Benefit Plans

Last Updated: 7 November 2016
Article by Stephanie Comtesse

Most Read Contributor in Switzerland, August 2017

Swiss occupational benefit plans – a pillar of the Swiss social security system – are increasingly outsourcing portfolio management responsibilities to investment professionals, including "foreign" (i.e., non-Swiss) managers, in response to the growing complexity of investment management.

This article provides an overview of Swiss occupational benefit plans; how management of these plans by foreign service providers fits within existing and proposed Swiss legislation; and additional legal considerations caused by the outsourcing of these responsibilities.

For coverage of additional Swiss regulations, see "New Swiss Regulations Require Appointment of Local Agents and Increased Disclosure in Hedge Fund Documents" (May 14, 2015); "Swiss Hedge Fund Marketing Regulations, BEA Forms and Form ADV Updates" (Mar. 5, 2015); and "The Changing Face of Alternative Asset Management in Switzerland" (Feb. 2, 2012). For analysis of similar outsourcing by U.S. pension plans, see our three-part series entitled "Understanding U.S. Public Pension Plan Delegation of Investment Decision-Making to Internal and External Investment Managers": Part One (Jan. 23, 2014); Part Two (Feb. 6, 2014); and Part Three (Feb. 21, 2014).

The Swiss Three-Pillar Social Security System

The Swiss social security system is based on three insurance levels known as the three "pillars." The first pillar – "old age and survivor's insurance" – is intended to ensure a basic minimum income for retirees or survivors (such as widows, widowers and orphans), as well as "invalidity insurance" covering the basic needs of disabled persons. The second pillar is

 known as "occupational benefit plans" and is described in detail below. The third pillar consists of private savings, mainly for retirement purposes, through tax incentives meant to encourage people to effectively save and maintain funds for their retirement because such savings are not compulsory.

The second pillar is intended, together with the payments from the first pillar, to enable elderly persons, survivors and disabled people to maintain their previous standards of living in an appropriate manner. Given the significant amount of assets held by these occupational benefit plans and their important role in the Swiss social security system, they are increasingly the focus of the investment management community and the subject of the further considerations below.

Background Information About Occupational Benefit Plans (Second Pillar)

Contributions

Virtually all employed workers must be insured within an occupational benefit plan established by their employer or with which their employer is affiliated. Self-employed workers are not, in principle, subject to this compulsory coverage but may join such a plan on a voluntary basis.

All employed workers must contribute a percentage of their salaries to their occupational benefit plans as determined by law. The employer must match the contributions of the employees into their benefit plan, effectively doubling the relevant amount saved.

The official retirement age in Switzerland is currently 65 for men and 64 for women. In some instances, the accrued monies of the employees can be partially or entirely paid out prior to the official retirement age. As a rule, however, the funds stay in the plan for a period of approximately 40 years.

According to the latest official reports, at the end of 2014, the total assets under management of Swiss occupational benefit plans (i.e., the second pillar alone) amounted to a substantial amount of approximately CHF 780 billion.

Compulsory Interest Payments on the Savings

The occupational benefit plans are obliged by law to pay interest on the employee's accounts. The minimum interest rate is determined at least every two years by the Swiss Federal Council, taking into account the yield of common investments in the market such as, in particular, Swiss government bonds, ordinary bonds, stocks and real estate.

The minimum interest rate in the year 2000 was still at 4%. For 2016, in view of the current market conditions, it has been set at only 1.25%.

Management of Plan Assets

One of the core principles of the Swiss occupational benefit plan legislation is that the management of the plan is entrusted to a body including, in equal numbers, representatives of the employer and of the employees. By establishing this system, the legislator intended to ensure that, in particular, employee representatives were empowered to actively participate in all of the most important decisions pertaining to the plans in which their retirement funds were held.

This has proven to be difficult for employee and employer representatives from all sectors of the Swiss industry in light of the ever-growing complexity of investment management and the fact that many representatives have limited knowledge of financial matters. Furthermore, recent scandals linked to the management of occupational benefit plans' assets have raised awareness of the necessity of ensuring that these assets are handled in a sophisticated manner.

Outsourcing and the Increased Role of Foreign Portfolio Managers

As a result of the complexity of managing plans and the increased scrutiny they have garnered, it is now common in the Swiss industry for representatives of these plans to outsource their asset management responsibilities. Over the past months, the number of foreign service providers seeking to manage assets of Swiss occupational benefit plans has been increasing.

The legislation of Swiss occupational benefit plans – described in more detail below – has been under almost constant revision for the last few years, but it still contains few provisions specifically addressing cross-border management. The following provides basic information on the rules applicable to internal and external managers, as well as consideration of some particular issues that arise when the portfolio manager is a foreign entity.

Existing Legislation

Swiss occupational benefit plans are generally subject to the Swiss Occupational Retirement, Survivors' and Disability Pension Plans Act dated June 25, 1982 (BVG) and its three implementing ordinances:

  1. the Supervision of Occupational plans Ordinance, dated June 10, 2011;
  2. the Occupational Retirement, Survivors' and Disability Pension Plans Ordinance, dated April 18, 1984 (BVV2); and
  3. the Ordinance on Investment Foundations, dated June 10 and 22, 2011 (ASV).

Legal Structure and Supervision

An occupational benefit plan must be established either as (1) a foundation or (2) a public law establishment with legal personality. Since the investment foundations and the public law establishments ultimately serve the same purpose, they are, to a large extent, subject to the same rules.

Each Swiss canton designates a cantonal supervisory authority with which all occupational benefit plans regardless of their legal form must register. These cantonal authorities are, in turn, subject to supervision by the federal High Supervision Authority (OAK).

General Eligibility of Portfolio Managers

According to Article 51b of BVG, all persons and establishments entrusted with portfolio management responsibility must be reputable and provide assurance of irreproachable activity. They are subject to a fiduciary duty of care and must act in the best interest of the plan and its beneficiaries when performing their duties. Conflicts of interest – both on a professional and on a personal level – are to be avoided.

Business conduct rules in line with recent international developments were enacted in Art. 48h to 48l BVV2 in 2011. In particular, they pertain to transactions with related parties, principal transactions, the surrendering of pecuniary benefits and disclosure.

External Portfolio Managers

Specific provisions concretely addressing which (Swiss or foreign) external entities can be entrusted with the portfolio management of occupational benefit plans were first introduced on January 1, 2014. Further to the Swiss regulated entities listed in the new paragraph 4 of Article 48f of BVV2, "foreign financial intermediaries" are mentioned explicitly for the first time.

The relevant section was originally intended to ensure that delegation to a foreign manager was only possible if that manager was subject to equivalent supervision abroad. However, in finalizing the wording, the equivalency requirement was deleted because no procedure to establish "equivalency" had been foreseen.

Article 48f, paragraph 7 of BVV2 provides that the OAK is to issue further guidance on the specific requirements for the eligibility of foreign portfolio managers. Until now, only an OAK guideline applicable to all external portfolio managers has been published. It foresees that not only unregulated Swiss managers – but also unregulated foreign managers – can apply for approval by the OAK.

As of the date of this article, the publicly available list of unregulated managers which have been approved by the OAK does not include any foreign entities. This is not surprising because prudential supervision is usually required in the foreign manager's country to provide portfolio management services there.

Anticipated Changes Under the Draft Financial Institutions Act

Based on the above, any foreign regulated entity fulfilling the conditions of Article 51b of BVG can, in principle, be appointed to manage the portfolios of Swiss occupational benefit plans. However, this is to change under the draft Financial Institutions Act (FinIA) legislation, which is currently being debated in parliament and expected to be enacted in 2018.

The draft FinIA provides a list of amendments to be made to numerous Swiss laws as a result of its enactment. No amendments to the BVG are foreseen at this stage even though the currently applicable rules will no longer be compatible with FinIA. This is because the FinIA provision which sets out the supervisory requirements for foreign portfolio managers of Swiss occupation benefit plans – as discussed below – is in an implementing ordinance (Article 48f of BVV2) rather than the BVG. Such provisions are to be amended by the Swiss Federal Council, rather than by parliament. The implementing ordinance can only be adapted once the FinIA is finalized.

Eligibility of Swiss Portfolio Managers

The current draft of FinIA provides for stricter requirements to manage portfolios of Swiss occupational benefit plans, including requiring Swiss managers to obtain a collective investment asset manager license from the Swiss Financial Markets Authority (FINMA).

This license will enable its holders to manage assets of:

  1. occupational benefit plans; and
  2. collective investment schemes.

Currently, such a license is only required to manage the assets of the latter. The requirements to be fulfilled are based to a large extent on those applicable to portfolio managers of alternative investment funds under the E.U.'s Alternative Investment Fund Managers Directive.

Once licensed, external portfolio managers of Swiss occupational benefit plans will be subject to the prudential supervision of FINMA. However, the occupational benefit plans themselves will remain under the supervision of the cantonal supervisory authorities.

Eligibility of Foreign Managers

Proposed FinIA legislation does not specifically address the eligibility of foreign managers to make investment decisions for Swiss occupational benefit plans or collective investment schemes as of this date. Nevertheless, it appears reasonable to assume that, as is currently required under Article 18b, paragraph 3 of the Swiss Collective Investment Scheme Act, delegation of the portfolio management of occupational benefit plans to a foreign entity will still only be possible if such entity is subject to the supervision of a "recognized" foreign authority.

Applicability of De Minimis Exemption to Foreign Managers

Article 20, paragraph 2b of FinIA includes a de minimis exemption which provides a lighter regulatory regime for Swiss external portfolio managers of occupational benefit plans that do not exceed total assets under management (AUM) of CHF 100 million or 20% of the AUM of one occupational benefit plan. It is unclear whether this de minimis exemption will also be extended to foreign portfolio managers of Swiss occupational benefit plans.

Swiss Managers of Foreign Occupational Benefit Plans

If foreign legislation requires prudential supervision of Swiss portfolio managers in order for them to be able to manage foreign occupational benefit plans, Article 20, paragraph 3 of FinIA permits Swiss portfolio managers to apply for a FINMA collective asset manager license even if they fall under the de minimis rule. This provision is intended to ensure that small Swiss portfolio managers are not excluded from managing the assets of a foreign occupational benefit plan.

Recurring Practical Issues for Foreign Portfolio Managers

The following practical issues are encountered on a regular basis in negotiations between the plans and foreign managers.

Representations Regarding Compliance With Swiss Law

When management of a Swiss occupational benefit plan's portfolio is delegated to a third party, the plan will usually expect to receive contractual representations pertaining to compliance with its investment guidelines, all Swiss laws and other rules applicable to this activity. This is common practice and part of exercising an appropriate level of care on behalf of the relevant occupational benefit plan.

From the foreign portfolio managers' perspective, however, there are often concerns that, despite making all required efforts, they may potentially not be aware of absolutely all such Swiss rules. Therefore, they will wish to limit the scope of these representations.

As a result of these different perspectives, the negotiation process can be lengthy. It often results in detailed wording pertaining to the obligations of the portfolio manager being included in the agreement to ensure the parties agree and are aware of what is most important.

Investment Restrictions

Various investment limitations foreseen in BVV2 and in ASV are formulated as percentages of the aggregate AUM of the relevant occupational benefit plan. In certain instances, these limitations linked to AUM find their way into the investment guidelines to be observed by the portfolio manager.

However, external managers are usually entrusted with the management of only a portion of the total AUM in order to diversify risks and take advantage of various specialized investment expertise. Investment instructions and restrictions expressed only as a portion of the total AUM cannot be complied with by a manager lacking complete oversight and control of all the relevant assets.

Additionally, it is important to ensure in the relevant agreement – and particularly in the relevant investment guidelines – that the responsibility for respecting the applicable investment limitations regarding the overall portfolio remains with the principal. Mechanisms ensuring that the external manager is practically in a position to monitor any applicable investment limits must be put into place where necessary.

Liability for Delegated Portfolio Management

Liability of the Principal

The ultimate responsibility for the management and administration of occupational benefit plans structured as private law foundations lies with their boards of trustees. Boards of trustees cannot delegate essential tasks such as setting the goals and principles governing the portfolio management. The issuance of the investment guidelines also remains exclusively within its scope of responsibility. Only the implementation of the investment guidelines can validly be delegated to the portfolio manager.

Some legal authors support the view that, unless the foundation's establishment deed explicitly allows a delegation, the board of trustees remains responsible for "each investment decision" – and compliance with all the applicable investment rules – irrespective of a delegation. This approach is supported by the draft FinIA. However, this is contrary to the predominant industry view that a board of trustee's responsibility is limited to proper care in choosing, instructing and supervising the portfolio manager.

Liability of the Foreign Portfolio Manager

From a liability perspective, it is clear that the foreign portfolio manager is bound by the terms of the private law agreement with the occupational benefit plan and can be, like in any contractual relationship, held liable in case of breach. This is why, as noted above, it is of particular importance for the agreement to clearly set out which Swiss law concepts and special rules need to be considered.

A different question often raised by foreign managers is whether a third party – such as an ultimate beneficiary – could file a claim for damages directly against them based on a violation of the investment rules in the BVG and its implementing ordinances. This would only be possible, if, in particular, the relevant BVG rules were directly applicable to the foreign portfolio manager. There are no precedents and very little industry literature addressing this issue. Accordingly, although there is no obvious legal basis for direct applicability of the BVG to foreign external portfolio managers, the possibility cannot be entirely discounted at this time.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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