Capital Markets: Derivatives 2024 Comparisons

Segments of the Swiss Derivatives Market

The Swiss derivatives market can be divided into the following segments.

• OTC derivatives – the OTC derivatives market consists of the market involving Swiss derivatives dealers trading OTC derivatives with other Swiss or international dealers in the inter-dealer market as well as transactions entered into between a Swiss dealer and end-users. The end-users may be corporations using derivatives for their hedging, investment or treasury management purposes or investors using derivatives for hedging or investment purposes. OTC derivatives may be cleared or uncleared products. However, there is no Swiss clearing house providing clearing services for OTC derivatives.
• Exchange-traded derivatives (ETDs) – the Swiss ETD market involves Swiss banks acting as clearing brokers or clients of clearing brokers providing Swiss end-users the access to the clearing services of a central counterparty (CCP) of the relevant exchange, where the ETDs are traded. There is no Swiss ETD exchange or Swiss CCP for ETDs. For this reason, the Swiss parties involved in the clearing chains always access the clearing services provided by foreign CCPs.
• Structured products – structured products are products issued usually under a programme for such products. To the extent that the products may be sold to retail investors, the products must be issued or guaranteed by a regulated issuer (ie, a bank, a securities house or an insurer) or the products must be fully collateralised. The products have an ISIN are and issued as securities. The pay-out of the products references an underlying asset and such products therefore have the economics of a derivative, but they are issued in securitised form. Such structured may be listed on a Swiss regulated exchange (eg, SIX Swiss Exchange). Structured products may be used for instance to have an exposure to a new asset class of underlyings such as digital assets, but in the form of traditional securities (eg, through exchange-traded products (ETPs), which are products listed on a Swiss regulated exchange that are secured by liquid assets or through tracker certificates on such underlyings that may or may not be secured by collateral).

Applicable Regulatory Requirements

OTC derivatives

OTC derivatives are subject to the Swiss regulation of derivatives under the Swiss Financial Market Infrastructure Act of 19 June 2015 (FinMIA). These regulatory requirements are the Swiss equivalent of EMIR and include:

• a reporting obligation for all such derivatives transactions other than transactions entered into between small non-financial counterparties;
• a clearing obligation for certain types of OTC derivatives (including some interest-rate derivatives and credit derivatives on indices as underlyings), except if they are entered into with a small financial or a small non-financial counterparty; and
• risk mitigation obligations for uncleared derivatives – including:
1. variation margin requirements for any transactions other than those entered into with a small non-financial counterparty;
2. initial margin requirements for financial counterparties and large non-financial counterparties crossing a threshold of CHF8 billion in aggregated average notional amounts;
3. the obligation to agree to portfolio reconciliation and dispute resolution (PRDR) processes and, to the extent the transaction is entered into with a counterparty other than a small non-financial counterparty, perform portfolio reconciliations;
4. the obligation to perform portfolio compressions in trading relationships that include more than 500 transactions; and
5. the obligation for any counterparty other than a small financial or a small non-financial counterparty to value transactions.

Under the rules of the FinMIA, financial counterparties are regulated banks, securities firms, insurance and reinsurance companies, holding companies of financial or insurance groups, managers of collective investment schemes, fund management companies, collective investment schemes and pension funds. All other counterparties are deemed to be non-financial counterparties.

Similar to EMIR, small non-financial counterparties are distinguished form large non-financial counterparties by reference to the nominal amounts of the outstanding OTC derivatives (average gross positions, calculated over 30 working days). A non-financial counterparty is deemed to be large if it exceeds at least one of the following threshold values with all of its trading activity with any counterparties.

• Credit derivatives: CHF1.1 billion.
• Equity derivatives: CHF1.1 billion.
• Interest rate derivatives: CHF3.3 billion.
• FX derivatives: CHF3.3 billion.
• Commodity derivatives and other derivatives: CHF3.3 billion.

The calculation is done by aggregating the positions of all group companies that are non-financial counterparties (worldwide), without counting the positions of financial counterparties (of the same group). Hedging transactions and physically settled FX forwards and swaps are not counted for the calculation.

The FinMIA distinguishes small and large financial counterparties by reference to a threshold of CHF8 billion including the entire derivatives portfolio (counting also hedging transactions) except for physically settled FX forwards and swaps. Except for funds, collective investment schemes and fund managers, the calculation is done by aggregating the positions of all group companies that are financial counterparties (worldwide), without counting the positions of non-financial counterparties (of the same group). As regards funds, collective investment schemes and fund/asset managers, there is no aggregation of their positions. The calculation is made in respect of each fund and collective investment scheme separately (even if the assets are managed by the same manager).

To the extent that the transactions are entered into on a cross-border basis, these regulatory requirements may also be complied with by applying the rules of a jurisdiction that has been recognised by FINMA as equivalent to the rules of the FinMIA by applying such foreign rules on a substituted compliance basis. This is at present possible for EMIR, UK EMIR and the US rules of the CFTC.

ETDs

ETDs are also subject to some regulatory obligations under the FinMIA, including a reporting obligation for all such derivatives transactions. However, the other regulatory obligations of the FinMIA do not apply to ETDs.

Structured products

Structured products are not subject to the regulatory obligations of the FinMIA. However, if they are issued to any retail investors, they must either be issued or guaranteed by a regulated firm or, as an alternative, they must be fully collateralised. Also, they must be issued under a programme or prospectus that complies with the disclosure requirements of the Swiss Financial Services Act of 15 June 2018 (FinSA) and any products that are offered to retail investors other than in the context of a discretionary asset management mandate or an advisory mandate entered into with a bank or a securities firm must be documented with a key information document (KID) that complies with the requirements of the FinSA or those of the EU PRIIPs.

As regards the offer of products available in the Swiss market, a key driver is the demand for products requested by the buy-side in the asset management and private banking sectors. In the past 12 months, on the supply side, the disappearance of Credit Suisse has left a gap that was filled on the sell-side by other derivatives dealers.

As regards the regulatory environment, Switzerland is closely aligned with the regulation of derivatives, as it applies in the European Union (EU) by following the rules of EMIR. The rules of the FinMIA were put in place after those of EMIR and, in some respects, the Swiss rules were more liberal than those of EMIR. This allowed the Swiss derivatives regulation to remain aligned with EMIR also after the EMIR Refit.

The Swiss Federal Department of Finances (FDF), in consultation with the financial industry, recently prepared a reform package for the FinMIA that was now adopted by the Swiss Federal Council and released as a consultation report (the FinMIA REFIT Report) together with a proposed draft of the revised FinMIA on 19 June 2024. The consultation will run until 11 October 2024. Under such revised rules, the Swiss derivatives regulation for OTC derivatives will be liberalised further, with the key proposals being the following.

• The determination of the status of a counterparty as a small or large financial or non-financial counterparty shall become an annual determination.
• To the extent that a jurisdiction is eligible for being applied instead of the FinMIA on a substituted compliance basis, this shall allow the application of such rules also for the determination of the counterparty status (ie, the question of the counterparty classification will not remain subject to a Swiss law analysis).
• The new rules will provide that small non-financial counterparties shall not come into the scope of the reporting obligation at any point in time.
• As regards the content of the reporting fields, the FDF further proposes to amend the content of reports to the trade repository by harmonising such content with international standards on ordinance level (eg, with regard to LEI, UTI and other critical data points). In this way the quality of the reported data shall be improved which should allow to determine financial stability risks more easily.

Futures are traded as exchange-traded derivatives (ETDs). Options may be traded either as ETDs or as OTC derivatives.

As regards the market for exchange-traded derivatives (ETDs), Switzerland does not have a trading venue for such products. Therefore, the products traded are those available in markets outside Switzerland. In terms of the demand for ETDs, Swiss investors have recently requested ETDs on cryptocurrencies as underlyings. These products may be sold in Switzerland also to retail investors. However, as such ETDs are qualified as “securities” for the purposes of Swiss regulation, any firm offering such products from a Swiss presence or using a Swiss intermediary to access the Swiss market may become subject to licensing requirements as a securities firm or it may have to obtain the authorisation of a Swiss branch or Swiss rep office of a foreign securities firm.

As regards options traded as OTC derivatives, the authors see innovative products used in the Swiss market for instance in the context of equity financing transactions. An example of such products are collar transactions that may be used for the purpose of hedging a long position in an equity investment with a put option by protecting the shareholder against a decline in the share price below a put strike price, while at the same time giving away the upside in the event of a development of the share price above the call strike price.

At present, options on single names or baskets of equities as underlyings and equity index options benefit from a temporary exemption from the variation and initial margin requirements that is currently in place until 1 January 2026.

Swaps are typically traded as OTC derivatives with the involvement of a swap dealer under the use of an ISDA Master Agreement or a Swiss Master Agreement as the relevant documentation. Under Swiss law, no distinction is made between security based swaps and other swaps.

Exemptions from the derivatives regulation apply in respect of physically settled FX swaps (in addition to physically settled FX forwards) and in respect of physically settled OTC derivatives (including swaps) with commodities as underlyings. The exempted FX swaps are only subject to a reporting obligation, but not the other regulatory requirements resulting from the FinMIA. The exempted swaps with commodities as underlyings are not subject to the derivatives regulation under the FinMIA at all.

Certain interest rate swap transactions as well as certain index credit default swaps are subject to a mandatory clearing obligation, except if they are traded with a small financial counterparty or a small non-financial counterparty. Other swap transactions may be subject to a voluntary clearing. Any such clearing occurs with a central counterparty outside Switzerland. To the extent that the clearing occurs through Swiss clearing brokers as direct participants of such CCPs, the CCPs must be authorised by FINMA for providing such clearing services in Switzerland (CCPs such as Eurex Clearing, ICE Clear, LCH, LME Clear and Cboe Clear have such authorisation).

Forwards are traded as OTC derivatives. Forwards may be traded in respect of any asset classes as underlyings. From a Swiss perspective, a derivative is defined as a financial contract (i) with a value depending on one or more underlyings, and (ii) that is not a spot transaction.

As long as a forward contract references the value of an underlying asset and it is not settled as a spot transaction (see 2.6 Exemptions, Non-derivative Products and Spot Transactions), it would fall with the definition of a derivative for the purposes of Swiss law. This would also include for instance FX Forward transactions.

Exemptions from the derivatives regulation apply in respect of physically settled FX forwards (in addition to physically settled FX swaps) and in respect of physically settled OTC derivatives (including forwards) with commodities as underlyings. The exempted FX forwards are only subject to a reporting obligation, but not the other regulatory requirements resulting from the FinMIA. The exempted forwards with commodities as underlyings are not subject to the derivatives regulation under the FinMIA at all.

Listed Derivatives/ETDs

At present, there are no Swiss exchanges, where derivatives in the form of exchange-traded derivatives (ETDs) are listed. Any such ETDs are traded on foreign exchanges. Swiss investors are accessing such foreign exchanges through a clearing chain, involving a clearing broker providing clearing services and, possibly, a client of such clearing broker providing indirect clearing services. For investors other than small non-financial counterparties in the sense of the FinMIA and for Swiss parties involved in the clearing chain, ETDs are subject to a reporting requirement from the perspective of Swiss derivatives regulation under the FinMIA, but not to other regulatory requirements.

For Swiss banks or securities firms providing clearing services in the clearing chain for clients, the positions resulting from ETDs are not subject to regulatory capital requirements, except where they to hold the client harmless for any losses incurred due to changes in the value of the transaction in the event of default by the qualifying CCP or they guarantee to the clients that the qualifying CCPs or clearing services provider perform their obligations. However, to the extent that banks or securities firms hold ETDs for their own account or in the event that they were to guarantee the exposures resulting from the ETDs to the their clients, the banks or securities firms must take into account the positions resulting from the ETDs for the purposes of their own regulatory capital analysis.

For the purposes of such analysis, a risk weight of 2% applies, to the extent that the ETDs are cleared with a qualifying CCP and legal opinions of the relevant jurisdictions involved confirm the following:

(i) the ETD Transactions are identified as “client transaction”;

(ii) margin assets held through the clearing chain with the qualifying CCP will be segregated for the benefit of the indirect clients, ie, the indirect clients will not incur any losses, in the event of:

a. the insolvency of the clearing services provider through whom the bank or securities firm acts;

b. an insolvency of other indirect clients of such clearing services provider; or

c. an insolvency of the clearing services provider and other indirect clients; and

(iii) in the event of an insolvency of the clearing services provider through whom the bank or securities firm acts as direct client of a clearing broker, the applicable laws and regulations lead to the conclusion that the positions and margin would either be upheld directly with the qualifying CCP or they could be transferred at the market value to another clearing broker (porting) or, upon request of the client, they could be closed-out.

OTC Derivatives

OTC derivatives are traded as bilateral contracts between two parties under the market standard documentation for such transactions. This is typically an ISDA Master Agreement, together with the relevant supporting documents, or a Swiss Master Agreement for OTC derivatives transactions, as published by the Swiss Bankers Association.

Such OTC derivatives are subject to the regulatory requirements of the FinMIA, which are closely aligned with EMIR (see under 1.1 Overview of Derivative Markets).

As regards their regulatory capital analysis, derivatives dealers trading OTC derivatives may account for OTC derivatives traded under netting set on a net basis if the following requirements, as implemented in Switzerland on the basis of the Basel rules, are met:

(1) A master agreement customarily used in the OTC derivatives market (a Master Agreement) including a close-out netting arrangement is in place that provides for a single lump sum termination amount including all the relevant derivatives transactions, provided that the Master Agreement includes termination events for a default or insolvency scenario of the counterparty.

(2) Reasoned legal opinions confirm that the contractual provisions of the Master Agreement pursuant to (1) are legally binding and enforceable:

a. according to the place of incorporation of the counterparty, including in the event of a default or insolvency of the relevant counterparty;

b. according to the law governing the individual transactions forming part of the netting arrangement; and

c. according to the agreement governing the netting arrangement.

(3) The bank has processes in place to monitor ongoing changes of the applicable laws that are relevant for the enforceability of the netting arrangement.

Swiss law does not restrict any particular asset class as underlyings of derivatives transactions.

However, certain exemptions from regulatory requirements apply with respect to some type of asset classes (see under 2.6 Exemptions, Non-derivative Products and Spot Transactions).

To the extent that derivatives transactions are not traded as transactions in the inter-dealer market, but they are traded with a client as a financial service like any other financial instrument, the relevant point of sale obligations resulting from the FinSA must be complied with.

As regards such point of sale obligations, FINMA intends to introduce specific risk disclosure requirements in connection with complex products offered to retail clients such as contracts for differences (CFDs), which would be modelled on the requirements of the European Securities and Markets Authority (ESMA) in the European Union. When disclosing the risks associated with financial instruments, the provider will have to inform its clients of (i) the proportion of clients who lose money in connection with CFDs, (ii) the potential obligation to make additional payments and the risk of unlimited losses, and (iii) leverage, margin rules, counterparty risk and default risk. At this stage, it is still unclear what products exactly fall into the scope of such obligations. FINMA’s explanatory report on these new rules also mentions rolling spot FX transactions.

New types of asset classes that are emerging in Switzerland include derivatives on cryptocurrencies and other digital assets as underlyings, derivatives on verified carbon credits (VCCs) and equity derivatives used in the context of complex equity financing transactions (eg, in the context of an accelerated share buy-back).

Non-derivative Products and Spot Transactions

From a Swiss perspective, a derivative is defined as a financial contract (i) with a value depending on one or more underlyings, and (ii) that is not a spot transaction.

With regards to (i) – value depending on an underlying:

Swiss law does not provide for an exhaustive list of underlying assets or values of a derivative. While the Ordinance to the FinMIA (the FinMIO) mentions shares, bonds, commodities and bullion as underlying assets as well as currencies, interest rates and indices as underlying values, these are only examples. A contract referencing other assets or values that shall be used to determine the value of the contract (eg, economic statistics, inflation rates or climatic variables) is also considered a derivative for the purposes of the FinMIA.

For the purposes of classifying a contract as a derivative under the FinMIA, it is a requirement that the value of the contract directly or indirectly depends on the price of the underlying asset. Therefore, the reference to the value of the underlying must result from the terms and conditions of the financial contract. It would not be sufficient that the value is derived from an asset pool. As a result, asset backed securities or collateralised loan obligations would not qualify as derivatives for the purposes of the FinMIA. Also, shares in an investment company investing in underlying assets would not be classified as derivatives for the purpose of the FinMIA.

Any instrument issued in the form of a certificated or uncertified security would not be classified as a derivative in the sense of the FinMIA, even if its value is directly or indirectly depending on the price of an underlying asset. For instance, any structured products issued in securitised form would not be viewed as a derivative.

Moreover, the definition of derivatives for purposes of Swiss law does not include instruments, where a derivative is only an embedded element, but the primary purpose of the contract is a different one (eg, stock options forming part of a stock option plan paid as compensation under an employment agreement or put/call options embedded in a shareholders agreement). To be classified as a derivative for the purposes of the FinMIA, the main contractual obligations of the parties must depend on the value of the underlying assets or values.

With regards to (ii) – not a spot transaction:

A spot transaction is a transaction that is settled within two trading days (T+2) of the trade date or within the longer settlement period that is customary for such transaction. A transaction would not qualify as a spot transaction, where the parties provide for a postponement of the delivery of the underlying asset that is longer than two days or, if longer, the customary settlement period for the assets concerned (one settlement cycle). However, if there is no customary settlement period for a specific product, the question may arise how to distinguish a spot transaction from a forward contract. In the event that the parties determine a settlement date that is not the shortest possible settlement date, the transaction is likely not to be qualified as a spot transaction but as a forward transaction, ie, a derivative for the purposes of the FinMIA.

A transaction for the sale and purchase of securities in any currency that settles within one settlement cycle of the securities transaction (securities conversion transaction) would also be viewed as a spot transaction. This raises the questions (i) whether this also applies also to foreign exchange transactions entered into separately from the securities transaction and, if so, (ii) whether there is a maximum time limit for the settlement cycle that would have to be complied with to fall into the scope of this exemption.

On the basis that securities conversion transactions qualify as spot transactions in the sense of Article 10(2)(c) MiFID II Delegated Regulation (ie, they are settled within the customary settlement cycle for the underlying securities transactions, which is not longer than T+5), the Swiss analysis should be that such transactions should also be classified as spot transactions for purposes of the FMIA. Regarding the cap of five trading days, while this is not addressed in the Swiss rules, the authors believe it is advisable to stay within the limit set by the EU regulation as a “safe harbour” in order for the transactions not to be classified as derivatives for purposes of the FinMIA.

Rolling spot transactions are permitted in Switzerland and qualify, depending on their structure, either as spot transactions or as derivatives for the purposes of the FinMIA. To the extent spot transactions do not include an enforceable obligation to extend the transaction, ie, if the parties can decide freely whether or not they wish to roll over the economic terms of a spot transaction, and provided further that such extension of the spot transaction is not the normal market practice between the parties, such transaction would be treated as spot transaction. However, if there is an obligation of the parties to roll a spot transaction or if such extension of the spot transactions is the normal market practice, such transaction would be qualified as a derivative for the purposes of the FinMIA.

Exempted Transactions

Under the Swiss rules, the following types of transactions are exempted from the derivatives regulation:

• physically settled commodity derivatives, except if they are traded on a regulated exchange, on a multilateral trading facility or on an organised trading facility;
• physically settled commodity derivatives on power or natural gas as underlyings traded on an organised trading facility; and
• derivatives regarding freight, inflation rates, climatic variables or official economic statistics that are cash settled only upon default or termination.

Other transactions are only exempted from certain obligations. This includes the following.

• ETDs are only subject to a reporting obligation, but not to other obligations of the derivatives regulation resulting from the FinMIA.
• Physically settled FX Forwards and Swaps, ie, where the confirmation specifies that the transactions shall be physically settled (however, the calculation should include cash settled FX Forwards (ie, NDFs) and Swaps, FX Options and Currency Swaps) are only subject to a reporting obligation, but not to other obligations of the derivatives regulation resulting from the FinMIA.
• Currency Swaps, which combine a swap of currencies and an interest rate derivative, are not subject to initial margin requirement for the FX component.
• Options on single names or baskets of equities as underlyings and equity index options benefit from a temporary exemption from the variation and initial margin requirements that is currently in place until 1 January 2026.

Switzerland does not have regulatory authorities on a local level (Cantons or Municipalities) that would be competent in this field.

For the derivatives market, there are no self-regulatory organisations or independent authorities that would be competent in this field.

However, Switzerland has trade associations such as the Swiss Bankers Association that are setting standards in respect of the documentation used (eg, by publishing the Swiss Master Agreement for OTC Derivatives Transactions or other Master Agreements) and by being the most relevant forum for the discussion of the industry position to new rules and laws and developing best practices.

Given that the country does not have a Swiss exchange for derivatives and no Swiss CCP for clearing derivatives, Switzerland does not have such Swiss market participants.

However, SIX SIS as the Swiss securities custodian offers a solution for the custody of securities for the purposes of using it with respect to initial margin assets under either Swiss Master Agreements for OTC Derivatives or ISDA documentations.

Clearing brokers and Swiss firms offering indirect clearing services usually have their own trade documentation used to document the clearing terms. Such terms are usually the same for all asset classes.

The Swiss clearing brokers and indirect clearing services providers usually have a set of disclosure documentation that is prepared on the basis of the FIA standards that are provided to the clients of the cleared derivatives.

The Swiss regulatory capital requirements require netting and collateral enforceability opinions for the purposes of allowing Swiss banks to account for derivatives transactions on a net basis for regulatory capital purposes (see under 2.4 Listed v Over-the-Counter). Such opinions must cover the enforceability of the netting arrangement and the enforceability of the collateral in the insolvency of the counterparty and under the governing law of the agreement as well as under the governing law of the transactions.

The Swiss margin rules require an opinion coverage for the enforceability of the collateral provided by the counterparty (collateral provider opinion) and, as regards initial margin, for the availability of the collateral to the collateral provider in the insolvency of the collateral taker (collateral taker opinion).

With respect to ETDs, the Swiss regulatory capital requirements also require a legal opinion regarding the positions and margin assets held through the clearing chain with the CCP for the purposes of applying a risk weight of 2% for own account positions (see under 2.4 Listed v Over-the-Counter).

FINMA has not published guidance on its priorities with respect to the enforcement activities regarding derivatives. Given that the first level of the enforcement activities lies with the auditors, any audit points tend to be addressed at that level.

For the future, an increased scrutiny may be expected for any derivatives transactions entered into with retail clients, in particular regarding compliance with any requirements to provide adequate disclosures under the point of sale information obligations of the FinSA (eg, for CFDs or similar retail products).