«Working Paper Nr. 39 Februar 2005 THE REGULATORY BURDEN IN THE SWISS WEALTH MANAGEMENT INDUSTRY _ Christian Buehrer Institut für schweizerisches ...»
In Switzerland, 2’000 to 2’500 Independent Asset Managers (IAM) function as financial intermediaries between private clients and banks; they operate with an average headcount of approximately 4. IAMs are subject to the Swiss code of obligations (CO), but they are not subject to prudential regulation. Authorisation is non-obligatory for IAMs to carry out their business. Neither the banking secrecy rules nor the broadly similar professional secrecy rules for SDs apply to IAMs. All IAMs are regulated through the Federal Act on the Prevention of Money Laundering in the Financial Sector (MLA). They are supervised either by intermediaries’ recognised self-regulating bodies or by the federal control authority to combat money laundering (control authority). Some professional associations such as the Swiss Association of Asset Managers (SAAM) have binding codes of professional ethics for their members. In contrast to the other regulatory frameworks, IAMs are not authorised to keep accounts or deposits.
Consequently, their clients’ assets are placed in the custody of a bank. IAMs are responsible to their clients for loyal and accurate accomplishment of the assigned mandate. If assets are invested on the basis of improper conflicts of interest (e.g. churning, violation of the portfolio management guidelines, scalping or front running) liability for damages may result from the CO and from Swiss Penal Law.
6 Regulatory Costs
The regulatory burden basically depends on three factors. Firstly, it is influenced by the institute’s regulatory status. Secondly, the institute’s primary activity (i.e. securities trading, wealth management, fund distribution, etc.) plays a major role. Thirdly, the size of the firm is important, because of distinctive economies of scale.
The costs of regulation (CHF per capita year 2002) for ASCB Banks, Private Bankers and SDs are illustrated in Table 3. The ASCB Banks have additionally been subdivided into large and small corporations, with a threshold level of 100 employees being taken as the distinction between the two subcategories. The SDs, all of whom employ fewer than 100 persons, have been subdivided with regard to their main activity (i.e. wealth management or securities trading).
The regulatory burden for the IAMs has not been analysed systematically, and only estimates are available. Generally, it is difficult to estimate the regulatory burden of IAMs, as they vary widely with regard to size, legal structure and activity. The total regulatory burden per capita for IAMs is around CHF 6’800; this figure is made up of about CHF 3’000 compliance costs, about CHF 2’700 incremental auditing costs and about CHF 1’100 direct costs. These figures are underpinned by input from representatives of a few self-regulating bodies, the control authority and several IAMs. In 2003, the University of St. Gallen surveyed 500 Swiss IAM companies with regard to the total regulatory costs that arise from the prevention of money laundering (other incremental regulatory costs excluded). The average cost for the responding companies was CHF 20’000. Assuming a company has four employees, the cost per capita would thus amount to CHF 5’000, which supports the estimated CHF 6’800 total regulatory burden for IAMs. Furthermore, it shows that almost all of the regulatory costs are generated by the prevention of money laundering.
Table 3: The costs of regulation in wealth management
Sources: Hubli 2004, Marti 2004.
The total regulatory burden per capita amounts to approximately CHF 12’200 and CHF 28’700 for large and small ASCB Banks respectively, to CHF 7'000 for Private Bankers and to CHF 18'600 and CHF 14’200 for SDs.
Compliance costs make up the lion's share of the regulatory burden, representing at least 80% of the total charges. Compliance costs are highest for the small ASCB Banks, followed by the SDs and the large ASCB Banks; of all prudential-regulated frameworks, it is the Private Bankers who bear the lowest compliance costs. This ranking is more or less the same for all compliance subfields, such as the prevention of money laundering, risk management, equity/liquidity/accounting requirements, and others. The costs arising from the prevention of money laundering mainly make up the greater part of the compliance cost (except for SD Securities Trading). This result is in line with other surveys showing that the initiatives of regulators and supervisors to prevent money laundering and the financing of terrorism have resulted in enormous increases in the burden of compliance. The incremental auditing costs are between 6% and 16% of the total regulatory burden; they are again highest for the small ASCB Banks, followed by the SDs, the large ASCB Banks and the Private Bankers. The proportion of external and internal auditing costs varies according to the regulatory framework: whereas, for the SD, the charges for the external audit are twice as high as for the internal one, the opposite is true in the case of ASCB Banks and Private Bankers.
Despite their increasing growth, the direct costs are of little importance compared to the other regulatory costs; they are highest for SDs, and only half as high for small ASCB Banks. Direct costs for Private Bankers and ASCB Banks are less than CHF 100 per capita.
In wealth management competition, market discipline and self-regulation are preferable to financial market regulation to guarantee system stability and the protection of depositors.
Therefore, we recommend that enough space for self-regulation be created by the formulation of skeleton laws, in order to concentrate on the bottom line and thus to aim at an optimum regulatory density in terms of “good practice” rather than “best practice” guidelines. The international "level playing field", implying compliance with certain common quality standards, should also be adhered to. However, it is important to ensure that Switzerland does not suffer from competitive disadvantages caused by overregulation compared to other countries. It must not be overlooked that many financial centres enjoy regulatory advantages which significantly boost their attractiveness and competitiveness. A “zero tolerance” philosophy, as intended by present-day Swiss regulation projects, will almost inevitably lead to high marginal costs which are not justified by marginal benefits in every case. The various regulation projects should be better coordinated in terms of content, time and systematics. Considering the differences between the various wealth management suppliers with regard to size and risk profiles, the regulatory design should be modular. Industry concentration caused by economies of scale in the area of auditing and compliance costs should be avoided.
However, it is important to set limits to differentiation and to avoid high complexity because of the need for transparency.
On economic-political grounds, it seems desirable that the four regulatory concepts should explicitly differ in terms of costs and benefits, in order to provide real alternatives for the market participants. Analysis of the regulatory frameworks and the corresponding costs, however, reveals conceptual deficiencies in the regulatory design.
Banks benefit most from their regulatory status, which allows them to be active in all areas of the banking business and to profit from the prestige of their banking status. Small ASCB Banks bear the highest regulatory burden, with CHF 28'700 per capita. For large ASCB Banks however, the costs are much lower (CHF 12'200), even less than for SDs (CHF 14’200 - 18’600). In this context, a significant weakness of the Swiss regulatory regime becomes apparent: economies of scale favour large companies and discriminate against small financial institutes to a great extent.
Private Bankers benefit from certain regulatory privileges, and this is reflected in a significantly lower regulatory burden compared to banks and SDs. Additionally, Private Bankers profit from a high level of prestige and a good reputation among the public. As regards income tax and pension payments, Private Bankers - being partnership companies - are treated differently from corporations; it would be desirable for company taxation to be more neutral with regard to the different legal structures of companies. Overall, Private Banker status seems to be an attractive regulatory framework in the wealth management business.
The examinations prove a bank-equivalent regulatory burden for SD which seems to be rather high. However, a comparison between those SDs which predominately operate in wealth management and small ASCB Banks reveals substantially lower costs for the SDs (CHF 18'600 per capita). Nevertheless, it is recommended that regulation for SDs should be eased, in order to create a real alternative to the banking license, in particular for small providers. Furthermore, a differentiated treatment of the five existing SD categories would seem appropriate. At least nonaccount-keeping SDs should be relieved, especially with regard to equity guidelines and similar directives. Finally, the SDs should be exempted from a future Basel II regime.
On the basis of the limited range of services provided by IAMs, it is obvious that they incur the lowest regulatory costs of all four concepts. In their final report, the ZUFFEREY group of experts proposed that IAMs be supervised prudentially. The ZIMMERLI group of experts analyzed the advantages and disadvantages of prudential supervision of IAMs, but the commission did not make any recommendations regarding their general supervision. In the U.S. and in European Union (EU) countries such as Germany and France, IAMs are supervised prudentially. It will become more and more difficult for Swiss IAMs to offer their services to customers in the EU without a license provided by a national regulator like the SFBC, as Swiss IAMs will face growing limitations on their cross-border business as a result of the lack of prudential regulation.
Under the amended EU Directive on collective investments (UCITS fund guideline), only supervised wealth managers are authorised to manage assets of an EU-domiciled investment fund. For this reason, there should at least be a possibility for Swiss IAMs to be supervised on a voluntary basis; otherwise, they will lose their share of the business with EU-domiciled investment funds. Such voluntary supervision could be conducted on the basis of a modified SESTA or a new law for IAMs. For small IAMs who are not dependent on cross-border business and who would not be capable of bearing additional regulatory costs, a mandatory regime of prudential supervision could lead to extinction. In order to protect their customers against operational losses, these small IAMs should at least take out liability insurance to cover potential claims. Both measures would lead to a better image for the IAM industry and strengthen the reputation of the Swiss financial industry as a whole.
In the future, regulations - and therewith the regulatory burden - will most likely increase further. Accordingly, banks and wealth management firms should examine whether their business processes still meet the regulatory requirements. Through innovative and joint solutions in areas such as transaction processing, education and IT-applications, the regulatory burden may be reduced, client relationship officers may be relieved, and smaller financial institutes may remain competitive.
Santos 2000, pp. 5.
Zufferey 2000, pp. 35 and 79.
Llewellyn 1999, pp. 13 and 22.
Llewellyn 1999, pp. 13.
KPMG International 2004.
Bührer 2004, Hubli 2004, Marti 2004.
Andrews / Klumpes / Meeks et al. 2000, pp. 4.
FSA 2000, pp. 5-9.
Alfon / Andrews 1999, pp. 15-16.
Alfon / Andrews 1999, pp. 18 and Zufferey 2000, pp. 92.
Hubli 2004, pp. 43-48 and Marti 2004, pp. 57-58.
Dérobert 2004, pp. 34.
Prevention of money laundering; Risk management; Equity/liquidity/accounting; Others (Independence of financial analysis, Market behaviour, Guidelines on portfolio management agreements, Fund distribution).
Prudential regulation in the sense of an institutional rather than a functional or market regulation. Prudential regulation is ideally designed to prevent the insolvency of the supervised institutes through preemptive measures like capital requirements.
With the exception of the canton Tessin where IAM need to be licensed.
Hess 1999, pp. 1431.
About half of all IAM in Switzerland are not associated to a HprofessionalH HassociationH. Villiger, 2001, pp. 19.
Zobl 1988, pp. 332 and 336.
KPMG International 2004.
Hoffmann 2004, pp. 29.
EU Directive 2001/107/EC (UCITS), article 5g/ 1/ c.
Roth 2004, pp 9.
Today about 50% of the Swiss IAM take out a liability insurance. Bührer 2004.
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