Material compliance gaps, not protectionism or politics, are why the finance hub is being frozen out of Europe, a finews.com analysis shows.

Private bankers tend to gripe, usually to anyone within earshot, about how everyone and everything is always conspiring to get between them and their clients.

This year seems no different. As finews.com previously reported, a line of thinking has developed in Switzerland about the lack of specific bilateral agreements with France and Italy such as the one it currently enjoys with Germany which allows smaller Swiss private banks to do business even if they don’t have an actual presence in the country.

Many senior industry proponents are calling for the same with the other two – supposedly - recalcitrant neighbors, saying they are either simply being protectionist or that there is a lack of political will in Bern to get one negotiated.

Lagging Behind

But the issue goes deeper than that. The indifference is probably far more due to Swiss regulation being at least a generation behind that of many major financial hubs, at least when it comes to protecting clients.

Finma, bashed together in 2009 from its three predecessors, initially and understandably focused on institutional solvency given the palpable heat that was still emanating from the financial crisis, not to mention the very vivid memories of repeated federal UBS bailouts.

The problem is that it doesn’t seem to have progressed all that much beyond that, even though protecting consumers, or clients, has been an integral focus of regulation and compliance for the better part of the last decade.

Beyond Tier 1

That trend looks set to continue, as Deloitte indicated in its 2022 regulatory outlook. Such things as fair conduct, responsible product offerings, investment suitability, and vulnerable client protections have all become at least, if not more important, than Tier 1 ratios worldwide.

But the Swiss regulator has precious little on its website about any of that. It states that its «principles-based» form of supervision requires only that it «regulates where necessary» and only when this is «expressly provided for by (SIC: the) legislation».

It does say it has the mandate to protect creditors and investors from unfair commercial practices or unequal treatment but there do not seem to be explicit references to bank clients, institutional conduct, or anything similar - apart from a mention of its deposit protection scheme and a passing, unsubstantiated reference to suitability in a brochure. Insofar as it can be ascertained, there are neither specific circulars nor guidance in English or any of Switzerland’s national languages on any of this. The Finma was directly queried on the matter but it has not, as of yet, responded.

Branch Required

With that, France and Italy are likely to have extremely little appetite for letting small private banking institutions in without the accountability of an actual presence, particularly if they offer offshore accounts and investment services.

Even for something as basic as deposit protection, which all three neighbors have standardized under the EU's regulatory framework at 100,000 euros, there are numerous questions. Who pays when things go wrong, notwithstanding whether it only forms a fraction of the original client’s account balance? Is it the receiving jurisdiction or the originator cum provider? The local deposit protection scheme or the Swiss one? How does the process even work if the bank is not even there?

The same goes for discretionary mandates booked outside their jurisdiction. How can anyone ensure that locally implemented MiFID II suitability assessment rules are followed and enforced? How can they ensure that a bank pays heed to fair conduct requirements? The short of it is - they can’t.

Family Liabilities

Family ownership, something that is prevalent among the smaller private banks, is also increasingly seen as a liability, according to a senior compliance expert with an extensive track record at Swiss, UK, and US institutions.

The issue here is that the family proprietors often get away with paying little more than lip service to the limited Finma standards on conduct and culture. In some cases, they simply ignore them, particularly when it comes to what they can and cannot do with clients.

«Ironically, for the larger banks, the business maintains far higher standards for their US, UK, Hong Kong, and Singapore entities than they do in Switzerland itself,» the expert maintains.

Business Ramifications

This has implications. The same expert noted that smaller private banks rarely get a full share of «wallet» from high-net-worth clients in international jurisdictions.

«The cachet of having a Swiss private bank account is still there - but clients won’t give them all their assets because of a lack of trust. Instead, they use pricing to play them off against each other, knowing that they need to be acting in the best interests of clients, which runs counter to their nature,» the expert maintains.

On top of this, as finews.com previously reported, the EU plans to introduce new legislation taking direct aim at the private banking business by rating it as a higher risk factor. Until the legislation comes into force or is diluted, both France and Italy will probably not take any steps allowing private banks free rein over their citizens.

No Direct Lockout

Despite that, a compliance expert at UK-based Storm-7 consultancy said it is unlikely that the EU will ever directly lock Switzerland out because that would be an expressly overtly political move.

Although individual countries will always have a margin of discretion when carving out exceptions, the EU‘s attempts to better harmonize its regulatory framework may result in significant changes to the German agreement at some point, particularly if either consumer protection laws or AML regulations are strengthened, since adherence to both is specified as conditions in the original.

If that were to happen, that by itself could prove extremely challenging to implement, not to mention expensive, for the internal risk frameworks of smaller banks.

Principle-Based

Principle-based regulation sounds reasonable in theory, and it may be as far as Finma can go under Swiss legislation. But that does not change the fact that the world is passing it by, with many observers characterizing the approach as well-intentioned - but obsolete.

Lessons from the financial crisis and the Libor scandal, among many others, show how unworkable a hands-off approach is, the same observers indicate.

Some even go so far as to maintain it is akin to putting drugs on a table in front of an addict going through withdrawal symptoms and then telling them how just how unhealthy the drugs are - in some vain hope they won’t be taken.

Institutional Safeguards

But adopting a stricter fairness regime would also render mute many questionable, time-honored private banking practices, among them how commissions are charged for each position sold when a client has decided to exit a relationship even though in most cases it would be easy enough to transfer the securities and investments to a new bank.

Another would be the unfettered ability to sell discretionary or other sophisticated investment mandates to vulnerable clients, or clients above the age of 65, without any kind of additional regulatory safeguards, such as many other financial hubs have.

Private bankers are indeed correct to believe that many factors are conspiring to get between them and their clients, although many are just prudential, reasonable measures. And until anything changes, any attempt to change the status quo with France and Italy, and the EU, is likely to be nothing more than a wild goose chase.