The bank reorganization proceedings applicable to banks and broker-dealers regulated by the Swiss Banking Act of 8 November 1934 (the "Banking Act") were amended recently and, as regards banks of systemic importance, amendments were made to the Banking Act in the context of the "too big to fail" reform. Such amendments of the Banking Act have an impact on netting and collateral arrangements.

1. INTRODUCTION

The Banking Act was amended on 1 September 2011 by introducing new bank reorganization proceedings. Such revised bank reorganization proceedings apply in a bank resolution scenario, where the Swiss Financial Market Supervisory Authority ("FINMA") – the regulator of Swiss banks – believes that a bank may be successfully reorganized or at least that some parts of the failing bank may be rescued from the rest of the bank. The revised bank reorganization proceedings broaden the options available to FINMA by including, inter alia, the option to transfer all or part of the business (including assets, liabilities and preexisting contracts) of the failing bank to another existing bank or to a "bridge bank". On 16 January 2012, FINMA released the draft of the secondary legislation to such new bank reorganization proceedings, which includes provisions on the treatment of netting and collateral arrangements in such proceedings. While the revised bank reorganization proceedings apply to any bank and broker-dealer licensed by FINMA, additional rules applicable only to banks of systemic importance are included in the "too big to fail" legislation that entered into force on 1 March 2012. The drafts of the relevant secondary legislation thereto were circulated for comments on 5 December 2011. Such secondary legislation is scheduled to enter into force on 1 January 2013.

According to the "too big to fail" legislation, the Swiss National Bank decides, in cooperation with FINMA, whether a bank is of systemic importance. Elements to be taken into account for such decision are, for instance, the importance of its deposit taking, lending and payment settlement business, the total amount of deposits held by the bank, the ratio between the balance sheet of the bank and the Swiss GDP and the risk profile of the bank. According to the explanatory notes of the Swiss Government to the draft of such legislation, only UBS and Credit Suisse qualify at present.

The "too big to fail" legislation amends the Banking Act for banks of systemic importance in various respects, e.g. by introducing more stringent regulatory capital requirements (the total capital requirement as proposed by the Swiss Government amounts to 19% of the risk-weighted assets) and liquidity rules. As regards contractual arrangements generally (such as netting and collateral arrangements), the relevant provisions are the additional requirements regarding the organization of the bank aimed at allowing a continuation of systemically important functions.

2. GOING CONCER N CONTE XT

2.1 Banks without Systemic Importance

Banks that are not of systemic importance (within the meaning of the "too big to fail" legislation) are not subject to new rules that would govern netting and collateral arrangements in a going concern context. Such banks remain subject to the requirements of the capital adequacy legislation (Basel rules, as implemented in Switzerland) as regards the recognition of netting arrangements for regulatory capital purposes.

2.2 Banks of Systemic Importance

As regards banks of systemic importance, the "too big to fail" legislation introduced additional organizational requirements applicable to such banks, which must be taken into account for the purposes of entering contractual arrangements generally. Part of such organizational requirements is that the bank must ensure the resolvability of the bank by structuring its operations in a way that its business units, which are deemed to be of systemic importance, may be continued even upon the occurrence of a bank insolvency. What business units are deemed to be of systemic importance exactly has yet to be determined jointly by the Swiss National Bank and FINMA.

The proposed secondary legislation to the "too big to fail" legislation specifies further what requirements must be met for the purposes of ensuring compliance with such organizational requirements. One of the requirements is that the bank must have in place an "emergency plan" that specifies how the bank will continue its operations that are deemed to be of systemic importance. When assessing the robustness of such "emergency plan", FINMA would take into account whether any contracts that are linked to such operations of systemic importance (including financing arrangements, guarantees and contracts with customers) are entered into in a way that allows either such business operations to be continued or transferred to another entity "overnight" in a resolution context. Therefore, to the extent that contracts with netting or collateral arrangements relate to such parts of the operations of a bank that are deemed to be of systemic importance (it remains to be seen whether any such operations of systemic importance affect the OTC derivatives business), such arrangements would have to be entered into in a way that they comply with such organizational requirements. As a result, in order to be easily transferable, it is conceivable that such transactions may have to be entered into under a separate master agreement.

Moreover, there is an incentive for banks of systemic importance to take as many preparatory steps as possible in advance to allow such separation (e.g. setting up separate legal entities for different business units), given that FINMA may grant regulatory capital rebates on the basis of how "resolvable" it deems the bank of systemic importance to be (the greater the possibility of a resolution, the greater the rebate).

3. BANK RESO LUTION CONTE XT

3.1 Bank Reorganization Proceedings

Under the Banking Act, if there are concerns that a bank is over-indebted or if a bank does not meet the liquidity or regulatory capital requirements, FINMA may, as appropriate: (i) take protective measures (such as a bank moratorium); (ii) initiate bank reorganization proceedings; or (iii) order the liquidation of the bank (bank insolvency).

Under bank reorganization proceedings, FINMA may approve a reorganization plan to transfer all or part of the business (including assets, liabilities and pre-existing contracts) of the failing bank to another existing bank or to a "bridge bank" (under the new Art. 30 of the Banking Act). Such a transfer (or partial transfer) of assets, liabilities and pre-existing contracts to the transferee would occur when FINMA approves the reorganization plan and no other formalities would need to be observed. In particular, the transfer of any pre-existing contract could be validly made without the agreement of the counterparty, and the provisions of the Swiss Merger Act of 3 October 2003 governing business transfers do not need to be complied with. To the extent that only a part of the business of a failing bank is transferred to a "good bank", while other parts are left behind, this requires that assets, liabilities and contracts are cherrypicked in order to implement such separation of the different parts of the business of a failing bank. The result of such reorganization may be that at least part of the business of the failing bank survives in the "good bank", while the failing bank is liquidated.

In such reorganization proceeding, a reorganization plan has to be prepared and approved by FINMA. Creditors of the failing bank have a right to be consulted on the reorganization plan if their rights are affected. If creditors representing at least 50% of the non-privileged claims reject the reorganization plan during such consultation, FINMA must proceed with the liquidation of the bank.

Such proceedings may apply to any bank licensed by FINMA (irrespective of whether or not the bank is of systemic importance).

3.2 Impact of Bank Reorganization Proceedings on Netting Arrangements

As regards netting arrangements (e.g. in a master agreement for OTC derivatives transactions), key questions to be considered are (i) whether or not it is possible that only some (but not necessarily all) of the transactions entered into under a master agreement may be transferred to another existing bank or a "bridge bank" and (ii) what the impact of any transfers or partial transfers is on the exercise of any rights to terminate a master agreement.

According to the wording of the reform bill addressing bank reorganization proceedings, as originally proposed on 12 May 2010, it could not be excluded that only some (but not necessarily all) of the transactions entered into under a master agreement with close-out netting provisions would be transferred to another bank. By expanding the scope of the "safe harbour" provision of Art. 27(3) of the Banking Act in the legislative process, the Swiss Parliament clarified that such partial transfers are not possible. In its amended form as adopted by the Swiss Parliament on 18 March 2011 and as entered into effect on 1 September 2011, Art. 27(3) specifies that the enforceability of any pre-existing netting arrangements or arrangements regarding the private sale of collateral (provided that such collateral consists of securities or other financial instruments traded on a representative market) shall remain unaffected by protective measures, reorganization proceedings or a bank insolvency.

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.

This is further clarified in the draft secondary legislation proposed by FINMA on 16 January 2012, which sets out that the reorganization plan must specify that any claims subject to a netting or set-off arrangement must be transferred collectively (i.e. any transactions entered into under a master agreement including netting or set-off provisions would have to be transferred collectively). More generally, any assets, liabilities and contracts with a nexus must be transferred collectively (or not at all). Moreover, the secondary legislation also specifies that any claims subject to a netting or set-off arrangement may not be converted into equity capital.

The parties to a master agreement including netting provisions (e.g. a master agreement for OTC derivatives) are free to include a termination event triggered by a transfer of all or part of the business of a failing bank. Such termination may apply (i) optionally at the discretion of the non-defaulting party as of the time specified by such party in a termination notice or (ii) automatically upon the occurrence of such event. However, according to the proposed secondary legislation to the Banking Act, FINMA has the right to suspend any such termination rights for a period of maximum 48 hours.

3.3 Impact of Bank Reorganization Proceedings on Collateral Arrangements

As regards claims of the failing bank that have been collateralized, the draft secondary legislation to the bank reorganization proceedings provides that any such claims and the relating collateral may only be transferred collectively in the context of bank reorganization proceedings.

3.4 Additional Rules Applicable to Banks of Systemic Importance

As regards the rules governing bank reorganization proceedings and a bank insolvency, to the extent that a bank is of systemic importance, it would be subject to the same regime as other banks to which the "too big to fail" legislation does not apply (with the exception that creditors representing at least 50% of the non-privileged claims may not reject the reorganization plan and, as a result, request that the bank must be liquidated). This includes for instance the possibility to effect transfers or partial transfers to another bank under bank reorganization proceedings. The netting and collateral "safe harbour" of Art. 27(3) of the Banking Act, as set out above, also continues to be applicable to banks subject to the "too big to fail" legislation.

4. CONCLUSION

The revised bank reorganization proceedings that were introduced into the Banking Act on 1 September 2011 have an impact on pre-existing agreements by virtue of allowing the transfer of all or part of the assets of the failing bank to another bank or a "bridge bank".

As regards agreements with netting or set-off provisions (such as OTC derivatives transactions under a master agreement), such bank reorganization proceedings do not affect the enforceability of any such agreements, given that any transactions entered into under such agreement may only be transferred collectively (or not at all).

However, banks of systemic importance have to set up an "emergency plan" and are subject to additional organizational requirements that may require that such agreements will be easily transferable in a resolution context, to the extent that such agreements have a nexus to business operations that are deemed to be of systemic importance. Depending on what business operations will qualify as such (this is yet to be determined jointly by the Swiss National Bank and FINMA), it remains to be seen whether and how such organizational measures affect the OTC derivatives business of such banks.

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.