FIDLEG SOLUTION - News 10/2019

When do I have to do an appropriateness test and what does exactly need to be assessed?

THE CURRENT STATUS OF THE ACTS AND ORDINANCES

The new Financial Services Act (FinSA) and the implementing Financial Services Ordinance (FinSO), the final version of which is expected to be released on 6 November, 2019 contain several new duties of conduct for those providing financial services. During the legislative process, of all these new duties, the duty to run a suitability test and the duty to run an appropriateness test caught the most attention. For this reason, this FIDLEG SOLUTION News 10/2019 explains in detail, when an appropriateness test needs to be done and what exactly needs to be assessed hereunder.

In a next, separate FIDLEG SOLUTION News, we will analyze as well the suitability test.

THE STATUTORY BASIS OF THE APPROPRIATENESS TEST

The duties of conduct to be observed when providing financial services are set out in art. 7 - 20 FinSA and are specified in art. 6 - 22 of the draft FinSO.

For its part, the appropriateness test is based on art. 11 and 13 FinSA and art. 16 of the draft FinSO.

Of the legislative materials, the pp. 8920, 8921, 8932 and above all 8956 – 8959 of the message of the Swiss Federal Council are relevant (here). It should be noted here, however, that the explanations on duties of conduct in the final version of the FinSA differ substantially from those in the message.

As we all know, the appropriateness test is not at all a helvetic invention. Like many other things in FinSA, it is an adoption from MiFID II (Directive 2014/65/EU), where it is regulated in whereas-clause 71 and in art. 25(2). However, MiFID II does not speak of an appropriateness test, it rather uses the term suitability test for both duties which under Swiss law are known as appropriateness test and suitability test.

WHEN IS AN APPROPRIATENESS TEST TO BE PERFORMED?

Pursuant to art. 11 para. 1 FinSA, the appropriateness test is to be carried out if investment advice is provided to a client for individual transactions without taking account of the entire client portfolio. This includes several restrictions:
On the one hand, an appropriateness test must only be carried out for investment advice, but not also for other financial services pursuant to art. 3 let. c FinSA, i.e. not for (i) the acquisition or disposal of financial instruments pursuant to cipher 1, (ii) the receipt and transmission of orders in relation to financial instruments pursuant to cipher 2, (iii) not for administration of financial instruments (portfolio management) pursuant to cipher 3 and not (iv) for the granting of loans to finance transactions with financial instruments pursuant to cipher 5.

On the other hand, the appropriateness test may only be carried out in the case of investment advice which is limited to individual transactions. If, however, a client is advised with regard to all or part of the client's portfolio, which include more than just one transaction, no appropriateness test is to be carried out.

This does not mean, however, that in such cases there is no need to carry out any duty of conduct at all. Rather, these cases must also be subject to conduct obligations and it must be made sure that the services rendered are appropriate - but not by way of the appropriateness test pursuant to art. 11 FinSA.

No appropriateness test is required for pure execution-only and reverse-solicitation transactions, since in these cases no financial service is provided at all (art. 13 FinSA).

Likewise, no appropriateness test is required if the counterparty is an institutional client pursuant to art. 4 para. 4 FinSA (art. 20 para. 1 FinSA). Professional clients, however, cannot waive the appropriateness test (art. 20 para. 2 FinSA e contrario). For information on institutional and professional clients, see FIDLEG SOLUTION News 5/2019 here.

Finally, no appropriateness test has to be carried out if the advice does not relate to a financial instrument but, for example, to an issuer, to market or interest rate developments, etc.

WHAT EXACTLY IS TO BE ASSESSED UNDER THE APPROPRIATENESS TEST?

Under the appropriateness test, the investment advisor must inquire about the client's knowledge and experience. Based on what is gained by way of this inquiry, the advisor must ensure that the financial instrument is appropriate for the client. A financial instrument is appropriate if the client can classify it, i.e. if he and she can assess the risks and opportunities, but also the characteristics of the financial instrument.

If it turns out that a client cannot classify a certain financial instrument with his knowledge and experience, this does not mean that the client cannot acquire this financial instrument. The investment advisor has the opportunity to inform the client about the risks and opportunities. The advice provided can therefore make up for the lack of knowledge and experience. However, the financial service provider is obliged to provide evidence of this, i.e. he or she must be able to prove that it has made up for this lack of knowledge and experience.

It is also possible that the investment advisor cannot make up for the lack of knowledge and experience, but the client still wants to acquire the financial instrument. In this case, the investment advisor has no other option than to advise against the acquisition and to record this in writing so that he can prove it.

It is not uncommon for the client to be additionally represented, e.g. by a custodian, a lawyer or another advisor. In this case, the knowledge and experience of the representing person may also be taken into account and can be attributed to the client (art. 16 para. 1 draft FinSO).

AND WHAT ABOUT THE DISTRIBUTION OF FINANCIAL INSTRUMENTS?

A still open question is what the situation is with regard to the disrribution of financial instruments, e.g. in the distribution of collective investment schemes.

It is only in the final version of the FinSO where it will (hopefully) be clarified whether pure distribution constitutes a financial service and falls under art. 3 let. c cipher 1 FinSA. If this is not the case, no appropriateness test must be carried out for pure distribution activities, otherwise it is.

However, if by way of the distribution of a financial instrument the target person also advised with regard to this financial instrument, an appropriateness test must be carried out on the basis of the advice provided.

WHAT IS THE RISK IF THE ADEQUACY TEST IS VIOLATE?

The question arises as to what threatens to result from a violation of the appropriateness test, i.e. if no appropriateness test is made or if the appropriateness test is not made correctly.

On the one hand, the investment advisor has violated the FinSA, i.e. regulatory law, and there is a risk of enforcement proceedings and, if necessary, that the person responsible does not meet the fit and proper test any more.

In addition, art. 89 FinSA contains a penal provision that sanctions precisely this conduct: According to art. 89 letter b FinSA, a fine of up to CHF 100,000 will be imposed if the obligation to conduct an appropriateness test is intentionally violated in a serious manner.

Finally, it is to be assumed that the investment advisor will thereby violate his contractual obligations and becomes liable to pay compensation to the client.

THERE IS MORE TO COME…

The next issue of FIDLEG SOLUTION will deal with the suitability test according to FinSA, which under FinSA will be mandatory for every asset manager.

Your FIDLEG SOLUTION Team
www.fidlegsolution.ch


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