CLIENT ALERT. OTC derivatives trading and financial market infrastructure. Recent developments in Switzerland. January 2014

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1 CLIENT ALERT January 2014 OTC derivatives trading and financial market infrastructure Recent developments in Switzerland

2 Background Further to the lack of transparency in the OTC derivatives markets highlighted by the financial crisis, international efforts have been made, in particular by the G20 and the Financial Stability Board (FSB), to improve transparency and stability in this specific market. In September 2009, the G20 countries committed themselves to ensure that: standardised OTC derivative transactions, if appropriate, would be traded via stock market or other electronic platforms, standardised OTC derivative contracts would be cleared by central counterparties, all OTC derivative transactions would be reported to trade repositories, and bilaterally settled OTC derivative transactions would be subject to more stringent capital requirements. The FSB has issued implementing recommendations and regularly examines these recommendations with regards to its member states. Switzerland is a member of the FSB. Federal Council s resolution of 29 August 2012 In August 2012, the Swiss governement (Federal Council) published a communication on its intention to amend the current financial legislation in Switzerland further to the G20 undertakings and the international standards in the areas of OTC derivatives trading and financial market infrastructure that are being implemented in national legislation in several countries, in particular the EU and the United States. The Federal Council acknowledged that the existing Swiss regulation of financial market infrastructure was no longer appropriate given the developments on the financial markets and did not satisfy the new standards developed by international bodies for important financial market infrastructure institutions such as trading platforms, central settlement offices, securities depositories or trade repositories. To safeguard the competitiveness of the Swiss financial centre and to strengthen financial stability, the Federal Council decided to reform Swiss legislation by implementing the G20 obligations and the FSB recommendations on OTC derivatives trading and by adapting to international standards the regulation in the area of financial market infrastructure. Regulation equivalent to that of the EU was to be sought in both areas. The Federal Department of Finance (FDF) had been instructed to prepare a draft consultation paper on both these matters by spring 2013.

3 Federal Council s resolution of 13 December 2013 In accordance with the Federal Council s instructions, the FDF issued on 13 December 2013 a consultation paper together with the draft of a new Financial Market Infrastructure Act (FMIA). The FMIA intends to regulate more adequately the organization and operation of financial market infrastructures and the market participants obligations. The FMIA will combine in a single law, provisions that are currently dispersed in various federal acts such as the Stock Exchange and Securities Trading Act (SESTA), the Banking Act and the National Bank Act. The main topics that are covered by the new FMIA are: Financial market infrastructures. The current stock exchange regulation will remain to a large extent but will be absorbed by the FMIA. In particular, the principle of self-regulation will be maintained. Certain terms or concepts will however be clarified, or adapted, in particular the expression institution similar to stock exchanges used in the SESTA, that will be replaced by multilateral trading system and organized trading system. Both these systems, along with stock exchanges, central counterparties, central depositaries and trade repositories will constitute the market infrastructures governed by the new FMIA and which will be subject to authorization by the Swiss Financial Market Supervisory Authority (FINMA). Derivatives trading. One of the objectives of the new FMIA is, by essence, to be euro-compatible. Consequently, the three following key obligations for derivatives trading foreseen by EMIR will also become applicable in Switzerland: (i) settlement of derivatives transactions via a central counterparty, (ii) trade reporting to a trade repository and (iii) risk minimization. In an attempt to anticipate future developments, the FMIA contains as well the legal basis for the implementation of an obligation to conduct derivatives transactions via a trading platform, but the relevant provisions should not enter into force until such an obligation is effectively implemented within the EU. Rules of conduct. The current rules of conduct contained in the SESTA - e.g. disclosure of holdings, public takeover bids, insider trading and market manipulation - will also apply to all market participants (and not only to securities dealers). These provisions will be integrated, mostly unchanged, into the FMIA. Categories of securities dealers. Upon to the entry into force of the FMIA, the SESTA will be abrogated to a large extent. The only provisions that will remain, are those applying to securities dealers, but because of their close factual connection with trading platforms, the regulation of the following categories of securities dealers will be transferred to the FMIA: (i) issuing houses, (ii) derivatives houses, (iii) dealers acting for their own account and (iv) market makers, leaving only the category of dealers acting on behalf of clients in the SESTA. Importantly, the new FMIA imposes that the activities performed by issuing and derivatives houses, market makers and dealers for own account be performed by banks and, subject to certain conditions, by regulated securities dealers. Under the new FMIA, own account dealing (proprietary trading) on a professional and short term basis (which is usually the category that applies to commodities traders) shall thus be reserved to banks and regulated securities dealers in the event that the activity could be deemed as threatening the proper functioning of the financial markets, and provided that the dealer is mainly active in the financial sector. Administrative assistance. The FMIA, in conjunction with the Financial Market Supervision Act, will also implement uniformed administrative assistance in relation to financial markets.

4 How these new regulations can affect commodities traders? Large commodities traders are increasingly using OTC derivatives as a hedging tool to cover risks implied by physical transactions. But not only. Speculative trading activities have also been developed by commodities traders, because of the high profit potential, and their natural understanding of the underlying products. To a certain extent, physical commodities houses are therefore active on the financial markets like banks, hedge funds, or financial trading companies. The current regime notably subjects to a FINMA authorization the Swiss commodities traders who trade derivatives on their own account (proprietary trading), on a professional and short term basis and in excess of CHF 5 billion per year. Also, Swiss commodities traders who are members of foreign stock exchanges should in principle apply for an authorization as securities dealer. Exemptions are however available to own-account traders not mainly active in the financial sector (i.e. whose financial activities do not clearly predominate over any other non-regulated activities such as commercial or industrial activities, thus including the trading of physical commodities). A tailor made exemption has also been created by the FINMA for commodities traders dealing derivatives as participants to a foreign stock exchange, provided that the following conditions are cumulatively met: (i) the trader must act for its own account or for the account of affiliated companies; (ii) the trader trades securities primarily for the purpose of hedging the risks within its group; (iii) the group to whom the trader belongs is not mainly active in the financial sector; (iv) in the event that regulated clearing-houses are affiliated with the stock exchange approved by the FINMA, the commodities trader must carry out its exchange transactions through those; and (v) the commodities trader must report to the FINMA on a quarterly basis its on-exchange transactions in derivatives. The FINMA also accepts that the report be addressed by the foreign exchange directly provided that such report be specific to the commodities trader. Under the new regime, commodities traders acting for their own account shall in principle still benefit from the not mainly active in the financial sector exemption. However the FMIA if and when adopted in the form circulated for consultation - will be completed and detailed by ordinances issued by the Federal Council and the FINMA. These ordinances may therefore add, extend, limit or simply remove conditions to existing exemptions. Regarding the tailor made exemption created by the FINMA for participants to foreign stock exchanges, the FINMA will have to confirm or amend its practice further to the entry into force of the FMIA. The new regime foreseen by the FMIA will impact commodities traders who even if not regulated - will have to comply with the new derivatives trading obligations implemented by the FMIA. The specific conditions, such as the thresholds from which derivatives transactions shall be settled via a central counterparty, will be detailed in ordinances to be issued by the Federal Council and the FINMA.

5 The legislative process The draft of the FMIA and an explanatory report have been sent to cantonal authorities, political groups, leading professional associations, etc. for consultation. The consultation will end on 31 March On the basis of the consultation s results, the FMIA s draft will be amended or redrafted. A final draft will then be transferred by the Federal Council to the Parliament. Both chambers of the Parliament must accept the project for the law to be validly accepted. After the Parliament s vote, the Swiss citizens have 100 days to require that the project be submitted to a referendum. Further to that deadline or if the project is accepted, the law will then enter into force. The Swiss legislative process is a long one. The entry into force of a new law such as the FMIA may take from a minimum of 12 months to several years. Chabrier Avocats is a Swiss law firm focusing on the commodities industry. Its clients base includes major energy and soft commodities traders, banks, surveyors, insurances, shipowners, charterers, and related service providers. Chabrier Avocats advises its clients (both established in Switzerland and abroad) in contentious and non contentious matters, such as trading and related agreements (international sale and purchase, CMA, transportation, tolling, agency, distribution, insurance, etc.), trade finance arrangements, commercial and industrial projects (e.g. port terminals, storage and processing facilities, etc.), cooperation agreements, corporate set-ups and restructuring, regulatory issues and the general corporate matters any company active in the commodities industry may be involved in. Chabrier Avocats commodities practice is headed by Marc Gilliéron, partner. Marc is also a member of the GTSA Geneva Trading and Shipping Association and leads its Regulatory & Compliance Working Group. For any additional information, please contact : Marc Gilliéron Corinne Antille Partner Associate t+41 (0) t+41 (0) [email protected] [email protected] CHABRIER AVOCATS 3, rue du Mont-Blanc - CP Genève 1