In 2021, Switzerland was home to around 384 FinTech companies. Although this was a decline of 21 compared to 2020, the median number of employees and average total funding for such FinTech companies increased in 2021, according to the FinTech Study 2022 of the Lucerne University of Applied Sciences and Arts.[i]
Also, the financing rounds went up from 61 with a total investment amount of CHF 259 million to 87 with a total investment amount of CHF 446 million.[ii] Data with analytics, big data and artificial intelligence have been the main drivers of the FinTech sector and we have seen interesting projects in the focus areas of web 3.0, in particular with non-fungible tokens (so-called NFTs) and metaverse, digital wealth management, in particular with trading bots, trading signals and algorithmic trading, as well as advancement of core financial institutions regarding combination of fiat- and cryptocurrencies within the same licence, as well as tokenising financial instruments. In particular, the latter have also seen a push because of the entering into force of the new legislation on distributed ledger technology (DLT Act) as of 1 February 2021 and 1 August 2021.
Tokenised Financial Instruments
The DLT Act introduced the possibility to issue and transfer ledger-based securities exclusively by a technical transfer on a blockchain or distributed ledger, which will be recognised as legally valid even without physical transfer of a document or paper (required for certificated securities); and/or a written assignment (required for simple uncertificated securities); or a booking implemented by a central securities depository (required for book-entry securities).
All rights that can be certificated in securities up to now can also be structured as ledger-based securities, i.e. in principle, all contractual rights including, in particular, receivables as well as shares in corporations. Therefore, tokenisation has become a lot easier since the introduction of the DLT Act in February 2021.
Hence, in the last months the interest in tokenising ordinary financial instruments has risen strongly as it enables direct trading on the blockchain (almost) in real-time and without the involvement of the banking system: all that is required is a mobile phone with access to a wallet. However, the biggest interest is not with the issuers of the financial instruments themselves as of yet, but on the secondary market with third-parties re-issuing ("re-packaging") existing financial instruments on the blockchain. Therefore, they often use what is known in Switzerland as structured products, where they issue new debt instruments tracking the ordinary financial instrument and are being issued in the form of ledger-based securities in accordance with Swiss law. A big breakthrough of directly issued tokenised instruments is expected in the coming years when fully regulated financial market infrastructures for tokenised instruments will be established on a broader basis; also, the new Swiss DLT trading platform licence will play its part in this new world.
Digital Wealth Management
Digital wealth management has been encouraged for several years. In particular the client onboarding and KYC-processes have been further automated and digitised thanks to continued updates of the Swiss regulator FINMA’s regulations on video- and online-identification, which made it economically more attractive. Further, the rise in popularity and the enlargement of the product offerings in exchange traded funds (ETFs) increased various algorithmic management offerings based on standardised ETF products, not only in classic management mandates with minimum investment amount requirements getting smaller and smaller, but also in the sector of voluntary Swiss pension plans (so-called pillar 3).
Further, there are more and more sophisticated models with providers of trading signals to established financial institutions. As such, trading signal providers do not need any financial market licence in most cases; this is because they do not know the specific end-client portfolios but deliver their signals on general expectations of its client regarding the market development of a specific security. Finally, social trading is still in vogue as there are views in the market that such activity is unregulated because despite the traders being followed by the users, the traders only trade based on their own criteria but do not know and do not want to know the interests and preferences of the users copying their trading behaviour.
Combining Web 3.0, Fiat- and Cryptocurrencies Within One Licence
In 2021, the legislator wanted to provide a level of protection for investors in crypto-based assets held in collective custody (i.e. in pooled custody wallets) similar to the banking regulation, and therefore made them subject to the FinTech licence. In contrast to the conventional FinTech licence for public deposits, the licence for crypto-based assets held in collective custody does not have a CHF 100 million limit, but the catalogue of exceptions is explicitly restricted to settlement accounts, accounts of state-supervised companies, and institutional investors with professional treasury operations.
This FinTech licence recently gained the interest of several projects as it allows – similar to the higher banking licence in Switzerland – the combination of fiat- and cryptocurrency custody business within one licence. Some projects even take this advantage a step further to introduce web 3.0 banking characteristics where the client can use his account balance either as fiat or as the respective stablecoin on the blockchain, i.e. he can use his balance in the shop nearby, in the metaverse for buying an NFT-based purse or to make an instant payment to the wallet of a friend.
Swiss Association For DAOs
With Decentralised Autonomous Organisations (DAOs), the community exercises control over the project through its tokens, e.g. use of funds, change of the protocol’s functionalities and execution of predefined smart contracts. Hence, the community with its voting rights through tokens replace certain governing bodies as in traditional organisations. While a DAO cannot currently be constituted under Swiss law, its effects may well be recognised thereunder and very often it would qualify as a simple partnership with unlimited liability and tax consequences. Many projects do therefore combine the DAO with the legal entity form of the Swiss Association, as the Swiss Association is a very flexible entity type which can be tailored to the specific needs of a project. In particular, the Association’s members elect a board of association, but it is up to the founding members to define the powers of the members and the board in the articles of association. Further, liability is limited to the Association's own funds and the DAO in the form of an Association has full legal personality and can therefore also enter into agreements.
Last but not least, there are many projects entering into the metaverse by either buying landmarks in existing platforms like Decentraland or Sandbox, or by even creating their own metaverse. Many things within this metaverse, such as cars, purses, nice outfits and art are being linked by hash values to NFTs, which ideally will become standardised in order to take them to other metaverses simply by connecting the wallet. It also involves the continuance, further development and wider adoption of in-game articles like rewards, better swords, fancier and faster cars and making them transferable between different games. All these NFT-based and software-based aspects are less in focus of financial market regulations than intellectual property matters. However, by dividing an art piece into one hundred pieces, it must be differentiated, if you own one specific individual piece, e.g. the piece D4, or if you own 1/100 of the painting: in the latter case, there are 100 identical pieces qualifying as security under Swiss law. In the first case, you have individual pieces not qualifying as financial instrument.
Whereas the new DLT Act that entered into force last year enabled various tokenisation cases on a broader base and extended the FinTech licence to become an interesting instrument for combining crypto with fiat and even bringing it to the Web 3.0 world, several incremental updates of the FINMA regulations regarding video- and online-identification allowed for further digitalisation and efficiency leading to lower onboarding costs. As in other nations, many NFT- and metaverse projects are in the making. Previously fully unregulated DAOs are searching for legal certainty by combining with a Swiss Association, allowing them to limit liability and even enter into legally valid agreements. Further, digital wealth management is still popular in different shapes, be it providing trading signals only without a licence, putting into place social trading platforms profiting from low regulations, or by implementing more ordinary but more effective discretionary mandates based on standardised strategies with ETFs and even in voluntary pension plans. The possibilities in the Swiss FinTech sector seem to be more diverse than ever and it remains to be seen which specific sector will establish itself in the long term.
[i] Lucerne University of Applied Sciences and Arts, FinTech Study 2022, p. 5 (found on 19 August 2022 under: https://blog.hslu.ch/retailbanking/files/2022/03/IFZ-FinTech-Study-2022.pdf).
[ii] Lucerne University of Applied Sciences and Arts, FinTech Study 2022, p. 61 (found on 19 August 2022 under: https://blog.hslu.ch/retailbanking/files/2022/03/IFZ-FinTech-Study-2022.pdf).
Dr. Reto Luthiger, Attorney-at-Law
Reto Luthiger is a Partner with MLL Legal and Co-Head of the Regulatory, FinTech & DLT Team. He is a financial market regulatory as well as a DLT/blockchain specialist. He advises and represents domestic and international clients in financial markets regulatory and civil law matters as well as proceedings before FINMA, self-regulatory organisations (SROs), supervisory organisations (SOs) other authorities and courts. He has wide-ranging experience in banking, securities brokerage, anti-money laundering, financial services, financial markets infrastructures and collective investment schemes as well as FinTech, InsurTech and DLT/blockchain.