True Sale and Secured Loan
From a Swiss insolvency law perspective, a valid transfer of assets can be achieved both by way of a "true sale" and by way of a secured loan. Under Swiss substantive laws, the term true sale is not defined. In order for a transaction to constitute an effective sale in Swiss contract law, the substantive risks and benefits associated with the underlying assets need to be transferred to the bankruptcy-remote special-purpose entity (SPE). In making that determination, a number of criteria are typically taken into account.
First, the transfer of assets needs to be final and irrevocable. The risk of any such transaction being voided in an insolvency as a transaction at an under-value or as a fraudulent transaction is typically mitigated by ensuring that assets are sold on arm's-length terms (see below for further details).
Second, the determination of the purchase price (fair value v nominal or discounted value) may have an impact on the analysis if, as a consequence thereof, a substantial part of the risks associated with the transferred assets remains with the seller. Structures involving a deferred purchase price or other potential credit enhancement elements are not uncommon in Swiss securitisations, but whether this may affect the effective sale analysis needs to be analysed on a case-by-case basis.
Third, any call option (portfolio call or clean-up call) needs to be designed in a way that does not create any legal obligation for the seller to repurchase part or all of the transferred assets, or other relevant step-in risk in case of underperformance.
As mentioned above, Swiss insolvency law does not generally invalidate a transfer of assets even if the transaction were to be recharacterised as a secured loan. However, in the case of a secured loan, the SPE would need to liquidate or otherwise enforce the transferred assets in accordance with Swiss law and to return any excess enforcement proceeds to the seller. Thus, any such recharacterisation would likely be in conflict with the contractual rights and obligations of the SPE typically provided for in Swiss securitisation transactions.
Recharacterisation Risk and Its Mitigation
In order to mitigate the recharacterisation risk, an opinion of a Swiss counsel is typically obtained to support the effective sale analysis and the analysis regarding the bankruptcy remoteness of the transfer.
Material qualifications usually reflect the fact that, under Swiss insolvency laws, an assignment of future claims would no longer be valid for claims that only come into existence after bankruptcy proceedings have been initiated with respect to the seller. Depending on the terms of the underlying contracts, the risk may be mitigated by transferring the entire contractual relationship (such as lease agreements) instead of solely assigning the claims arising under the contractual relationship. In addition, Swiss legal opinions typically reflect the fact that, in the case of the seller being adjudicated bankrupt or the conclusion of a composition agreement with an assignment of assets (Nachlassvertrag mit Vermögensabtretung), the insolvency official or, under certain conditions, creditors of the seller may challenge the transfer of assets under Swiss insolvency laws. In particular, Articles 285 et seq of the Swiss Debt Enforcement and Bankruptcy Act provide that the transaction may be subject to challenge if:
In addition, moneys collected by the servicer (or any other person) on behalf of the SPE, unless and until paid over to a bank account maintained in the name of the SPE, are commingled with the funds of the servicer (or such other person) and would fall into the bankruptcy or liquidation estate of the servicer (or such other person), leaving the SPE with a non-secured claim against the bankruptcy estate.
Swiss securitisation transactions, as well as securitisation transactions involving Swiss law-governed assets, typically involve an SPE to insulate the transferred assets from the financial risk of the originator/seller. Whether the SPE is set up in Switzerland or domiciled abroad depends on a number of factors, such as tax and specific secrecy obligations attached to certain assets (such as banking secrecy and restrictions on foreign ownership of certain assets involving real estate). While today, Swiss SPEs are usually set up in the form of a stock corporation (Aktiengesellschaft), historically the legal form of the limited liability company (Gesellschaft mit beschränkter Haftung) was also used. In order to support the deconsolidation of the assets from the originator, and with a view to fostering the legal robustness of the transfer of the assets, Swiss transactions frequently feature the concept of a "golden share", which is held by an independent third party or the trustee. In addition, the articles of association of a Swiss SPE then provide for certain core provisions that may only be amended by way of a unanimous resolution of all shareholders. Also, to mitigate the risk of bankruptcy of the SPE, the articles of association typically contain quite specific restrictions on the type of activities the SPE may carry out. Finally, in order to increase the independence of the SPE from the originator, the SPE normally has one or two independent directors and appoints a corporate service provider to maintain its separate books, records and accounts, and prepare its financial statements. Additional steps need to be taken when not only are the assets to be deconsolidated from the originator, but also the SPE is to be deconsolidated from the originator group.
In an insolvency of the originator, the separation of assets belonging to the SPE is, subject to the rules on voidable transactions referred to in 1.1 Insolvency Laws, generally respected, provided that the SPE is set up and operated under its own name, conducts its business in its own name and does not hold itself out to be acting on behalf of the originator.
A legal opinion of Swiss counsel is typically obtained confirming that in an insolvency of the seller/originator, there will be no "substantive consolidation" of assets and liabilities of the SPE with those of the originator.
An important fact to keep in mind when structuring Swiss securitisation transactions is that, unlike for SPEs located in other jurisdictions, Swiss SPEs do not allow for segregation of assets within the same legal entity and thus, for multi-issuance structures, normally a separate SPE is set up for each new issuance of notes.
Perfection requirements to be complied with under Swiss substantive laws depend on the type of assets that are envisaged to be transferred to the SPE. Most importantly, for the assignment of claims governed by Swiss law, the assignment needs to be in writing and the transfer documentation needs to designate specifically the claims that are being transferred. This requirement applies to true sale transactions and secured loans. Failure to comply with the requirements may render the transfer of the relevant claims invalid.
Swiss law does not provide for a specific statutory regime allowing the creation of a bankruptcy-remote SPE. Therefore, Swiss transactions typically involve a number of contractual features to increase the bankruptcy remoteness of the SPE. Transaction documents usually provide that any rights and claims of transaction parties and investors against the SPE are limited to the amount available to satisfy the relevant obligations ("limited recourse"). This is necessary to avoid over-indebtedness of the SPE from an accounting/corporate law perspective in the event that the assets acquired by the SPE become impaired. In addition, contractual creditors of the SPE are usually bound by a "non-petition" provision whereby the transaction creditors consent that they will refrain from enforcing their claims against the SPE in a way that would lead to insolvency proceedings being instituted against the SPE.
Under current Swiss legislation, the taxes that are to be considered in connection with the transfer of financial assets from an originator and any intermediary operation companies or SPEs are Swiss federal withholding tax, Swiss value-added tax (VAT) and Swiss federal stamp duties.
Federal Withholding Tax
In the case of a securitisation structured as a true sale, the transfer of the financial assets from the originator and any intermediary operation companies or SPEs must be made for an arm's-length consideration, and in the case of a securitisation structured as a secured loan, the transferor must receive an arm's-length consideration for the security provided. If, in each case, the transferor does not receive an arm's-length consideration, the transferor is subject to 35% Swiss federal withholding on the difference between an arm's-length consideration and the consideration it actually receives.
As concerns Swiss VAT, in the case of securitisations structured both as a true sales or as secured loans, the transfer of financial assets itself does not normally constitute a taxable supply. The foregoing even applies if the contracts underlying the financial assets are transferred together with the financial assets (ie, the assigned claims) and the supplies under the contracts constitute taxable supplies. In such a case, only upon notification of the debtors will the originator be considered as having supplied to the transferee the assets for purposes of Swiss VAT and be liable for Swiss VAT on the transfer at a current (January 2021) rate of 7.7%. The originator can normally discharge the liability by notification. As a result of such a transfer, the transferee will itself become liable for Swiss VAT following the transfer in respect of any supplies continuing under such contracts.
Irrespective of whether a securitisation is structured as a true sale or a secured loan, the transfer of financial assets from the originator and any intermediary operation companies or SPEs should generally not be subject to Swiss federal stamp duty or similar transfer taxes in Switzerland. Only exceptionally, when the financial assets are classified as taxable securities for purposes of Swiss federal stamp duty and the transfer is structured as a true sale will Swiss federal stamp duty on the transfers of financial assets apply. In such a case, transfers will be subject to stamp tax at a rate of 0.15% of the consideration in the case of financial assets issued by an issuer resident in Switzerland and at a rate of 0.3% of the consideration in the case of financial assets issued by an issuer resident outside Switzerland.
In principle, a Swiss SPE's income will be subject to corporate income tax in Switzerland at ordinary effective tax rates between about 12% and 20% depending on the canton and municipality in Switzerland in which the Swiss SPE is resident. In addition, a capital tax of between 0.0001% and 0.03% on the taxable capital applies. However, since SPEs typically bear no risk from the securitisation, it is accepted under current tax practice that SPEs earn a marginal income and have a marginal capital only, and can pass on all risks and rewards from the assets held. Thus, if structured properly, a Swiss SPE is not subject to meaningful income or capital taxes in Switzerland.
Under the current Swiss tax legislation, interest paid in respect of notes issued by an SPE resident in Switzerland is subject to Swiss federal withholding tax at a rate of 35%. While Swiss investors are used to the Swiss withholding tax, there is a limited market outside Switzerland only for debt instruments subject to Swiss withholding tax despite most of the double taxation treaties of Switzerland providing for a full refund of the Swiss withholding tax deducted. For that reason, securitisations involving Swiss originators and foreign capital markets use structures allowing the issuer to make interest payments free of Swiss federal withholding tax. This typically requires relatively complex structures, which may include structures using two SPEs – ie, a foreign issuer SPE and a Swiss intermediary SPE. There are ongoing discussions to abolish the withholding tax on interest payments on bonds and debentures. However, it is unclear by when and how the system will be changed.
Under the current Swiss tax legislation, no other taxes arise in connection with securitisation transactions.
Swiss legal advisers are typically required to provide customary legal opinions, in particular on the non-consolidation of the transferred assets and/or the lack of substantial risk of (re)characterisation of the transaction as a secured loan and on the analysis regarding the bankruptcy remoteness of the transfer.
While the accounting analysis of a transaction is, in principle, carried out independently from the legal analysis, there are certain interdependencies. In particular, a favourable accounting treatment will, depending on the applicable accounting standards, require a sufficiently robust legal opinion confirming non-consolidation of the transferred assets and/or lack of substantial risk of (re)characterisation of the transaction as a secured loan. For banks and other regulated originators, additional requirements need to be met to allow for an off-balance sheet treatment of a securitisation transaction for regulatory capital purposes.
Swiss legal advisers are typically required to provide a legal opinion as set out in 3.1 Legal Issues with Securitisation Accounting Rules.
ABS transactions (just like any other debt and equity instruments publicly offered in Switzerland or listed on a Swiss exchange) are subject to the revised Swiss prospectus regime under the new Financial Services Act (see 4.2 General Disclosure Laws or Regulations).
Under the revised prospectus regime, which came into effect on 1 January 2020, subject to phase-in periods, issuers of ABS that are publicly offered or listed in Switzerland will become subject to the new prospectus rules. As a consequence, the prospectus relating to ABS will have to comply with the specific requirements set out in paragraph 3.7 of annex 2 of the Ordinance on Financial Services. In particular, the prospectus relating to ABS transactions will need to contain a summary of the key elements of the transaction structure and the risks associated with the purchase of the securities. In addition, the prospectus will need to contain:
Exemption to the Rule of Ex Ante Approval
As a general rule, the revised prospectus regime requires the prospectus to be approved by the competent approval authority prior to a public offering or an admission of securities to trading on a trading platform in Switzerland. However, with a view to not overly delaying the time to market for debt issuances, the revised law provides for an exemption to the rule of ex ante approval for certain debt securities to be specified in the implementing Ordinance on Financial Services. As a consequence, ABS structured as bonds or notes are likely to benefit from an exemption. Where the exemption applies, issuers must still ensure that the prospectus is available in line with the requirements of the Financial Services Act and published no later than the day on which the public offering commences or admission to trading is applied for, while the review and approval of the prospectus by the approval authority may take place ex post – ie, after the launch or completion of the offering. In order to be in a position to benefit from this exemption from the ex ante approval requirement, a Swiss bank or securities dealer will have to confirm in writing to the issuer that the key information regarding the issuer and the relevant securities is included at the time the prospectus is published. Yet, given the potential risk of having to deal with comments from the approval authority during or after the offering, it remains to be seen to what extent issuers and arrangers will rely on the possibility of an ex post approval of the prospectus.
Swiss law does not provide for any specific rule on credit risk retention or similar "skin in the game" requirements. As far as capital requirements for investors in ABS are concerned, Swiss law generally follows the approach taken by Basel III but allows for specific bank internal models to the extent that they have been approved by the bank's auditors. The Swiss Financial Market Supervising Authority (FINMA) may also request additional regulatory capital to be held for securitisation risk acquired by regulated financial institutions.
For issuers of ABS instruments listed on the SIX Swiss Exchange, the following disclosure requirements need to be complied with on an ongoing basis.
Regular reporting obligations include information on the issuer (eg, change of name, change of external auditors, change of reporting standards) as well as information concerning the securities (eg, amortisations, increases, restructuring of the issuer, issuer substitution, resolutions of general meeting of bondholders). Furthermore, issuers are, subject to certain exemptions, required to disclose information that relates to potentially price-sensitive facts (ad hoc publicity).
In addition, issuers of debt securities listed on a Swiss exchange are required to publish annual reports comprising audited annual financial statements in accordance with applicable financial reporting standards and the corresponding audit report, as well as semi-annual financial statements. Recognised accounting standards for issuers of debt securities include the International Financial Reporting Standards (IFRS), US Generally Accepted Accounting Principles (US GAAP) and Swiss GAAP FER, as well as standards pursuant to the Swiss Banking Act.
While certain exemptions from the listing rules can usually be obtained by SPE issuers (eg, with respect to the required financial track record of the issuer), issuers of ABS typically opt to issue periodic asset reports.
There is no specific Swiss regulation on rating agencies. However, in the case of supervised institutions including banks, in order to meet certain specific regulatory requirements (such as capital adequacy-related calculations), only ratings from agencies recognised by FINMA may be used. The requirements for recognition are set out in FINMA Circular 2012/1 'Credit Rating Agencies'.
Capital requirements for Swiss banks and securities dealers are set out in the Capital Adequacy Ordinance (CAO). As a general rule, Articles 49 et seq of the CAO provide that securitisation positions must be risk-weighted, with FINMA being competent to issue implementing provisions with respect to the risk weighting. The implementing provisions are contained in FINMA Circular 2017/07 'Credit Risk – Banks'. The basic rule set out in the Circular is that the Basel standards apply, including the 2016 Basel securitisation framework and rules relating to simple, transparent and comparable securitisations (STC securitisations) as well as Pillar 2 requirements (see Basel II framework paragraphs 784-807 and related amendments pursuant to the revisions to the securitisation framework of 11 December 2014, as further revised in July 2016 and amended by the rules on "capital treatment for short-term simple, transparent and comparable securitisations" of May 2018).
As far as the Basel rules provide for options over national implementation, FINMA Circular 2017/07 'Credit Risk – Banks' provides that banks may use a securitisation external ratings-based approach (SEC-ERBA) if the bank has the necessary expertise and an adequate internal process to verify ratings and rating methodologies applied, and applicable operational requirements are complied with.
There are no specific laws or regulations on the use of derivatives.
There are no specific laws or rules on investor protection.
See 4.6 Treatment of Securitisation in Financial Entities.
See 1.2 Special-Purpose Entities.
Swiss SPEs are typically structured so as not to become subject to Swiss financial market regulations, including anti-money laundering laws. The mere acquisition of assets and the issuance of debt instruments to finance that acquisition in the context of a securitisation transaction can normally be structured so as not to constitute an activity that would require a licence under Swiss financial market regulations.
Forms of credit enhancement used in Swiss securitisation transactions may, depending on specific transaction structure, include subordination (eg, a subordinated loan given by the originator/seller), over-collateralisation, cash reserves, guarantees and credit default swaps. As mentioned in 1.1 Insolvency Laws, any such credit enhancement elements need to be carefully analysed in light of the assessment of effective sale.
It is not typical for Swiss government-sponsored entities to participate in the securitisation market.
While there are no specific rules restricting the offering and sale of ABS to specific classes of investors, ABS are typically considered suitable for professional institutions and institutional investors, which is often reflected by a relatively high minimum denomination (eg, CHF100,000). Under new legislation that came into effect on 1 January 2020, subject to phase-in provisions, financial services providers offering or selling ABS to their clients will be subject to statutory point-of-sale obligations, including an obligation to perform suitability and appropriateness checks depending on the classification of the relevant client.
As far as institutional investors are concerned, applicable regulatory restrictions need to be observed. By way of example, for pension funds, the Ordinance on Occupational Retirement and Disability Insurance No 2 limits investments in ABS and synthetic securitisation transactions at 15% of the total investments. Similarly, in the case of insurance companies, the Insurance Supervisory Act provides for a cap of permissible investments in securitised assets at 10% of the assets of the regulation-affected assets of the insurance company.
The transfer and sale of assets is typically effected by way of an asset purchase agreement. The agreement usually sets out, among other things, eligibility criteria, the modalities of the transfer (including whether the sale relates to a revolving portfolio) and the perfection requirements. As mentioned in 1.3 Transfer of Financial Assets, perfection requirements depend on the type of assets that are sold to the SPE.
Representations and warranties given by the seller typically relate:
See 1.3 Transfer of Financial Assets.
Covenants of the seller frequently require:
The servicing agreement usually contains provisions relating to:
An important part of the servicing agreements are the provisions relating to the potential removal of the servicer upon the occurrence of a servicing termination event and appointment of the replacement servicer (see 6.4 Servicers).
Issuer and pool related event of defaults, depending on the type of issuer and underlying assets, are the principal defaults used in securitisation documentation.
Indemnity provisions typically provide that the seller shall hold harmless and indemnify the SPE from and against any damages, losses, claims, liabilities, costs and reasonably documented expenses incurred by the SPE in connection with any breach of obligations on the part of the seller of applicable laws or its obligations under the transaction agreements or relevant representations and warranties and covenants. The indemnity obligation in the servicing agreement usually extends to any failure by the servicer to comply with contractual terms regarding the transfer of collections to the SPE's bank account in due course.
The issuer (ie, the SPE) purchases the assets from the originator under the asset purchase agreement. The issuer therefore becomes the legal owner of the assets but typically delegates the servicing of the assets to the servicer, which is often identical to the seller/originator. In order to finance the purchase of the relevant portfolio of assets, the issuer issues ABS in the market that are usually unsecured but economically backed by assets held by the issuer.
As in other jurisdictions, the sponsor of an ABS transaction may be the originator (eg, the bank originating a loan portfolio), a parent company or any other group company responsible for managing the group's consolidated capital and liquidity situation.
In the case of a public offering of ABS, the notes are often placed in the market by one or more managers. The lead manager is typically involved in the structuring of the transactions and related discussions with rating agencies. Other, non-bank specialists may contribute to the structuring of the transaction without being involved in the underwriting.
The role of the initial servicer is typically performed by the originator/seller of the assets. The delegation is set out in the servicing agreement (see 5.5 Principal Servicing Provisions). The mandate of the seller usually requires the servicing of the assets in accordance with its own collection and enforcement standards. The servicing agreement regularly sets out specific servicing termination events (eg, insolvency proceedings initiated with respect to the servicer or material non-compliance by the servicer with the terms of the transaction agreements), in which case a replacement servicing needs to be appointed. With a view to limiting the risk that a replacement servicer will not be available, Swiss securitisation transactions sometimes provide for a servicing facilitator whose role is to look out for a replacement servicer should the need arise.
In the Swiss market, investors usually invest by directly acquiring the notes issued by the SPE in the offering.
Unlike in other jurisdictions, Swiss law does not provide for a trust concept. ABS transactions that are designed to be placed in the international market therefore sometimes provide for the involvement of a non-Swiss trustee and related concepts. That said, Switzerland has recently seen a trend towards more domestically oriented structures with a Swiss entity taking on the responsibilities of the trustee. In this case, concepts that are usually present under foreign trust laws need to be replicated contractually under Swiss law.
Synthetic securitisation is generally permitted in Switzerland.
The Swiss market has recently seen a number of transactions involving synthetic securitisation (ie, transfer of credit risk relating to an underlying asset portfolio by means of a derivative or similar instrument). Synthetic securitisations allow the originator to maintain the legal ownership of its assets, thereby entering the pool of eligible assets and facilitating the documentation and servicing process. The risk transfer may be achieved by way of credit default swaps, credit linked notes or similar (funded or unfunded) instruments. While synthetic transactions do not result in an off-balance sheet treatment of the relevant portfolio, they may, if properly structured, significantly reduce the risk-weighted capital requirements for banks holding the underlying portfolio.
There is no specific regulation of synthetic securitisation in Switzerland.
Synthetic Securitisation Structures
The risk transfer in synthetic securitisation transactions is typically achieved by way of a derivative (eg, a credit default swap). The derivative transaction is usually documented by way of a standard master agreement (often, an International Swaps and Derivatives Association master agreement) and pertaining annexes. In terms of regulations, the Swiss Financial Market Infrastructure Act (the Swiss equivalent to the European Market Infrastructure Regulation) provides for a number of obligations that apply to derivatives trading in general, including risk mitigation, reporting and margin rules. In structuring a synthetic securitisation transaction, the aim is usually to structure the transaction in such a way as not to fall within the scope of application of Swiss margin rules, since they are generally considered as overly burdensome for an SPE.
A transaction structure that is frequently used is the combination of a (funded) credit default swap (CDS) and the issuance of credit-linked notes (CLNs). In such a structure, the protection buyer (eg, a bank holding a loan portfolio) purchases credit protection under a CDS from the protection seller (ie, the SPE). In the CDS documentation, certain events are defined in relation to the underlying portfolio held by the protection buyer that will trigger a compensation payment of the SPE under the CDS. The SPE in turn issues CLNs to investors. Issuance proceeds from the CLNs are deposited with a bank and/or invested in low-risk marketable securities to provide funding for a potential compensation payment under the CDS. As a consideration for the credit risk protection provided, the protection buyer pays a periodic premium under the CDS to the SPE, which is used by the SPE to meet interest payments due under the CLNs.
In terms of risk-weighting of the counterparty risk under the CDS/CLN transaction, counterparty risk may be reduced to zero if the transaction is fully funded and the structure ensures that sufficient amounts will at all times be available to meet potential compensation payments under the CDS if and when due. However, since credit default swaps typically only cover part of the credit risk related to the underlying portfolio (eg, only the equity tranche), the regulatory capital required to be held against the underlying portfolio will be reduced, but normally not fully eliminated.
Also, in order to qualify as sufficient risk protection, the credit derivative will need to comply with a number of requirements set out in FINMA Circular 2017/07 'Credit Risk – Banks', which requires, among other things, that the contractual arrangement needs to be binding and enforceable under the laws of all relevant jurisdictions. Therefore, originators looking to benefit from synthetic risk securitisation typically obtain legal opinions confirming the aforementioned aspects.
To date, the most common financial assets securitised include auto lease receivables, credit card receivables, mortgage loans and trade receivables.
While relatively homogeneous assets (credit card receivables, auto lease receivables, mortgage loans) are often included in true sale transactions, more heterogeneous portfolios such as corporate loan portfolios originated by banks are more typical in synthetic securitisations.
The year 2020 has been a very challenging one in many respects. Like others around the globe, Swiss capital markets have been heavily impacted by the COVID-19 pandemic. However, following very difficult weeks in March, April and May 2020, markets picked up again and a fair number of securitisation transactions have since come to market in Switzerland. Also, there have been very few securitisation transactions with Swiss underlying assets that became distressed. There are a number of other hot topics that will be relevant for securitisation markets in the upcoming months and years.
The COVID-19 Pandemic
General situation in Switzerland
More recently, the emergence of the novel coronavirus (SARS-CoV-2) and related respiratory disease (COVID-19) has had an adverse impact on the Swiss economy in general, even though it has been less affected than others. Swiss GDP dropped by 8.2% in Q2 2020 as compared to the Q2 2019, but was only 2% lower in Q3 2020 as compared to Q3 2019.
On 16 March 2020, the Swiss Federal Council declared Switzerland to be in an "Extraordinary Situation" pursuant to the Swiss Epidemics Act and introduced measures to protect the public from COVID-19. Measures included the closing of shops, bars, restaurants and entertainment and leisure facilities until 19 April 2020 and beyond. Schools were closed and public and private events were prohibited until June 2020. Whilst most measures were relaxed during June until October, the second wave hit Switzerland quite severely in November and December and certain restrictions were reimposed.
In addition, the Swiss government passed various regulations in response to the pandemic, including measures to avoid bankruptcies of businesses which may arise as a consequence of the COVID-19 pandemic (eg, availability of an emergency moratorium for small and mid-cap size businesses of up to six months, subject to less formal requirements than a general composition moratorium, temporary standstill measures and others). In addition, a COVID-19 loan programme has been established under which bridge loans have been made available, which are backed by Swiss governmental guarantees. According to publicly available information from the Swiss government, CHF16.9 billion of Swiss COVID-19 loans had been granted by the end of July 2020. As of December 2020, there is an ongoing debate as to whether or not the programme should be resumed.
Impact of the COVID-19 pandemic on portfolios
Since the outbreak of the COVID-19 pandemic, originators that issue ABS to the Swiss capital market as well as investment banks have monitored the relevant portfolios very closely. However, in the consumer lending space, the number of reminder letters sent out to customers remained stable and no increase in delinquency rates has been identified so far. Default rates are, for most originators, even at record lows. It remains to be seen, whether this will remain the same during the second or even a third wave.
Still, the outbreak of the COVID-19 pandemic had a massive impact on the ability of originators to originate new assets, but only during the months of March, April and May 2020. Since essentially all structures in Switzerland are revolving transactions, originators in Switzerland started working on contingency plans for the purposes of ensuring a proper replenishment of the portfolios, or for the purposes of allowing the substitution of assets by cash in larger amounts. However, already in June 2020, business picked up quite heavily and portfolios started to grow again. In the auto lease sector, June, July and August 2020 have been record months for some originators. Accordingly, public ABS transactions proved to be very robust, even during the crisis and the situation in Switzerland appears to be under control so far.
Response of capital markets to the COVID-19 pandemic
Capital markets in Switzerland reacted quite dramatically and, as in most European countries, April and May 2020 were very difficult months for the Swiss capital markets in general. However, already in June 2020, the first public ABS transaction since the lockdown was successfully marketed in Switzerland, followed by further auto lease ABS transactions in October and November. Whilst coupons have been higher than in previous transactions, it was important for originators and the market more generally that these transactions were successfully placed.
Focus of rating agencies
Recently, during the structuring process of the latest Swiss ABS transactions, rating agencies have had a strong focus on the collection policies around granting payment holidays to customers and on governments imposing mandatory payment holidays through emergency legislation.
So far, the Swiss government has not imposed emergency legislation that would impose obligations on originators to grant payment holidays to private customers or businesses. Also, it appears that voluntary payment holidays have been granted by originators only in very exceptional cases. Finally, payment holidays have been granted such that the underlying credit arrangement would not be extended. Rather, instalments have been shifted by a couple of months. Accordingly, deal structures have accommodated rating agencies' concerns over recent transactions.
New Prospectus Requirements under the FinSA
Another novelty in the Swiss market is the new prospectus regime that applies as from 1 December 2020 and that has been introduced by the Federal Financial Services Act (FinSA).
In a general attempt to bring the Swiss regulatory framework in line with international regulations, such as MiFID II and the EU Prospectus Directive, the Financial Market Infrastructure Act (FinMIA), the FinSA and the Financial Institutions Act (FinIA) replaced major portions of the existing regulations. The FinSA and the FinIA entered into force on 1 January 2020 along with the explanatory Financial Services Ordinance (FinSO, relating to the FinSA) and the Financial Institutions Ordinance (FinIO, relating to the FinIA).
For the first time in Switzerland, the FinSA introduces a new comprehensive prospectus regime that covers and harmonises disclosure requirements for different types of financial instruments and establishes a level playing field with the EU Prospectus Directive. This also affects the issuance of instruments to the capital markets in securitisation transactions.
According to the FinSA, "any person offering securities for sale or subscription in a public offering in Switzerland or any person seeking the admission of securities for trading in a trading venue as defined in the FinMIA must first publish a prospectus".
The most important novelties introduced by the FinSA in relation to the prospectus requirements are the following.
Exemptions are based either on the type of offering, the type of securities offered or, in the case of the admission to trading only, related to the admission.
Type of offering
No prospectus is required if securities are offered:
Type of securities
No prospectus is required in the case of exchange of equity securities, offerings in the context of a merger, spin-off, conversion or asset transfer transaction (to the extent equivalent information is available) or in case of offerings to executives or employees.
Finally, certain exemptions apply for admissions to trading.
Under the newly introduced prospectus pre-approval regime, the FinSA grants the Swiss Financial Market Supervisory Authority FINMA the authority to designate and grant licences to the reviewing bodies for prospectuses. Only on 1 June 2020, FINMA designated and granted a licence to each of BX Swiss AG (the Berne Stock Exchange) and SIX Exchange Regulation AG (Zurich) to act as prospectus review body. Hence, even though in force since 1 January 2020, the mandatory pre-approval process applies only once a six-month period lapsed following 1 June 2020 as per the transitional provisions of the FinSA. Nevertheless, some issuers have recently already gone through the approval process.
A substantial number of Swiss franc bonds are trading at negative yields in secondary markets, but hardly any ABS issuers were able to issue Swiss franc debt securities to primary markets at negative yields. In fact, it was only Multilease AG that was able to place its latest ABS transaction at a negative yield just before the COVID-19 pandemic crisis. Investment bankers close to the industry are of the view that the main reason for this is the fact that ABS are not included in the list of eligible collateral for repo transactions with the Swiss National Bank (SNB). The discussion is not only linked to the portfolio quality and the risk profile and rating, but also to the liquidity of the securities. There is still a hope that the SNB will accept ABS as eligible collateral at some point and follow the position of the European Central Bank (ECB) and other central banks. This would broaden the investor base substantially.
Negative Interest Rates
Swiss markets continue to be driven by the negative interest environment. Since January 2015, the Swiss National Bank (SNB) has charged negative interest on bank deposits (currently minus 75 basis points). Even though interest rates have increased in the US market in the interim, it cannot be expected that rates will rise in Switzerland in the near future, given the dependence on the euro markets. The SNB policy rate (which substituted, as from 13 June 2019, the target range for the three-month LIBOR used previously) remains at -75bps. In the last couple of months, the three-months LIBOR CHF fluctuated between -70 bps and -80bps, but was as low as -85bps in late August 2019.
Structural challenges as a consequence of negative interest rates and mitigants
Structurally, rating agencies have become more and more concerned about negative interest rates being charged on transaction accounts. Negative interest rates exert downward pressure on cash amounts or eligible investments held within a deal structure. However, rating agencies generally consider this impact to be negligible because cash amounts tend to be small compared to the note amounts. Still, for deal structures with higher cash amounts standing to the credit of reserve accounts, deposit accounts or similar accounts, rating agencies kept a close eye on the account bank arrangements. Account banks normally refuse to agree to a floor on their interest rates, given the exposure they have themselves to fluctuations in interest charged by the SNB on bank deposits.
As a consequence, structural features have been developed to address negative interest rates. As an example, some originators structured the transaction to avoid high cash amounts by accepting lower advance rates on the asset pool, which results in lower reserve amounts being required.
Also, account banks are sometimes willing to offer account products with more attractive interest rates. However, these accounts normally provide for longer notice periods for withdrawals. Therefore, the structuring process for the account mechanics are relatively challenging, as longer notice periods are normally of concern in light of liquidity requirements. Therefore, the reserve and deposit cash amounts that are permitted to stand to the credit of such special accounts are typically subject to rather complex calculation and monitoring mechanisms.
Withholding Tax on Bonds and Other Collective Debt Financings
Unlike most other countries, Switzerland does not levy withholding tax on interest paid on private and commercial loans (including on arm's-length inter-company loans). Rather, 35% Swiss federal withholding tax is levied on interest paid to Swiss or foreign investors on bonds and similar collective debt instruments issued by or on behalf of Swiss resident issuers (such as Swiss ABS), as well as on interest paid by Swiss banks.
International capital markets do not typically respond well to bonds subject to Swiss withholding tax. Therefore, the investor base is relatively often limited to Swiss investors, or, in the case of Swiss multinational groups, bonds are issued through a foreign subsidiary. However, the Swiss Federal Tax Administration (SFTA) reclassifies such foreign bonds into domestic bonds if the amount of proceeds used in Switzerland exceeds certain thresholds (ie, the combined accounting equity of all non-Swiss subsidiaries of the Swiss parent company and the aggregate amount of loans granted by the Swiss parent and its Swiss subsidiaries to non-Swiss affiliates).
In order to prevent Swiss federal withholding tax from being imposed on normal loans (in contrast to bonds triggering such tax anyway), credit facility agreements entered into by a Swiss borrower, or a non-Swiss borrower under a guarantee from a Swiss parent company, must contractually restrict free transferability and syndication by invoking the so-called "10/20 non-bank rules" and stating that:
In the context of securitisation transactions, this is relevant in the case of single investor transactions and transactions with very few investors (less than 10), ABCP transactions that are refinanced through a single multi-issuances platform.
Fundamental changes envisaged by Federal Council
The Federal Council will, in response to its consultation document, submit a request to Swiss Parliament that withholding tax on bonds be abolished. The corresponding message to the Federal Assembly will likely be issued in Q2 of 2021.
On 3 April 2020, the Federal Council opened the consultation process for the withholding tax reform. The purpose of this proposal is twofold. On the one hand, the Swiss debt capital market (including ABS and covered bonds) should be strengthened. Issuers domiciled in Switzerland should be given the opportunity of raising debt capital from within Switzerland on competitive terms and conditions. To this end, Swiss issuers and all foreign investors should be exempt from withholding tax on interest.
On the other hand, the safeguard purpose of the Swiss withholding tax should be extended at the domestic level. For natural persons resident in Switzerland, withholding tax on interest should continue to be levied (as a backup tax) and be imposed on foreign bonds and other securities. Technically, this would require a change to the so-called paying agent principle, under which the paying agent (usually a bank) levies the withholding tax due, in accordance with the investor's status.
During the consultation process, many participants have supported the desired strengthening of the Swiss debt capital market and the necessary exemption of domestic legal entities and foreign investors from withholding tax. However, there was some controversy around withholding tax as a means of securing taxes due from natural persons living in Switzerland. The Federal Council's proposal was deemed to be administratively burdensome by various parties, especially in the area of foreign collective investment schemes. These parties advocated a solution that was easier to administer.
On 11 September 2020, the Federal Council changed its course and set out its policy. It decided to go ahead with the reform and continue strengthening the Swiss debt capital market. However, in light of the consultation process, the Federal Council has decided to discontinue its backup withholding tax system in relation to interest on bonds and other collective debt financings paid to individual persons resident in Switzerland.
Rather, it has requested Parliament to abolish withholding tax on interest in its entirety on bonds and suchlike (excluding bank deposits of natural persons resident in Switzerland).
The Federal Council is expected to present its dispatch to Parliament in Q2 of 2021. Once this has been adopted, it will also decide on the remaining key issues of the reform. This concerns the abolition of securities transfer tax on domestic bonds, which was also proposed during the consultation.
The abolition of Swiss withholding tax on bonds and other collective debt financings should significantly strengthen Switzerland’s position as financial market and treasury centre. All types of financing and refinancing activity in Switzerland (eg, raising of capital via bond issuances, crowdfunding platforms, ABS structures and other capital market transactions) will be facilitated. This fundamental change to the Swiss withholding tax regime is expected to come into force not before 1 January 2022.