Pitfalls for Swiss industrial companies in derivative trading

FMIA as part of global derivative regulation
Since 1 January 2016, the Swiss Financial Market Infrastructure Act (FMIA) has been in force. Among other things, the FMIA implements the worldwide regulation of the derivative market in Switzerland, which was the intention of the G20 summit in Pittsburgh in 2009. It contains numerous obligations for Swiss companies both in and outside the financial sector. With its Guidance 5/2017, FINMA extended the transitional periods for the fulfillment of the mandatory derivative reporting obligation in accordance with the FMIA for so-called NFC- until 1 January 2019. What does this mean for Swiss industrial companies?

The FMIA is particularly also demanding for industrial companies
Contrary to what its name suggests, the FMIA does not only apply to traditional financial market participants such as exchanges, central counterparties (CCPs), payment systems and other financial market infrastructures. Rather, the FMIA is directly relevant for the many Swiss industrial companies outside the financial sector (so-called non-financial counterparties, "NFCs").

Although the FMIA provides many exceptions and simplifications for these market participants. This applies in particular to small and medium-sized industrial enterprises (so-called "NFC-"). For example, neither the clearing obligation nor the platform trading obligation apply, while the risk mitigation obligation is limited (no exchange of collateral, no valuation of outstanding transactions). However, the obligation to report derivatives (Art. 104 et seqq. FMIA) covers all derivative transactions of all large and small financial and non-financial counterparties domiciled in Switzerland without exception. However, if the counterparty is a bank or a securities dealer, this obligation (which is designed to provide transparency for the regulator) is, in principle, to be fulfilled by this so-called Financial Counterparty ("FC").

First, check whether derivative transactions are being made – then resolution or doc-ument procedures
The term "derivative" is very broad and covers all financial contracts whose value depends on one or more underlyings and which are not spot transactions. Derivative transactions, in this sense, are not only carried out by traditional financial market participants and large companies, but can also be used in practice by smaller industrial companies (NFCs), e.g. swaps to hedge the interest rate risks of a credit agreement or currency risks in export transactions.

In order to fulfill its obligations under the FMIA, each Swiss company must first check carefully whether it is carrying out derivative transactions. If no derivative transactions are actually made, this must be recorded in writing in a resolution. Responsibility for this lies with the board of directors of a corporation (Ltd) or the management of a limited liability company (LLC).

If it transpires that derivative transactions are (will be) carried out, the procedures must be documented in writing to ensure the implementation of the obligations under the FMIA in connection with derivative trading. Typically, an internal directive is drawn up.

Since 2017 (for the financial year 2016), the statutory auditors have been checking whether Swiss companies comply with their derivative trading obligations. If the auditors find any violations, they set a deadline for rectification. Repeated violations or non-timely remedies must be reported to the Federal Department of Finance (FDF).

Attention: report to Swiss or foreign trade repository?
If an NFC- concludes a derivative transaction with a Swiss bank, the bank must make a FMIA-compliant derivative report to the trade repository. To date, FINMA has approved a Swiss trade repository (SIX Trade Repository AG, Zurich) and has recognized a foreign trade repository for reporting under FMIA (Regis-TR S.A., Luxembourg).

On the other hand, if an NFC-'s derivative transaction is concluded with a foreign bank (e.g. with registered office in the EU), the bank will make a derivative report but, as a rule, only to the foreign (EU) repository in accordance with the foreign law applicable to it (EMIR). Practice shows that the foreign bank usually does not (not even additionally) report to a FINMA-approved trade repository. The notification to a trade repository that is not approved by FINMA, albeit to one that is approved under EU law, does not suffice for the fulfillment of the obligations under the FMIA from the point of view of Swiss law.

Exactly this sort of handling led in practice to greater difficulties for the NFC- in implementing their reporting obligation, as FINMA noted in its Guidance 5/2017. In many cases, there was the expectation that the foreign FC would, with its derivatives declaration to an EU trade repository under EU law, be complying with the reporting requirement of the Swiss NFC- according to FMIA. The derivative reporting requirement according to FMIA therefore remains unfulfilled for many Swiss NFC-, a fact of which they are often unaware.

Derivative reporting obligation according to FMIA starts for NFC- new from 1 January 2019
FINMA has correctly recognized that the NFC- now need more time to prepare themselves for the implementation of their reporting obligation in accordance with FMIA. FINMA has therefore complied with the often-expressed request to extend the existing transition period for derivate reporting (see Art. 130 FMIO) by nine months to 1 January 2019. NFC- must therefore report open derivative transactions in accordance with FMIA from 2019 at the latest, whereby derivative transactions between two NFC- (which is likely to be rare in practice) need not be reported.

Swiss companies are advised to carry out the pending check carefully (if this has not already been done) and, if (even a single) derivative transaction is conducted, they should prepare an internal directive. They are also required to prepare themselves for the fulfillment of the derivative reporting obligation under FMIA to the Swiss trade repository (SIX Trade Repository AG) or the only currently approved foreign trade repository (Regis-TR SA). These actions should be carried out without delay.

Authors: Jana Essebier, Peter Kühn