Aftershocks – hard decisions for Swiss lawyers amid a turbulent market

When even that most venerable of Swiss industries, watch-making, comes under threat, you know the country has a problem. But this proved to be the case in the early weeks of 2015: global brand Swatch saw its share price slump 15% after the Swiss National Bank (SNB) announced on 15 January that it would abandon the cap on the Swiss franc against the euro that it first introduced in September 2011. Keeping the franc at CHF1.20 to the euro had became increasingly expensive for the SNB, as it sold its own currency and bought up euros, sterling, US and Canadian dollars and yen, usually in the form of government bonds.

Many were shocked by the move, which has left investors worrying that with the CHF now floating against the euro, Swiss companies will struggle to maintain export levels. Swatch chief executive Nick Hayek called the decision ‘a tsunami’ for Switzerland’s economy. Mark Haefele, chief investment officer of UBS, has estimated that the policy will cost Swiss exporters close to CHF5bn (£3.3bn), equivalent to 0.7% of Swiss economic output.

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So far most of the discussion around the SNB’s move has focused on industrial exporters, tourism and retail, all of which undoubtedly will be the hardest hit. But there will also be a significant impact on the professional services sector, which constitutes at least one fifth of Switzerland’s economy. The SNB’s move will no doubt put substantial parts of the sector under financial pressure, raising questions as to what this will mean for the legal industry in a country that has arguably not experienced such turmoil in peace time.

TOP DEAL LEGAL ADVISERS – SWITZERLAND
Announcement date	Target	Bidder	Target/ seller advisers	Bidder advisers	Deal value (£m)
07/04/2014	Lafarge	Holcim	Allen & Overy; AZB & Partners; Bär & Karrer; Bredin Prat; Cleary Gottlieb Steen & Hamilton; Levy & Salomão; McCarthy Tétrault	Amarchand & Mangaldas & Suresh A Shroff & Co; Blake, Cassels & Graydon; Freshfields Bruckhaus Deringer; Homburger; Lenz & Staehelin; Linklaters	24,215
06/08/2014	Walgreens Boots Alliance (55% stake)	Walgreen Company	Darrois Villey Maillot Brochier; Debevoise & Plimpton; Simpson Thacher & Bartlett Advising FA: Davis Polk & Wardwell	Allen & Overy; Bär & Karrer; O’Melveny & Myers; Wachtell, Lipton, Rosen & Katz Advising FA: Cleary Gottlieb Steen & Hamilton; Gibson, Dunn & Crutcher	14,831
22/04/2014	GlaxoSmithKline (oncology division)	Novartis	Norton Rose Fulbright; Baker & McKenzie; Blake, Cassels & Graydon; Bonelli Erede Pappalardo; Cleary Gottlieb Steen & Hamilton; Niederer Kraft & Frey; Slaughter and May	Bär & Karrer; Freshfields Bruckhaus Deringer; Hogan Lovells; Kaye Scholer; Linklaters	8,833
24/08/2014	InterMune	Roche Holding	Cravath, Swaine & Moore Advising FA: Sullivan & Cromwell	Davis Polk & Wardwell; Richards, Layton & Finger	5,040
22/04/2014	Novartis (global vaccines business)	GlaxoSmithKline	Bär & Karrer; Covington & Burling; Freshfields Bruckhaus Deringer; Hogan Lovells; Kaye Scholer; Linklaters	Baker & McKenzie; Blake, Cassels & Graydon; Cleary Gottlieb Steen & Hamilton; Hengeler Mueller; Niederer Kraft & Frey; Norton Rose Fulbright; Slaughter and May Advising FA: Herbert Smith Freehills; Skadden, Arps, Slate, Meagher & Flom
NB: FA refers to financial advisers.				Source: Mergermarket

Roll with the punches

Eric Stupp, Zürich-based banking partner and head of the financial services team at Bär & Karrer, admits that ‘many people were shocked by the decision, which makes Swiss companies and firms 20% more expensive and makes it more difficult to be competitive. This is a substantial increase in a market where there is fierce competition’.

‘Legal advice has also become more expensive and this may lead to increased pressure on fees. Switzerland is still not the most expensive country for legal services but costs have gone up for international clients as a matter of the less favourable exchange rate.’

Lalive partner Alexander Troller says that some firms, including his own, have suffered ‘damaged finances’ as a result of ‘sitting’ on euros and dollars and that some Swiss companies have been brought to the verge of bankruptcy.

CMS Zürich-based partner Patrick Sommer agrees: ‘I know if you do work for companies in the EU and invoice in euros and not in Swiss francs you would have suffered.’

Poledna Boss Kurer (PBK)’s Zürich-based co-founding partner, Walter Boss, says that the day after the SNB’s announcement he received a call from a German client asking for the resulting fee increase to be discounted.

‘We are having to accommodate clients and while Swiss rates are very competitive, it could cut into the margins if we keep doing that,’ he admits.

Typically partners at the top-tier Swiss firms are able to charge between CHF600 and CHF800 (between £415 and £550) per hour for their services but, with the lifting of the SNB cap, fees at the top end have effectively risen to nearly CHF1,000 (£700) per hour for foreign clients, something which some are reluctant to stomach.

One partner at a mid-tier firm says that it is difficult to justify the hike in fees when typically they are lower in other European jurisdictions. This price pressure is forcing Swiss firms to take a harder look at how they resource work, something that has been part of the process at UK law firms for some time.

‘Whether they admit it or not, all firms are giving discounts to some of their clients, they are also looking at how they can work much more efficiently and making sure they are using associates to do work that partners may have traditionally done, but not necessarily needed to do,’ says the partner.

Benedict Christ, a Zürich-based partner at Vischer, agrees. ‘This situation forces us to produce our services more efficiently and become even more client-focused. We also now need to take the person most appropriate for the work in terms of the fee range,’ he says.

Manuel Bianchi della Porta, Geneva-based managing partner of Geneva and Lausanne practice BCCC, admits that the firm, along with some of the clients it advises, is having to consider lowering salaries and re-examine the pricing structure and fees it charges for services.

And BCCC’s co-head of banking and finance Thomas Goossens says that the SNB has taken the view that the economy as well as the companies and firms in Switzerland should have anticipated that the cap would be lifted at some point.

Philippe Weber, corporate partner at Niederer Kraft & Frey (NKF), says that while it is fortunate that the hourly rates of Swiss firms are still lower than those in the UK and the US, pressure on fees is growing now.

‘We cannot exclude the possibility that clients will pressure us to reduce fees but that is the case for all tier-one firms. We know what our competitors charge and there is always pressure on fees,’ he says.

‘The most important thing is that we have a reputation for doing top-end work and people come to you because they see the quality of your work: track record is so important. In the M&A area I don’t have the impression that clients shop around, it is much more about trust.’

The inevitable conclusion is that headline CHF prices will need to come down or be heavily discounted to keep and attract the best clients, except for the most high-stakes work.

There is no getting away from the fact that this will present problems because a number of major Swiss law firms have not increased their standard hourly rates for more than five years, some for much longer.

Fallout advice

While fees will take an inevitable hit, Goossens says he expects there to be some fallout litigation arising from the SNB move. ‘The foreign trade market is now looking into trying to find out if they can recover what they have lost and see if anyone can be found liable. When there is a monetary problem, people always look for blood and lawyers are invited to try and find solutions so this will have an impact on work for lawyers in the short term. A lot of Swiss entities are also considering how they can restructure their businesses and lawyers will be asked to assist in this.’

Christ says that clients are going to feel the pressure to get more cost-efficient as they are losing margin. There is also some discussion around the execution of trades and when they happened. ‘Litigation typically takes more time but I imagine that some traders might go into bankruptcy, which will entail litigation,’ he says.

He also speculates that inward M&A work may take a hit as targets become more expensive to buyers, having a discernible effect on foreign investment.

Marc Iynedjian, a partner in Python & Peter’s Geneva office, says any litigation arising from the SNB fallout will depend on the evolution of the exchange of the CHF compared to the euro.

‘Swiss companies which export goods are suffering and they are considering several measures to alleviate the effects of the unpegging with some trying to reduce the salaries of their employees, which might create some legal issues,’ he says.

There are also fears in some quarters that cross-border work for Swiss firms could take a hit as a result of the lifting of the cap.

Jakob Hoehn, Zürich-based partner and head of the corporate M&A group at Pestalozzi, fears that the unpegging and subsequent increase in fees will affect Swiss firms involved in cross-border work because clients will use UK or US law firms for most of their advice and only come to Swiss lawyers for very specific Swiss advice (see box, ‘Boom nation’).

Regulating markets

In what many see as very timely, given the SNB’s recent decision, the Swiss government had in 2014 already published drafts of three new statutes with the intention of completely overhauling the existing Swiss financial market regulation.

Although the drafts are still under consultation and need to go through the full legislative process, which is expected to be completed by 2019, the new regulation on financial market infrastructures could come into force as early as 2016.

As it stands, Swiss financial market regulation is largely product- or sector-oriented. While some financial products, services and institutions – in particular in the areas of banking, insurance, funds, and securities dealing – are regulated by various disparate acts and ordinances. Other areas – including asset management, advisory services, and structured products – remain entirely, or largely, unregulated.

The new regulation aims to introduce new architecture that implements the ‘same business, same rules’ principle across the financial industry. At the same time, the Swiss government wants to send out a clear message of transparency and inclusivity by aligning the new regulation more closely to international standards, in particular EU rules.

Four laws will constitute the core of this new horizontal financial market regulation. These are: the existing Financial Market Supervision Act (FINMAG); the Federal Financial Services Act (FIDLEG); the Financial Market Infrastructure Act (FINFRAG); and the new Financial Institutions Act (FINIG).

According to Weber, such reforms are also an attempt by the Swiss government to support the economy. ‘One of the big advantages of Switzerland has always been that it is a reliable and stable jurisdiction… in the long term, the SNB decision may trigger new opportunities for Swiss and foreign investors in Switzerland and that would also create interesting work for us.’

FINMAG established the Swiss Financial Market Supervisory Authority (FINMA) – a single, integrated supervisory authority across different sectors, which continues to carry out banking and insurance supervision functions but is also responsible for anti-money laundering control. FINMA is also responsible for implementing FINMAG and financial market legislation in general.

The proposed drafts of FINFRAG, FINIG and FIDLEG will partially amend the existing FINMAG. Discussed key amendments are the extension of prudential supervision to all Swiss asset managers, as well as new, more relaxed rules for FINMA to transfer information cross-border for the purpose of enforcing financial market regulations.

The new FIDLEG legislation proposes to comprehensively govern the provision of financial services and the product documentation for financial instruments. It will apply across all financial services sectors, whenever they are providing services, or distributing, issuing or offering products that are within its remit.

The draft FINFRAG provides for a consolidated and comprehensive set of rules for the supervision of financial market infrastructures. It also introduces new regulations and obligations for market participants in the area of derivatives trading, substantially in line with the European Union (EU) and US regulations.

Finally, the draft FINIG introduces a differentiated supervisory and regulatory regime for financial institutions that provide asset management services to third parties.

According to Bär & Karrer’s Stupp, the new regulations will mean that a number of smaller banks will stop operating out of Switzerland as their costs become higher.

‘The bigger banks will not have a problem because they have already adopted the laws, which replicate European legislation. It is the smaller banks that will be hit, as they will have to invest a lot of money to become compliant and we will see smaller banks merging with larger banks,’ he predicts.

Consensus is that the new regulations will fundamentally change the legal framework for any participant in the Swiss financial market, regardless of whether it is a Swiss or a foreign entity. Current business models will need to be evaluated as to the extent they need to be adapted to comply with the new rules and, by default, this will generate a significant amount of work for the Swiss legal sector.

According to Zürich-based partner Georg Umbricht at Umbricht Attorneys At Law, the new regulations will inevitably mean that smaller banks are forced to consolidate.

‘The smaller banks will need to specialise more and only the very big ones will be able to cover the whole world… There will also be some consolidation of asset managers, some will just give up because it will be too expensive to become compliant, others will pool their resources or merge,’ he explains.

One of the first indications of this has come with the announcement that Swiss private bank Notenstein, a subsidiary of Swiss lender Raiffeisen and formerly part of Wegelin, had bought the 228-year-old traditional private bank La Roche from Basel.

The sale of family-run La Roche, one of Switzerland’s oldest banks, comes against the backdrop of a Swiss banking sector which is expected to shrink by around a third in the coming years, as higher regulatory and operating costs push smaller players out.

This type of smaller bank is seen by many as most exposed to the Swiss central bank’s decision last month to allow the franc to float freely.

‘What I hear from in-house colleagues is that they foresee a huge amount of work and will need more legal advice,’ says CMS’s Sommer. ‘They are steadily building up their in-house teams, something that is the reverse of a few years ago, but they will need more external legal advice too.’

He is concerned that the banks will be so focused on compliance and rectifying past mistakes that they may miss out on planning adequately for future trends and are left playing catch up.

‘This would be a disaster for the Swiss economy. The financial industry is already really suffering but if they were to miss out on implementing new trends and ways of working, that would be disastrous,’ he says.

As Weber puts it: ‘Long term the Swiss banks will still benefit because they will provide a very good service in a legally sound way; their challenge will be the cost [of implementation] compared to benefit ratio and we will see consolidation in the banking sector because of the costs.’

International relations

Another concern is the time and money that is still being put into working through the US Department of Justice (DoJ)’s tax evasion programme.

The collapse of the private bank Wegelin coupled with the indictment by the US authorities of former NKF partner Edgar Paltzer certainly caused a stir in 2013 and the once-fabled image of private Swiss banks ready to shield the money of the rich and famous from prying eyes has undoubtedly been challenged by the programme. The concern now is that the process that many banks voluntarily entered into with the US has dragged on for too long.

Froriep partner Philippe Pulfer says: ‘For some banks who signed up to the programme, it is not exactly what they were told it would be. Some banks find it has lost its way and is too expensive and they are withdrawing from it… hopefully it will end one day. Many banks believe the programme was mis-sold and there is disappointment.’

Meanwhile, Boss puts it bluntly: ‘We are all a bit angry at the DoJ that things don’t move forward.’

However, others see it as an opportunity for legal work both in advising the banks on compliance and disclosure and on the future advice that will be needed when the smaller banks consolidate.

Borel & Barbey partner Nicolas Piérard believes that the fact that more than 100 Swiss banks are currently enrolled under the category two disclosure programme shows the ‘various dramatic effects of the US programme on Swiss banks. It represents a lot of administrative and legal work and engaging lawyers and accountants on both sides of the Atlantic to comb through their books has already cost them a lot of money since September 2013’.

However, once agreements have been made and fines paid, Piérard predicts that there will be a ‘higher level of buying and selling of portfolios, transactions which have already been prompted in the last years by reduced margins in the banking industry’.

And NKF’s Weber believes that the conclusion of the US tax evasion programme will be a catalyst for consolidation.

‘We will see more M&A activity in the banking sector,’ he says. ‘The process has been onerous and painful for many banks but my personal experience with the US authorities is that if you try to understand them and what their needs are and where they are coming from, there is a way to find solutions and work with them. The banks’ biggest frustration is costs. For some they have been enormous, but those banks that employed the necessary resources will come out of it.’

Meanwhile, another recent set of government proposals could see legislation on changes to the country’s federal withholding tax system.

At the core of the proposed reform is a change to bond interest taxation so that the duty to withhold and pay tax from relevant revenues would be transferred from the Swiss issuer to the Swiss paying agent of the revenues. This change would also affect other Swiss and foreign financial revenues such as dividends and income from the fund units of Swiss-resident beneficiaries.

The system shifts the legal duty to levy, deduct and pay federal withholding tax from Swiss issuers to Swiss paying agents – in the majority of cases, banks. Swiss and foreign issuers would transfer the gross amount of taxable revenues to their Swiss paying agents. The Swiss paying agent would then need to determine whether withholding tax is applicable to the payment or credit of taxable amounts to its customer and income beneficiary.

The proposals are also being driven by the government’s intention to remove traditional Swiss banking secrecy even for Swiss resident bank customers. Generally, the fact that the Swiss-resident customers are reporting income and the cross-border automatic information exchange handles income for foreign-resident customers relieves the Swiss paying agent from the obligation to withhold and pay Swiss withholding tax.

Christ says that one of the knock-on effects of the new proposals would be to eliminate the need to pay withholding tax on income outside Switzerland and could make it more attractive to issue Swiss bonds.

As befits a period of significant upheaval, greater banking and financial market regulation and the subsequent sector consolidation should also give Swiss lawyers enough to feed on for the next 12 months.

While many Swiss clients in the export, tourism and retail industries are fearful about what the SNB’s announcement will mean for their profit margins against their European counterparts, for law firms in Switzerland, the consolation is the increased need for legal advice. But with margins being pressured and clients becoming more cost-conscious, the inevitable downward pressure on fees has started to touch the sophisticated offices of the corporate law elite in Zürich and Geneva.

And while large volumes of work are welcome, the question is how long this will last. The fear in some quarters is that in mid-size firms and even the top tier that profits based on corporate work will start to decline (see box, ‘Boom nation’). This stress will be more keenly felt as US and UK firms are increasingly instructed as lead counsel for traditional Swiss corporates such as Nestlé and Novartis on cross-border deals. And, with long-term consolidation in the financial sector likely, local law firms may not be able to rely on their banking practices to shore up other losses. Take away the investigations and disputes work that will inevitably reduce, and the market looks set to get a little more turbulent for the Swiss lawyer. LB