Switzerland: Developments in Listing Derivatives

• Swiss Law No Longer Required

• Issuer Requirements

• Ongoing Disclosure and Reporting Obligations

• Eligible Underlyings

• Important Practice on Indices

Warrants, certificates and other types of derivative instrument suitable for mass trading may be listed on the Swiss Exchange (SWX). The SWX provides a substantial marketplace in such derivatives, especially since the Directive on Listing Derivatives, which supplements the general listing rules, entered into force in June 2000. The directive introduced a new framework for the listing of derivatives and abolished the minimum free-float requirements. Since then, the SWX has promulgated further regulations (eg, with respect to documentation and listing of plain vanilla warrants) and established new practices.

Since the entry into force of the SWX's new Directive on Applicable Law and Jurisdiction for Debt Securities on February 1 2005, derivatives issues need no longer be governed by Swiss law, nor be subject to Swiss jurisdiction. The directive requires only that (i) the terms and conditions of the derivative instrument be governed by the laws of any Organization for Economic Cooperation and Development member state or, upon reasoned request, another country; and (ii) a place of jurisdiction be established in the country whose law will govern the terms and conditions.

Besides the Swiss franc the SWX accepts the following denominations for derivatives: Argentine peso, Australian dollar, Canadian dollar, US dollar, Hong Kong dollar, Singapore dollar, New Zealand dollar, euro, British pound, Danish krone, Norwegian krone, Swedish krona, Hungarian forint, Polish zloty, Turkish lira, Thai baht, South African rand, South Korean won, Israeli new shekel and Japanese yen.

Issuer Requirements

The listing rules still require that an issuer of derivatives meet the following requirements:

• have existed for three years;

• have a minimum equity of at least Sfr25 million; and

• be a regulated entity (ie, a licensed bank or securities dealer, regulated by the Federal Banking Commission or equivalent foreign authority).

If the issuer does not meet the above requirements, a guarantor must satisfy them in lieu of the issuer.

In order to maintain the listing of derivatives on the SWX, the issuer and guarantor (if any) must meet certain disclosure and reporting obligations.

Under the listing rules, a derivatives issuer must prepare an annual business report, including the report of its auditing bodies (statutory and group auditors), which shall be lodged with the SWX within four months of the end of every fiscal year and - at latest - on publication. The business report shall include the annual report and the annual financial statements prepared in accordance with applicable accounting principles. Swiss or foreign entities that have bonds and/or derivatives listed on the SWX only are not required by the listing rules to produce interim financial reports. If they are required to prepare interim reports under their home country accounting rules, they must submit them to the SWX. However, issuers with equity securities listed on the SWX are obliged by the listing rules to publish interim reports. Interim financial reports must be published within three months of the end of the relevant period and submitted to the SWX no later than their publication.

Under the Directive on Requirements for Financial Reporting, which entered into force on January 1 2005, the following accounting standards are recognized by the SWX for derivatives issuers:

• Swiss generally accepted accounting principles;

• international financial reporting standards;

• US generally accepted accounting principles;

• the accounting standards of the member countries of the European Union or the European Economic Area; and

• the accounting principles of Australia, Japan, Canada, New Zealand, South Africa and Brazil.

In March 2005 the SWX ruled that it may recognize further accounting standards for derivatives issuers if the following conditions are met: (i) the accounting standards guarantee a true and fair view; and (ii) the differences between the applied accounting standards and international financial reporting standards or US generally accepted accounting principles are explained writing and in detail the listing prospectus and annual reports. The auditors must confirm the correctness of these explanations to the SWX. However, no such explanations need be published if the audited annual accounts include a numerical reconciliation of the applied accounting standards with international financial reporting standards or US generally accepted accounting principles on the basis of the net income and the shareholders' equity, along with explanations of the main positions.

Banks, securities dealers and mortgage credit institutes must comply with the special legal provisions applicable to them.

According to the Directive on Listing Derivatives the eligible underlyings are as follows:

• equity securities or bonds that are listed, or have been admitted to trading, on the SWX;

• foreign equity securities or bonds, insofar as they are listed, or have been approved by the responsible authorities for trading, on an official securities exchange in the country of domicile of the underlying instruments' issuer or some other internationally recognized exchange;

• indices based on the prices of the underlying instruments, insofar as the respective index is re-calculated at regular intervals and published accordingly;

• freely convertible currencies;

• interest rates;

• banking-standardized precious metals - especially gold, silver and platinum;

• commodities traded on an official domestic or foreign futures exchange;

• investment funds, primarily invested in eligible underlying instruments, that are listed on the main segment of the SWX or another securities exchange recognized by the SWX and for which the offer or distribution in or from Switzerland has been approved; and

• baskets consisting of eligible underlying instruments.

Since 2002 the SWX has permitted the listing of certificates on hedge fund indices. In 2002 the SWX admitted composite hedge fund indices as underlying (eg, Absolute Return Investment Index top return index, Credit Suisse First Boston/Tremont and Hedge Fund Research Index (HFRX) global index), and in 2004 it also admitted single strategy hedge fund indices (eg, HFRX single strategy indices).

Generally the constituents of such indices are not listed at an exchange nor approved for public distribution in Switzerland by the Federal Banking Commission, which is the supervisory authority for banks, securities dealers and investment funds. The index will be calculated pursuant to the index rules of the index sponsor, and the hedge funds must meet the eligibility and reporting criteria of the index rules (including performance disclosure and audited financial statements). The net asset value of the index will be calculated on a monthly basis and re-balanced on a quarterly or semi-annual basis. Hedge fund indices are normally performance or tracker indices. In order to provide a liquid secondary market for the certificates, the SWX essentially requires that: (i) during the exchange trading hours a market in the certificates is made by a SWX participant; and (ii) the net asset value is published on a regular (monthly) basis.

In June 2005 the Federal Banking Commission has released its white paper on structured products for consultation among the Swiss financial industry. The white paper serves to summarize its current practice regarding the regulation of structured products and other financial vehicles. Market participant are about to submit their comments. However, the white paper is no mere proposal for future legislation, but immediately applicable. With respect to certificates on hedge fund indices the Federal Banking Commission has granted clearance where the following conditions are met, and it is expected that the conditions will continue to be imposed:

• The issuance does not create a separate pool of assets and the repayment amount will be booked on the equity and liabilities' side of the issuer's balance sheet as liability; the holders thus have an individual claim against, and bear the credit risk of, the issuer. However, an issuance by a special purpose vehicle could be viewed as a separate pool of assets;

• The certificates are structured as a debt instrument with a fixed maturity date (like a bond, but with a variable cash settlement obligation) and investors have no redemption right (unlike open-end certificates, which regularly provide for an investor redemption right);

• The index serves as a benchmark for the calculation of the cash settlement amount as per the due date;

• The certificates do not provide for physical settlement, but only cash settlement (ie, units of, or shares in, the constituents may not be delivered);

• During the life of the certificates the index consists of less than five different constituents, which must be weighted appropriately;

• The certificates are neither registered as an investment fund with a foreign authority, nor subject to any foreign supervisory control;

• The certificates do not bear the name 'investment fund', 'fund' or a similar expression that could indicate that they are subject to the Investment Funds Act; and

• A prospectus is prepared under the chief executive officer and states the following:

• The certificates do not constitute investment fund units;
• The certificates are not subject to Federal Banking Commission supervision;
• The investor cannot benefit from the protection under the Investment Funds Act;
• The investor bears the credit risk of the issuer; and
• The value of its investment does not depend solely on the value of the underlying, but also on the credit standing of the issuer.

In 2004 the SWX created new stock market indices that may also serve as an underlying. Most importantly, the SXI LIFE SCIENCE® index comprises pharmaceutical, medical technology and biotechnology companies, and the SXI Bio+Medtech® is a more focused sub-index. Both indices will serve as benchmarks.

New issuer indices

Until recently, a derivatives issuer was permitted by the SWX to use an index that is sponsored by a third party only. In May 2005 a ruling was obtained from the SWX permitting an index that is created by the issuer itself. However, this is subject to the following conditions:

• existence of index rules;

• real-time feed of the index data to the SWX;

• availability to the SWX of the persons with the issuer who are responsible for the index calculation, during exchange trading hours; and

• certain transparency conditions on the content of the prospectus.

This new ruling constitutes a change from the SWX's former practice and needed approval from the SWX Admission Board and SWX Management Committee. The ruling satisfies a growing need of issuers and opens the door to new issuer-made indices.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.