Global custodians are finding Swiss accounting regulations a barrier to its custody and servicing market, writes Iain Morse
Pension assets of over CHF600bn (€486bn) and as much as CHF1.76trn per annum in cross-border banking assets make Switzerland a lucrative market for global custody banks. In fact, the global custodians have less direct market share here than they would like. This might help explain mighty State Street's recent acquisition of Complementa, a home-grown Swiss investment consulting boutique.
"The business will remain completely independent, preserving its internal culture," explains Jörg Ambrosius, managing director at State Street Germany. Complementa has helped changed the investment culture in Switzerland in recent years by applying cost and performance analytics to domestic asset managers and pension funds, part of a wider move to transparency in a traditionally secretive market.
There is a clear message in State Street's acquisition in worth of the process and values that Complementa embodies for its clients. Complementa may remain independent, but there is nothing in the arrangement to prevent it from introducing clients to State Street.
All this might still seem an expensive exercise for State Street, except that penetrating the Swiss custody and asset servicing market has proved such a challenge for the global custodians. Part of the reason for this lies with Swiss accounting regulations. Because Switzerland is not a member of the EU it is not subject to the IAS Regulations or Accounting Directives. The Swiss Foundation for Accounting and Reporting publishes domestic accounting standards (ARR/FER or Swiss GAAP). All limited companies must comply with ARR/FER, but voluntary compliance with IFRSs is deemed to meet ARR/FER compliance.
This loophole has created a two-tier accounting system for Swiss companies. Since 2006, most Swiss multinational companies listed on the main board of the Swiss Stock Exchange (SME) have been required to use either IFRSs or US GAAP. Swiss GAAP is not sufficient. However, this applies only to Swiss multinational companies. Companies whose main or primary business is domestic, denominated in Swiss francs, are permitted to use Swiss GAAP while listing on the SME. The same applies to privately owned Swiss companies. Swiss banks, pension funds and insurance companies also invest directly into Swiss companies by buying their bonds, but do not generally require the bond issuers to be IFRS/US GAAP compliant; if they did, Swiss investors would face more competition from foreign rivals.
The treatment of the defined benefit pension liabilities of Swiss companies varies as to whether they use Swiss GAAP or IFRS/US GAAP. The key difference lies in the IFRS/US GAAP emphasis on marking pension scheme assets and liabilities to market. "Swiss pension funds can choose the discount rate they employ," notes Christian Bodmer, head of investment consulting at Mercer in Switzerland. The possible consequences of implementing IAS19 for Swiss pension schemes has sparked plenty of criticism from Swiss sponsors and pension boards.
KPMG warns that implementation could cost Swiss sponsors an average contribution rate rise of 34%, with five out of 30 of the largest sponsors obliged to double contribution rates. Sticking to Swiss GAAP regulations permits sponsors and pension boards to continue using the ‘corridor method' for valuing assets and liabilities under long-term assumed rates of return and volatility. Discount rates vary between 2.5% and 4%. "Public pension schemes tend to use higher rates," adds Bodmer. "Private sector schemes use lower rates." The corridor method is constructed out of mean variance; as long as volatility of investment returns is within upper and lower limits around the mean they do not require immediate compensatory action. Swiss custodians are used to complying with Swiss accounting standards but their rivals are not.
Swiss custodians are also protected by domestic regulations which variously require domestic mutual funds, pension funds and insurance companies to employ a local, Swiss custodian in the preparation of their annual accounts. "It is unusual for pension schemes to use both a local and global custodian," notes Sven Ebeling, head of asset servicing at UBS. Under Swiss GAAP FER 26, introduced in 2004, defined benefit schemes must publish audited annual accounts which comprise a balance sheet and multi-step profit-and-loss account presenting a ‘true and fair' valuation of the relevant assets and liabilities.
However, pension boards are allowed discretion on the assumptions made in forming these valuations. There is also active debate over whether Swiss ‘defined benefit' schemes are appropriately classified as such; contribution rates and minimum rates of investment returns may be pre-set or guaranteed but boards can adjust benefit levels payable by the schemes. The Swiss have argued that these schemes should, anyway, be exempt from the full consequences of IAS19 if they come under that regime.
Swiss second pillar funds are obliged to secure a net minimum annual return for their members. This has been set at 1.5% by the Federal Council (LPP) from 1 January 2012, reduced from 2%.
With so many regulatory impediments in their way, not many global custodians that dominate the upper tiers of the European market have bothered to open permanent offices in Zurich. Instead, they cover the country from Germany or London. A short list of domestic custodians has the huge majority of market share: UBS, and Credit Suisse most likely share the custodianship and administration of over 50% of Swiss domiciled pension, mutual fund and insurance company assets. They are backed up by some large local boutiques, notably Pictet and Julius Bär. The ratio of ‘captive' to ‘free' assets - with captive assets custodied and serviced in-house - remains high. Despite pressure to end Swiss bank secrecy laws, none of this business will be given up lightly.
To this end, Switzerland has also taken care to build glossy, world-class infrastructure to support its financial services industry. The SIX SIS group of companies provide this through six component companies which hold, respectively, a central securities depositary, central counterparty, share registry for public companies, IT and logistics division, domestic and international payments system, and market data provider which also services Belgium and Liechtenstein.
SIX Securities Services is intended to provide centralised custody services for the Swiss banking sector, including its more than 100 small depo banks. Clients of the SIX SIS companies include the major Swiss custody banks and their services are designed to provide a one-stop shop for domestic mutual and other funds such as special investment vehicles (SIVs) now used by an increasing number of pension schemes as a medium for property investment. The SIX SIS infrastructure is designed to interface seamlessly with foreign investors and markets.