FIDLEG – Mission, Challenge and Opportunity

FIDLEG, the Swiss Federal Council and Parliament’s response to the European regulations to strengthen investor protection (MiFID II and PRIIPs), fits seamlessly into the mission of regulators around the world to respond to the shock of the financial crisis of 2008. It is safe to say that these regulations combined are having the biggest impact to date on the business of wealth managers and private banks as well as on their interaction with clients. In particular, they have legal implications that should not be underestimated. This article will further elaborate on the impacts.

There have been three main waves of regulation since 2007. The first was mainly aimed at reducing the risk of contracts concluded directly between banks (over-the-counter (OTC) products). Products like these were one of the main reasons for the domino effect that started with the bankruptcy of the Lehman Brothers investment bank and led to the near collapse of the global financial system. The EMIR (EU) and subsequent FinfraG (CH) regulations introduced a strict reporting regime to the regulators for this type of trading.

A second wave was intended to tighten international fiscal control and was initiated by the USA with FATCA. A further 100 countries, including Switzerland, followed suit and adopted the AEOI (Automatic Exchange of Information) standard, which came into force in January 2017.

The third wave strengthens investors’ rights and aims to provide full transparency on both risks and costs while further reinforcing the infrastructure of the financial industry. On the heels of the EU’s MiFID II and PRIIPs regulations, which came into force on 3 January 2018, Switzerland intends to have its equivalent regulation (FIDLEG) take effect as of 1 January 2020.

FIDLEG objectives and structure

The goals and the structure of FIDLEG closely follow those of MiFID II and PRIIPs, the latter defining the key information documents (KID) as highly standardized product handouts to be distributed to clients during the sales process. The main purpose is to ensure that customers are only offered products that are suitable and in line with their knowledge, experience, risk appetite and investment objectives. The customer further receives standardized and detailed information about the proposed product, the risks, costs (product costs as well as service costs), and what to do if they feel they are being misled.

Most notably, if a client suffers losses and deems that the bank failed to meet its suitability, product information or documentation obligations, they are well positioned to seek recourse via the courts and obtain compensation for any losses incurred. This, of course, adds to the urgency of a robust implementation plan and execution.

As they serve both Swiss and European clients, Swiss banks and wealth managers will seek to be compliant with both FIDLEG and MiFID II. They will choose an optimal hybrid approach, a mix between the two regulations that best suits their client base and business model.

Impact of FIDLEG

Aimed at client relationship management, which is the very core of wealth management and private banking, FIDLEG is reshaping all aspects of the business:

• Risk management: As stated previously, banks will be exposed to civil risks towards their clients if they do not meet their regulatory obligations. This reflects risks incurred by the client against the market and therefore has no theoretical financial cap.
• Compliance: This function has a key role to play in defining suitability rules. Compliance is responsible for monitoring end-to-end client interaction, from acquiring client information during onboarding and matching product information during marketing and sales processes to ensuring the correctness of all client reports. These requirements should ideally be supported and enforced by technical frameworks.
• Business: The additional compliance costs, especially for complex products, can have an impact on profitability leading to a revised product portfolio. The cost transparency prescriptions, especially as service costs must now be disclosed separately, may have a significant impact on a bank’s service offering structure and pricing.
• Advisors/RMs: The new suitability requirements result in increasingly complex interaction between advisors/RMs and their clients. This adds to RMs’ already high workload and may result in greater dissatisfaction for both RMs and clients. Just like for compliance, appropriate technical and business frameworks can be very beneficial.
• IT: Depending on their specific business model and client base, banks will need to define the level of automation for each aspect of the regulation. It is clear that the quality of data – on clients as well as products – has to be improved if not already done. The reporting framework has to be set up and the technical FIDLEG requirements have to be met. Further impacts on Avaloq Banking Suite implementation are discussed in the next section of this article.
• Client: Finally, clients have evolving expectations driven by technology advances (24/7 access), digitalization (seamless personalized responses) and social communities (specific needs related to investments), and they do not care about regulatory complexities, technical difficulties or RMs’ workloads. What they want is an efficient and pleasant advisory experience.

Given the scale of the transformation, a strategic approach to integrating compliance needs with business and IT requirements and ensuring a future-proof data strategy is critical. With the right approach, this challenge can become a huge opportunity paving the way to a more client-centric, innovative and efficient business structure.

Technical implementation with the Avaloq Banking Suite

Banks that run the Avaloq Banking Suite can be described as having four main components in their IT landscape:

The Investment Suitability Framework (ISF or Rule Engine) as part of Avaloq’s core banking system is the basis for any suitability implementation within the software and allows for the customization of client-specific FIDLEG rules. At this point, we need to differentiate between clients with on-premises Avaloq software (deployed clients) and those using Avaloq SaaS, as the latter will rely on a standard.

FIDLEG setup provided by Avaloq which may be further adapted to bank-specific needs on request.

Next steps:

The very first step on the road to FIDLEG compliance is to raise awareness among all parties involved, at the very least among the compliance, business and IT teams, and to define common goals and an initial implementation plan. Given the 1 January 2020 deadline, the institutions that already laid the foundations for their transformation in 2018 will be best positioned for strategic implementation. Other institutions can make up ground by working with experts and learning from the MiFID II experience of their peers in the EU.

To give you a head start on this endeavour, we propose a workshop with expert representatives from Orbium and BRP SA, a leading legal advisor in regulatory topics in the financial services industry.