Switzerland: hedge funds
5 November 2007
In comparison with other countries, until recently Switzerland did not play a significant role in the hedge fund industry, except that the Swiss banks manage a huge asset basis that also seeks investments in hedge funds.
Strict regulatory rules on investment funds deterred hedge funds from establishing their investment vehicles in Switzerland, and unfavourable tax conditions did not attract the industry to move to Switzerland either. This may now change.
A recent report on the hedge fund industry issued by the Swiss Federal Banking Commission (SFBC) revealed that around 5 per cent of all the assets invested in Switzerland are invested in hedge fund products. Moreover, hedge funds investment advisers are increasingly opening offices in Switzerland.
The area at the upper end of Lake Zurich has become a centre for the industry; the favourable tax regime in the canton of Schwyz probably being one of the factors for this development. Easy access to the Zurich area has also contributed to this development.
And yet a further benevolent factor may be that advisers to hedge funds are not subject to regulatory oversight or licensing requirements in Switzerland as long as they stay away from running the fund itself and do not engage in brokerage activities.
The hedge fund report concludes that at present the SFBC has a sufficient oversight of the hedge fund industry through its supervision of the banks in Switzerland, which hold the assets and partly also act as prime brokers, although primarily via their London and New York operations. In the SFBC's view this 'indirect' regulation of the hedge fund industry is quite an effective tool to monitor the activities and assure financial stability.
On the other hand, the hedge fund report seems to acknowledge that Switzerland's regulatory and tax regime needs some amendments and alignments to make Switzerland a more attractive and competitive location for hedge funds and their managers.
Aside from the need to align "today's unfavourable tax conditions with those of the most important foreign locations" (the Hedge Fund Report), the regulatory regime needs some improvement as well.
Room for improvement
There were a number of important findings in the hedge fund report.
- The new act on collective investment schemes does provide for some increased flexibility with a number of different corporate forms for hedge fund activities. However, strict rules on asset allocation and risk diversification may still provide a too stringent framework for hedge funds to seriously consider setting up in Switzerland.
Unless these rules are loosened and the tax treatment of investment vehicles in Switzerland is not improved, it is hardly conceivable that hedge funds (in significant numbers) would choose Switzerland as their domicile.
- So far it may have been quite attractive for fund managers and investment advisers not to be subject to regulatory supervision and licensing requirements in Switzerland. Increased pressure on fund managers, in particular calls for self-regulation or direct regulatory oversight, however, has led to a general trend towards requiring that fund managers be regulated (most notably in the EU). In particular, certain investor categories (in particular pension funds) may only invest in funds, the managers of which are subject to official oversight.
The current regulatory regime in Switzerland, however, provides only a very limited opportunity for fund managers to subject themselves under the supervision of the SFBC. The hedge fund report noted that to enhance Switzerland's attractiveness as a location for hedge funds these rules must be changed to allow asset managers to come under official more extensive supervision.
- A further factor is the only partial opening of the Swiss workplace for foreign employees. The bilateral treaties with the EU now provide for freedom of movement for employees from the member states of the EU. This already allows skilled and highly educated fund specialists to come to and work in Switzerland without significant local barriers.
However, the situation is still different for non-EU citizens, most notably US citizens. If Switzerland really wants to further promote itself as an attractive place for the hedge fund industry it needs to further liberalise its work permit regime.
At present Switzerland provides an attractive environment for investment advisers, analysts and even fund managers for non-Swiss domiciled hedge funds; they are not under regulatory supervision and benefit from an attractive work environment in close proximity to a huge customer base, namely the Swiss private banks and independent asset managers.
However, neither the current regulatory framework nor today's tax regime really attract the funds to establish their headquarters or incorporate in Switzerland. Moreover, managers of foreign funds may find it difficult to subject themselves to regulatory oversight.
If Switzerland wants to play a more active role in the hedge fund world, the Swiss legislator needs to follow the recommendations of the SFBC to provide for regulatory and tax incentives for (more) hedge fund managers to settle in Switzerland.
René Bösch is a partner at Homburger