Key developments & the latest trends in Switzerland

Inflation, the economy & interest rates

Following record rates of inflation in 2022 – with the Eurozone and the UK (and temporarily also the US) hitting double-digit figures and even Switzerland exceeding the SNB’s inflation target of 2% for the first time since 2008 – inflationary pressures appear to have eased. While advanced economies started 2023 with inflation rates averaging 7.5%, at the beginning of this year, these have dropped to 3.2%. For emerging economies, rates dropped from 8.1% to 4.1% over the same period. In Switzerland, inflation now stands at 1.20%. However, as it is still above central bank targets in most countries, it needs to fall further.

In order not to hamper global economic development which, after rapid growth rates in 2021-2022, slowed further in 2023, the consistent raising of policy interest rates over the past two years, described by the BIS as “the largest and most synchronised global monetary policy tightening in a generation”¹1. Where are we on the journey towards price stability? (bis.org) , seems to have been brought to an end.

In the Eurozone, economic activity in 2023 is estimated to have expanded by only 0.5% and the growth outlook for 2024 has been revised downwards to 0.9%. We now know that the UK economy entered a technical recession in the fourth quarter of 2023 but the expectation is still that its GDP will grow by 0.9% in 2024. Meanwhile, economic growth in the US was 2.5% last year and is estimated at between 2.2% and 2.4% for 2024. In Switzerland, whose economy grew at 1.2% in 2023, the expected growth rate for 2024 lies at 1.3%.

On 7 March 2024, the ECB announced that it would keep its key interest rates unchanged at 4.50%, 4.75% and 4.00%, respectively, with a first reduction being expected in June this year. On 20 March, the US Federal Reserve also decided to maintain its current range of 5.25% to 5.50% and, a day later, the Bank of England said that it would keep its interest rate unchanged at 5.25% for the fifth time in a row. But both US and UK policymakers signalled three interest rate cuts later this year after seeing “encouraging signs” of falling inflation. The SNB, as the first major central bank, felt that it could already act and, on 21 March, cut its main interest rate by 25 basis points to 1.50% with the expectation for this to be reduced further in the course of the year. This marks the first rate cut by the SNB in nine years.

Market performance

Swiss capital markets

In 2023, the SIX Swiss Exchange saw the lowest trading activity in over a decade. It recorded a trading turnover of CHF 1,046.3 billion, 13.4% lower than in 2022, and a 24.2% drop in transactions.²2. B1G Numbers 2023: Key Figures from SIX Swiss Exchange (six-group.com)

There were ten new listings of equity securities, most prominently, that of the Novartis spin-off Sandoz and of the first Swiss Special Purpose Acquisition Company (SPAC), R&S Group. Eight Chinese issuers listed Global Depository Receipts (GDRs) on SIX, bringing the number of Chinese companies that have listed GDRs in Switzerland since the launch of the China-Switzerland Stock Connect between the SIX Swiss Exchange and the Shanghai and Shenzhen stock exchanges in July 2022 to 17. In addition, existing issuers raised around CHF 8.3 billion via capital increases (CHF 1.3 billion more than in 2022).

On the debt capital side, there were 436 new bond listings, 90% of which were denominated in Swiss francs, and the total volume of debt capital instruments (bonds and money market papers) was around CHF 116 billion (up from CHF 114 billion in 2022). Also, the number of outstanding green, sustainable, sustainability-linked and social bonds traded on SIX increased from 108 with a volume of CHF 28 billion in 2022 to 136 and a volume of CHF 31 billion in 2023.

M&A activity

After two record-breaking years, 2023 saw 25% fewer M&A transactions in Switzerland than in the previous year (484 transactions with a deal volume of around USD 72 billion in 2023 compared to 647 transactions and a deal volume of USD 139 billion in 2022) with the highest levels of activity in the industrial goods, media, technology and telecommunications and the pharmaceuticals and life sciences sectors.

For 2024, expectations are positive, however. While the market still needs to adjust to higher interest rates and tightening lending standards on the one hand and the increasing complexity of M&A transactions, due to both higher sustainability requirements and technological developments, on the other, early indicators point to a gradual increase in dealmaking as the year progresses.

Swiss banking sector – Optimism among Swiss banks

EY Switzerland gave its Banking Barometer 2024 the subtitle “Confidence” which, on the one hand, was intended to allude to its overall positive assessment of 2023 and its optimistic outlook for 2024 but also to the pivotal role confidence plays in the financial system.

With one notable exception, Swiss banks did well in 2023. For the first time since the 2008 financial crisis, banks recorded a rise in their interest rate margin in the previous 18 months resulting in a notable increase in profitability. Also contributing to the positive outlook is the expectation of the majority of Swiss banks that impairment losses on residential mortgages and SMEs will remain low. Mortgages notably make up around 75% of the loan portfolio of Swiss banks and, despite the challenging environment, the forecast for SME credit defaults is considerably lower than in previous years.

However, total Swiss bank assets contracted by 4.8%, client lending by 3.0% and client deposits by an estimated 5.5%, the latter mainly due to the large-scale deposit outflows from Credit Suisse in the final weeks and days before its takeover.

According to Fitch Solutions, client deposits are expected to grow again by 3.2% in 2024. Swiss bank assets, almost half of which are now held by UBS, are expected to increase by a mere 0.2% by the end of the year and client lending by only 0.7%.³3. Swiss Banking Sector Will Return To Growth In 2024, But UBS-Credit Suisse Merger Will Weigh On Performance (fitchsolutions.com) After the considerable accounting gain experienced by UBS from its acquisition of Credit Suisse which led it to report a record-breaking USD 29 billion of pre-tax quarterly profit in Q2 of 2023, the bank is now expected to divest itself of high-risk and non-performing Credit Suisse assets, in particular, in its foreign loan portfolio and see its profitability further impacted by other costs associated with the merger, especially as it has declined to draw on the CHF 9 billion loss guarantee offered by the Swiss government. The predictions for UBS’s long-term prospects are positive, however, despite the bank having to meet more onerous regulatory capital requirements from 2030 due to its changed systemic importance.

Geopolitical developments – From the war in Ukraine to conflict in Gaza and the US elections

Against this backdrop of cautious optimism in Switzerland, it is difficult to ignore escalating geopolitical tensions. Two years after Russia’s full-scale invasion of Ukraine, the conflict seems far from resolution and its impact on elevated and volatile commodity and energy prices is still being felt across the world, albeit less strongly than in 2022. However, financial and military support for Kiev appears to be dwindling and the relationship between Washington and Kiev, or rather Washington and Moscow, may be redefined depending on the outcome of the US elections. The recent death of Alexei Navalny, one of Vladimir Putin’s most prominent critics, in an Artic penal colony is yet another demonstration of the Russian president’s scrupulousness and lack of concern for his country’s standing in the international community.

The current Israeli military operation in Gaza which followed on from a dramatic attack by Hamas terrorists on Israeli civilians on 7 October 2023 has resulted in an unprecedented death toll, mass displacement and destruction of civilian infrastructure. Economic activity across all productive sectors has ground to a halt and it is estimated that Gaza’s annual GDP in 2023 declined by USD 655 million with unemployment having reached 79.3 per cent by December 2023.⁴4. Preliminary assessment of the economic impact of the destruction in Gaza and prospects for economic recovery | UNCTAD According to the IMF, while the impact of the conflict on energy prices and financial markets has been limited and temporary, tourism-dependent economies in the region, where the sector accounts for between 35-50% of the total economy, were hard-hit.⁵5. Middle East Conflict Risks Reshaping the Region’s Economies (imf.org)

alleged support of the Palestinian cause, Iranian-backed Yemeni Houthi rebels have been attacking commercial ships in the Red Sea and the Strait of Bab al-Mandab since mid-November 2023, leading to US and UK airstrikes on Houthi bases and further increasing tensions in the region.

The US presidential elections in November will potentially have a large impact on US economic policy, regulatory frameworks and investor sentiment. A transition of power from one administration to another can lead to important shifts in fiscal policy, healthcare and environmental policies, international trade and foreign relations, affecting global trade flows, supply chains and investment behaviour. Globally, 2024 can be considered as the ultimate election year with national elections in a minimum of 64 countries (as well as on EU level) representing 49% of the world’s population. The outcomes of those elections will undoubtedly have significant macroeconomic and geopolitical implications.

An international minimum tax

In December 2021, the members of the OECD’s Inclusive Framework on Base Erosion and Profit Shifting reached an agreement on reforms to the international tax system (Pillar 2). One of the agreed measures consisted of the introduction of top-up tax rules to ensure a minimum effective taxation of 15% in each jurisdiction where multinational enterprises with a minimum global turnover of EUR 750 million have a taxable presence (the Global Anti-Base Erosion Rules / GloBE Rules). Pillar 2 consists of a series of interwoven measures, including an Income Inclusion Rule (IIR), an optional Qualified Domestic Top-up Tax (QDMTT) and an Undertaxed Profits Rule (UTTPR). The introduction of these measures will significantly change the international tax system.

Switzerland, together with 139 other countries, committed to implement Pillar 2. The domestic implementation of the GloBE Rules in Switzerland required a national referendum to approve the necessary constitutional amendment. It was approved on 18 June 2023. On 22 December 2023, the Swiss Federal Council decided to implement the QDMTT as of 1 January 2024. The introduction of IRR and UTTPR will be decided upon at a later date.

Artificial intelligence

The potential impact of artificial intelligence on the world cannot be overstated. According to PwC, AI is not “just a new set of tools. AI is changing the way we work, live, and connect with the world.”⁶6. How AI can help improve business | PwC Switzerland AI was also the key theme at this year’s World Economic Forum in Davos from 15-19 January 2024. Antonio Guterres, the UN Secretary- General, warned of the “existential threat” posed by “the runaway development of AI without guardrails”, whereas the Managing Director of the IMF described AI as “transformational, with a lot of promise, but also risk associated with it”.

On 9 December 2023, the European Parliament and the Council reached provisional agreement on the Artificial Intelligence Act (AI Act) which had been initially proposed by the European Commission in April 2021 as the first-ever comprehensive legal framework on artificial intelligence worldwide. According to the Commission, the AI Act “aims to provide AI developers, deployers and users with clear requirements and obligations regarding specific uses of AI” while, at the same time, seeking to “reduce administrative and financial burdens for business”.7

The AI Act will be fully applicable within two years. In order to facilitate the transition to the new regulatory framework, the Commission has launched the AI Pact, a voluntary initiative that encourages AI developers from Europe and beyond to comply with the key obligations of the AI Act ahead of time. On 2 February 2024, the draft text of the AI Act received unanimous approval from the Council, with the final vote expected in April. The European AI Office, which was established in February 2024 within the Commission, will be tasked with overseeing the AI Act’s enforcement and implementation in member states.

Meanwhile, Switzerland has not yet adopted any legislation specifically dealing with AI and there is also currently no such proposal in the legislative pipeline. However, in November 2020, the Swiss Federal Council adopted guidelines for the use of AI in federal departments and agencies and has launched a national research programme on digital transformation. In addition, the revised Swiss Federal Act on Data Protection deals, among other topics, with data privacy in relation to automated decision-making. The expectation is that, as so often, Switzerland will analyse the impact of the EU AI Act before embarking on harmonisation efforts of its AI regulations with EU law. The Federal Council has advised that it will be publishing further information on potential sector-specific regulatory measures by the end of this year.

According to the EY Banking Barometer 2024, 82% of Swiss banks surveyed said that they were currently concerned with the topic of artificial intelligence in one way or the other, with 32% having developed initial applications or conducted pilot projects but only 6% effectively using AI applications operationally.

ESG reporting and due diligence requirements in Switzerland

Non-financial reporting

In November 2020, the so-called “Responsible Business Initiative” – which had aimed to strengthen respect for human rights and environmental standards by introducing a vicarious liability regime for Swiss companies for harm caused by controlled entities abroad – failed to win a majority of the Swiss cantons and was thus rejected. Instead, EU-style ESG reporting and due diligence requirements were introduced in the form of new provisions included in the Swiss Code of Obligations (CO) (arts. 964 et seqq. CO) which entered into force on 1 January 2022 for the 2023 financial year, with the first reports having to be published this year.

The new reporting requirements, which are modelled on the European Non-Financial Reporting Directive (NFRD), apply to Swiss-domiciled public interest companies (including banks, insurance companies and securities firms) which, together with their controlled companies in Switzerland and abroad, (i) have at least 500 full-time employees on annual average and (ii) assets in excess of CHF 20 million or revenue in excess of CHF 40 million in two consecutive years.

Potential in-scope companies are exempt from the reporting requirements only if they are controlled by another entity to which the Swiss non-financial reporting obligations apply or which is required to prepare an equivalent report under foreign law.

Companies need to report on environmental (in particular, climate, i.e. CO2 targets), social and labour matters, human rights and anti-corruption measures. The annual report which must be approved by the company’s AGM has to address the company’s business model, the concepts which it applies with respect to the relevant ESG matters, including a description of its due diligence procedures, the measures taken by it as well as an assessment of the efficacy of such measures, KPIs, the impact of its activities on the relevant ESG matters as well as the risks of such matters on the company (double materiality). The Swiss reporting requirements currently use a “comply or explain” approach, i.e. it is possible that some companies may choose not to report on certain topics if they are of the view that a certain topic or matter is not relevant to their business. What will be considered acceptable will also very much depend on investor expectations and it is expected that certain industry-specific standards will develop.

In the area of climate disclosure at least, the Swiss legislator has offered additional guidance. On 23 November 2022, the Swiss Federal Council adopted its Ordinance on Climate Disclosures which governs disclosures on climate issues in accordance with art. 964b CO and requires in-scope companies to publish their climate risks based on the recommendations of the Task Force on Climate- Related Financial Disclosure (TCFD). The ordinance entered into force 1 January 2024.

For the largest Swiss banks and insurance companies which fall into FINMA’s supervisory categories 1 and 2, these obligations have already been in force since July 2021 under revised FINMA Circular 2016/1, which will be the subject of a further review this year. Also, on 1 February 2024, FINMA has launched a consultation on a new “nature-related financial risks” circular which is due to enter into force on 1 January 2025 and will specify risk management requirements for banks and insurance companies in relation to material financial risks resulting from climate change and nature degradation.

The relevance of the CSRD to Swiss companies

The European Corporate Sustainability Reporting Directive (CSRD) which entered into force on 1 January 2023 and pursuant to which certain in-scope companies will need to report for the first time in 2025 with respect to the 2024 financial year substantially amends the NFRD both in terms of scope and reporting requirements.

The CSRD abolishes the “comply or explain” approach adopted by the NFRD and introduces a “double materiality” standard which means that in-scope companies need to report on both the financial risk of ESG issues for their company (financial materiality) and the impact of the company’s business on people and the environment (impact materiality). In addition, the CSRD expands KPIs and target requirements (including alignment with EU taxonomy), introduces new European Sustainability Reporting Standards as well as an external audit requirement.

In terms of scope, the CSRD no longer applies only to public interest companies but, based on a phased approach, also to large private companies (as of 2026 with respect to the 2025 financial year), listed SMEs (as of 2027 with respect to the 2026 financial year) and, finally, undertakings with a non-EU parent with EU-wide sales in excess of EUR 150 million (as of 2029 with respect to the 2028 financial year).

Swiss companies, or their EU parent companies or subsidiaries, may fall within the scope of the CSRD. Also, the Swiss legislator is expected to further align the Swiss rules to the EU requirements. In the meantime, many large Swiss companies may anyway already choose to report according to CSRD or other international regulations or standards, which will be deemed acceptable from a Swiss perspective provided that such foreign regulations address all of the Swiss requirements and the report clearly identifies the regulations and/or standards on which it is based.

It is unfortunate that the new Swiss ESG reporting requirements, having been closely modelled on the NFRD, are now already superseded at European level.

Berne Financial Services Agreement

On 21 December 2023, Switzerland and the United Kingdom signed an eagerly anticipated agreement on mutual recognition in financial services, the Berne Financial Services Agreement.

Following the UK’s effective departure from the EU after the end of the transition period on 31 December 2020, existing bilateral agreements between Switzerland and the EU have been substituted with nine new agreements with the UK government, including, on trade, citizens’ rights, service mobility, social security, air and rail services and direct insurance. What had been notably lacking between the two countries that are home to two of the most important European financial centres was a broader financial services agreement.

The Berne Financial Services Agreement provides for recognition of equivalence of national legislation and regulations in the areas of banking, insurance, investment services, asset management and financial market infrastructures for professional and sophisticated clients.

It has been hailed as “ground-breaking” by the UK government, providing a “new and innovative model of mutual regulatory recognition” and establishing a “new global best practice for regulatory and supervisory cooperation”. The purpose of the agreement, according to the Swiss government, is to “facilitate cross-border business activities, while at the same time ensuring financial market stability and integrity and guaranteeing client protection”.

Following its signature, the agreement is now awaiting parliamentary approval in both countries.

Separately to the Berne Financial Services Agreement, Switzerland and the UK are also currently negotiating an enhanced Free Trade Agreement.

L-QIF

On 31 January 2024, the Swiss Federal Council decided that the revised Collective Investment Schemes Act (CISA) and the amended Collective Investment Schemes Ordinance (CISO) shall enter into force on 1 March 2024, creating the legal basis for the Limited Qualified Investor Fund (L-QIF). The introduction of the L-QIF aims at strengthening Switzerland’s position as an asset management and fund distribution hub.

The main advantage of this new fund category is that it is not subject to the licensing and approval requirements of FINMA, resulting also in less stringent investment regulations. However, the L-QIF must be managed by entities which themselves are supervised by FINMA, it is only available to qualified investors and, from a tax perspective, is treated like other Swiss regulated collective investment schemes.

Credit defaults & bankruptcies and the failure of ‘too-big-to-fail’

Corporate insolvencies in Switzerland

Alongside the worldwide increase of government debt, companies have also significantly boosted their debt ratios in recent years. The impact of such high debt on the economy was apparent again in 2023 with the number of corporate defaults up 80% (from 85 defaults in 2022 to 153 defaults in 2023). The US accounted for 63% of all defaults globally with 96 defaults, whereas Europe saw 30. Prominent corporate defaults include WeWork, Covis, Diamond Sports, Bausch, Mallinckrodt and Adler Group as well as the bankruptcies of Rite Aid, Bed Bath & Beyond, Yellow Corp. and Signa. For 2024, S&P are expecting further global credit deterioration, particularly at the lower end of the rating scale (‘B-‘ or below) where almost 40% of issuers risk further downgrades. Financing costs are expected to remain elevated despite anticipated rate cuts and there are upcoming maturity walls for a considerable amount of speculative-grade debt in 2025 and 2026. In Switzerland too, a slowdown in economic growth, a drop in share prices and higher interest rates have been creating a challenging environment for many companies, in particular, those that were already reliant on governmental support to get them through the COVID-19 pandemic and that now find that loan financing is becoming again more difficult and more expensive.

According to Dun & Bradstreet, corporate insolvencies in Switzerland increased by 8% in the first three quarters of 2023. Between 1 January and 30 September 2023, 3,845 Swiss companies had to file for bankruptcy, compared to 3,552 in the same period in 2022.

Nevertheless, as mentioned above, the majority of Swiss banks surveyed for EY’s Banking Barometer 2024 expect SME credit defaults in 2024 to be considerable lower than in previous years.

It should also be noted that the overall increase in corporate insolvencies in Switzerland has been accompanied by a slight rise in the incorporation of new businesses. Dun & Bradstreet record 38,325 new company registrations in the commercial register in the first three quarters of 2023, compared to 37,091 in 2022 (+3%).

Credit Suisse – A failure of ‘too-big-to-fail’?

In March 2023, the Swiss Federal Council, the Swiss National Bank and FINMA intervened amidst a growing crisis of confidence and instituted various measures in order to safeguard Credit Suisse’s solvency and assist its acquisition by UBS, which was announced on 19 March 2023 and took legal effect on 12 June 2023. The Swiss financial services sector and the country as a whole not only had to come to terms with the disappearance of one of Switzerland’s two large global banks but also the reality that, after the bail-out of UBS in 2008, the carefully designed “too-big-to-fail” regulations had once again failed. A thorough analysis of events was demanded and very much warranted.

On 1 September 2023, the group of experts on banking stability under Prof. Lengwiler submitted its eagerly awaited report entitled “Need for reform after the decline of Credit Suisse” requested by the Swiss Federal Department of Finance. The report stresses the macroeconomic significance of systemically important banks and the financial centre as a whole and notes that the government-supported takeover of Credit Suisse by UBS represented a key contribution to international financial stability. It notes that the fact that the restructuring option was not chosen in the case of Credit Suisse did not mean that resolution planning had failed and that the existing “too-big-to-fail” regulations were certainly helpful in terms of ensuring adequate levels of capital and liquidity. The expert group believes that no regulation can rule out a crisis with complete certainty and recommends reforms in crisis management, the broadening of liquidity provision and a significant strengthening of the tools and authorities of the financial supervisor.

This assessment was shared by FINMA itself which, on 19 December 2023, published its report on “Lessons Learned from the CS Crisis” in which it analyses the development of Credit Suisse between 2008 and 2023 with regard to the bank’s strategy, business performance, management decisions, risk management and crises preparation as well as FINMA’s supervisory work with the bank.

In the report, FINMA identifies the main reasons for the failure of Credit Suisse. According to the supervisory authority, certain required strategic changes (such as downsizing the investment bank, reducing earnings volatility and a greater focus on asset management) were not consistently implemented. FINMA states that Credit Suisse’s reputation was undermined by recurrent scandals resulting in irreparable reputational damage. Despite extensive adjustments over the years, deficiencies in risk management identified by FINMA were never sustainably remedied. FINMA also notes that, although the bank met regulatory capital and liquidity requirements, neither the regulatory capital nor the liquidity buffer could contain the loss of confidence in the bank.

Using Credit Suisse as an example, FINMA further examines problematic areas in its supervisory practice and suggests potential solutions. It notes, among other things, its limited influence in matters of strategy and governance. According to FINMA, these deficiencies could be remedied by establishing a stronger legal basis, e.g. through (i) a senior managers regime, (ii) powers to impose fines, or (iii) the option of publishing enforcement proceedings on a regular basis. In addition, FINMA will also adapt its supervisory approach and step up its review of whether stabilisation measures are ready for implementation.

For the Swiss lending market, the disappearance of Credit Suisse may well lead to the major cantonal and regional banks increasingly using syndicated lending to jointly finance larger loans. A number of foreign banks may also consider expanding their activities in the Swiss corporate client business.

Special insolvency regime for insurance companies

In addition, in 2022, the Swiss parliament adopted a special insolvency regime for insurance companies in order to enable the restructuring of an insolvent insurance company instead of the direct opening of bankruptcy proceedings. The aim of this revision is to protect the interests of the insured parties.

The revised Insurance Supervision Act, together with the associated implementing provisions, has entered into force on 1 January 2024.

New legislation to combat bankruptcy abuse

In March 2022, the Swiss parliament passed the Federal Act on Combating Abusive Bankruptcy which contains amendments to several laws, namely the Swiss Code of Obligations, the Debt Enforcement and Bankruptcy Act, the Criminal Code and the Swiss Federal Act on Direct Federal Taxation. The purpose of the new rules is to combat the abusive use of bankruptcy proceedings by preventing debtors from using such proceedings to free themselves from their financial obligations thereby damaging their creditors und unfairly competing with other companies.

While the Swiss Federal Council had originally proposed for the amendments to enter into force at the beginning of this year, cantonal authorities had asked for this to be postponed until 1 January 2025 in order to provide them with the necessary time to adapt their internal processes.