SWITZERLAND
A EUROMONEY SURVEY – MARCH 1996
Introduction
A PROMISING FUTURE
When referring to Switzerland as a financial centre, what is often meant is the unique position that Switzerland has long held in the world of private banking. This history deserves a brief review, since it is relevant to Switzerland’s current status as an international financial centre. Equally important to global investors, however, is the future development of Finanzplatz Schweiz and the comparative advantages it will offer private and institutional investors.
PRIVATE BANKING
The leadership position Swiss private banking enjoys today was not achieved by mere circumstance. Rather, it arose out of a number of different factors:
Factors which built leadership
1) The first crucial factor in Switzerland’s leadership position was its unconstrained openness towards its European neighbours, manifested by its multicultural society and the four languages spoken within its narrow borders.
2) A second factor derives from the country’s relatively small size and lack of natural resources, which encouraged the Swiss to look beyond their national borders and cultivate business relationships with foreign merchants.
3) A third factor is the confidentiality desired by the wealthy; a need which Swiss financial institutions have always been capable of meeting. Today, Switzerland’s banking secrecy laws guarantee investors confidentiality and security. Other countries, such as Luxembourg, France or Austria, have now also made the violation of banking secrecy laws a punishable offence, but in Switzerland banking secrecy is particularly stringent. Swiss banking secrecy is not intended to serve as a barrier to criminal investigations but as protection for people who have accumulated investment assets through entirely legitimate means.
4) A fourth factor is Switzerland’s political stability and long-standing neutrality. Foreign investors, whose assets were often imperilled by political upheaval, warfare or runaway inflation, often saw Switzerland as a financial safe haven, where their assets were managed reliably and professionally.
5) Finally, there is the quality of financial services offered by Switzerland. Quality has since become an important criterion by which international financial centres are measured. A recently published study by London-based property company Healey & Baker confirms that Swiss employees are ranked among the best in Europe with regard to quality. Fluency in several languages, for instance, is just one advantage when dealing with a Swiss investment advisor.
Because of the above factors, as well as the strong Swiss currency and the country’s historically stable macroeconomic conditions, Switzerland has become a major financial centre. An estimated 35% to 40% of all foreign-managed assets, or Swfr2,000 billion to Swfr2,500 billion, are managed in Switzerland. Maintaining leadership is a challenging task in today’s highly competitive environment. The needs and desires of both domestic and foreign clients have to be constantly clarified and competently addressed, and services continuously tailored to these ever-changing requirements.
INSTITUTIONAL CLIENTS
Financial services specifically designed to accommodate the needs of institutional investors did not emerge until the mid-1980s, but have since grown to become one of the major segments within the financial services market. The aggregate total of pension fund assets alone is likely to grow to $12,000 billion by the year 2000. This development has given rise to a vast array of products for institutions, offered as an all-in-one or tailor-made service .
The preferences and valuation criteria of institutional investors differ from those of private individuals on a number of points: Institutions are interested, for instance, in well-organized and efficient stock exchanges, a modern framework and an attractive macro-economic and micro-economic environment.
Unfortunately, Switzerland used to be handicapped by a number of structural deficiencies which provided other financial centres, such as Luxembourg or London, with a competitive advantage. One particular disadvantage was Switzerland’s stamp duty, which considerably increased the cost of stock-market transactions and encouraged investors to take their business elsewhere. This deprived Swiss exchanges of several billion francs worth of turnover every year. Laws regulating Swiss investment funds were also highly restrictive until very recently, inducing both Swiss and foreign banks to establish and operate fund companies in Luxembourg or other offshore centres, rather than in Switzerland. Switzerland’s open outcry system and the fragmented structure of three cantonal exchanges in Zurich, Basel and Geneva, were neither modern nor competitive.
Influential leaders from Swiss political, business and stock exchange circles were realizing where the financial world was heading and worked together to come up with several important innovations.
One major area involved legislative modifications to improve investment conditions in Switzerland. Another big project is the Elektronische Börse Schweiz (EBS), a screen-based trading system which will bring about major improvements for investors. These efforts, along with Switzerland’s favourable macroeconomic environment and interesting microeconomic developments, will make Finanzplatz Schweiz even more attractive in the next few years. This should encourage more and more international investors to do business in Switzerland.
IMPROVEMENTS
Legal developments
Switzerland’s new securities law, which went into effect in 1992, provides greater protection for shareholders and has also increased transparency. As a result, the attractiveness of investing in Swiss equities has been greatly enhanced. Since then, important amendments have been made. For instance, companies are prohibited from arbitrarily refusing to enter registered shareholders in their registrar.
A new investment fund law, conforming to EU directives, was enacted on January 1 1995. This new law gives Swiss fund managers greater leeway with regard to options, securities lending, leverage and short selling. Newly created fund categories (‘other fund’ and ‘other fund with increased risk’), enable a greater differentiation of fund strategies and thus broaden the range of Swiss funds from which investors can choose.
The new stock exchange law will tentatively come into effect in July 1996 and the new listing regulations in January 1997. Both are designed to improve shareholders’ rights and the transparency of the Swiss stock market.
The stock exchange law represents a significant improvement in the rights of minority shareholders: major shareholders must notify both the company and the stock exchange authorities once their interest in a company exceeds or falls below a certain level. In addition, a public offer has to be made to all shareholders once a single investor owns more than 33% of voting rights.
New listing regulations will require companies to present their accounts according to ARR guidelines (Swiss accounting and reporting recommendations), which correspond to true and fair principles. ARR guidelines are compatible with accounting and disclosure standards established by the EU.
From an investor’s point of view, they go even further than EU directives, since they will require companies to provide a detailed funds flow statement. Thus the numerous companies which have already voluntarily adopted ARR guidelines also comply with the 4th and 7th EU directives. The flow of information will improve further in June 1998, when companies will be required to publish an interim report.
Swiss Electronic Exchange
The Swiss Electronic Exchange (EBS) was long awaited, much criticized and, some claimed, doomed to fail from the outset. However, it got off to a successful start. On December 8 1995, screen-based trading in non-Swiss equities and related options went on-line and the fully automated exchange system functioned without any major problems.
In the second phase, Swiss equities will be transferred to the electronic exchange. Major organizational change will occur when the three Swiss stock exchanges Zurich, Basle and Geneva merge into a single Swiss Exchange. This will increase liquidity and make investments in the Swiss market more attractive. Market activities will be subject to new regulations.
Rapid and fair execution of all orders
Once EBS is fully operational, all securities will be traded permanently from 9:30am to 4:30pm without interruption. This means that in future it will be possible to buy and sell second-tier stocks at all times. These are currently traded only twice a day. The new electronic exchange provides for some new types of orders that complement the trading instruments available to traders and investors.
The electronic exchange guarantees equal opportunity for all market participants. The system operates according to a clearly defined price/time priority for the execution of orders, regardless of their size. First, all at-best orders are carried out, followed by the highest bid or lowest ask price, respectively, with priority given to the orders which have been in the system the longest when entered prices are equivalent.
A solution to the problem of odd lots was found by combining them into round lots which are then traded at the reference price. Sizing of round lots has been simplified, making the minimum more accessible to retail investors.
Unlike the London Stock Exchange, where prices are quoted by official brokers only, EBS operates on the basis of an order-driven system. Supply and demand are determined by price, not by market-makers. Market-making within EBS merely serves to support market depth and improve liquidity.
Efficiency of exchange organization and reporting
Swiss stock exchanges used to suffer from a lack of transparency and incomplete information, compared with other international exchanges. The launch of EBS and the new exchange regulations which will now take effect, will eliminate this competitive disadvantage.
Article 7 of the exchange regulations stipulates that members are obliged to make all transactions on the electronic exchange system during trading hours. Exceptions are dealt with in Directive 3, which regulates the size of orders that may be traded off-exchange.
In adherence to the principle of best execution, a client may at any time ask the bank which carried out the transaction to verify whether an off-exchange execution produced a more favourable price than trading via the EBS.
According to Directive 10, exchange members now have to report off-exchange transactions within 30 minutes or, for transactions conducted outside trading hours, by the next start of trading at the latest. In its trading statement the bank must designate all transactions not done via the matcher as off-exchange transactions.
With this new regulation, investors have an effective means of protecting their investments, significantly improving transparency and making it impossible to by-pass the official electronic trading system.
An elaborate form of self-regulation guarantees that EBS is adequately supervised. The new federal law on securities trading empowers the federal banking commission to supervise the exchange.
Thanks to the utilization of high-tech trading methods, the supervisory bodies are equipped with innovative and effective monitoring tools. The authorities have instant access to the order book for each security and, if necessary, can reconstruct any unusual movements in the market step-by-step.
A special stock-watch programme was designed to detect sudden price changes and/or conspicuous fluctuations in volume, and will enable supervisory staff to take immediate action. The aim of these innovations is to ensure a fair and orderly market as well as provide all participants with access to up-to-date information.
Timely and faultless clearing and settlement
A Swiss exchange brochure states that: “In 1993 a new milestone was reached in the settlement of exchange transactions.” It refers to the electronic clearing system for Swiss securities (SECOM), which has enabled Switzerland to take a leading international position in clearing and settlement procedures.
Linked to EBS’s fully electronic matching system, the SEGA communication system permits clearing of market transactions on the value date set by the exchange. The pre-matching procedure operated by SECOM provides the back office with details of individual transactions prior to the actual settlement date. Input errors can therefore be detected and rectified at an early stage, which ensures settlement within the usual three days after closing. As securities are transferred on the settlement date, payment is made automatically, at the same time, via Swiss Interbank Clearing (SIC). Investors will certainly appreciate these advantages and do more and more of their trading through the Swiss exchange.
The successful launch of EBS does not mean, however, that the development and improvement of Switzerland’s financial centre has been completed. It is in fact just the starting point for an ongoing process of refinement.
With the realization of EBS, as well as the legal and regulatory amendments made in the run-up, the member banks of the Swiss Exchange have forged an excellent basis for improving the services provided to their clients. Highly-skilled traders and client-oriented investment advisors are the pillars on which the improvements will rest, along with the role played by a rapid transmission of information to and from the exchange.
MACROECONOMICS
Moderate growth at low interest rates
Expectations of rapid economic growth accompanied by a high rate of inflation sent bond and stock markets on a downward spiral in 1994. This pessimistic sentiment vanished in 1995. Economic activity generally remained moderate in 1994, with GDP growth at 4.1% in the US, 0.5% in Japan and 2.9% in Western Europe, and even sagged in 1995, with the exception of Japan. According to provisional estimates by Swiss Federal Institute of Technology and the Centre for Research of Economic Activity, Switzerland’s GDP growth in 1995 weakened to 0.4%. Consequently, many economic forecasters no longer speak of a resurgence in inflation, but instead are warning of possible deflation, which would knock the Swiss economy into a recession.
It is now projected that real GDP will grow at a modest rate of between 1% and 2% in 1996 and 1997. Most GDP components will post only modest increases in the next two years. Private consumption will be subdued in 1996, as it was in 1995. Due to uncertain job security and only marginally higher disposable incomes, private consumption is expected to expand by only 1% in real terms in 1996. An acceleration can be expected no earlier than the beginning of 1997. Construction activity is unlikely to contribute to GDP growth during the next two years either, since there is still a large supply of unoccupied properties in the commercial and residential real estate markets. Bank Vontobel expects that construction activity will remain flat during the next two years.
Growth will be sustained once again by domestic capital spending and exports. The disadvantages faced by Swiss companies competing in foreign markets, due to the strong Swiss franc, have forced these firms to modernize and rationalize their production facilities. This, in turn, gives Swiss companies a technological lead which is expected to raise exports by around 5% in real terms during the next two years. A two- to four-year postponement of European monetary union would be particularly beneficial for Switzerland’s export and tourism industries. The Swiss franc would weaken against the German mark, since German investors would no longer be rushing to park their funds in Swiss francs. In addition, investors would most likely close speculative positions that have given the Swiss franc’s upward trend an extra boost.
The difficulties encountered by Swiss companies due to a strong domestic currency are clearly evident when looking at the development of foreign exchange rates for 15 major currencies in the past six years. During this period the value of the Swiss franc has risen by 25% (approx. 4% pa). The franc’s appreciation against the dollar is even more dramatic, as the real dollar/franc exchange rate was 41% lower at the end of 1989 than it is now, corresponding to a 6% annual rise in value for the Swiss franc.
The effect on business is that Swiss firms have been forced to substantially increase productivity while slash-ing costs, just to offset the adverse effects of a strong domestic currency and to remain competitive in international markets.
With moderate growth rates and poor consumer sentiment, Swiss inflation should recede further. Despite the uptick attributable to the introduction of a value-added tax system, last year’s rate of inflation was less than 2% (annualized average: 1.8%). A continued decline in inflation to 0.4% is expected in 1996, with a slight upturn in 1997 to 1.0%. The downward trend of the consensus inflation forecast shows that inflationary expectations for 1996 were originally far too high. In March 1995 the consensus figure for average inflation in 1996 came to 2.0%, which was then steadily revised downward to the 1.14% figure published in December 1995. This is still well above Bank Vontobel’s estimate. The inflation estimate of 0.4% for 1996 is based on the following three points: firstly, the absence of last year’s VAT effect reduces inflationary pressure; secondly, lower food prices due to downward price pressure from cheaper imported goods and the intensifying struggle among retail distributors for market share; and thirdly, housing rents will hardly go up because of the large supply of unoccupied housing and falling mortgage rates.
Although the Swiss National Bank (SNB) reduced its key rates several times during 1995, bringing them to their current historical low of 1.5%, money supply expanded by only an estimated 0.7%, rather than the 2% target set by the SNB. It is unlikely that SNB will have any reason to reverse its monetary course this year.
Although Bank Vontobel did forecast at the beginning of 1995 that interest rates would be falling in congruence with the bank’s inflation expectations, the extent of the subsequent interest rate decline did take the bank by surprise. The average yield of government bonds tumbled by around 150 basis points to 3.7%, and three-month Swfr Eurorates fell from around 4.5% to roughly 1.75%. The bank believes that current interest rates are not a sign of market overshooting and expects a volatile sideways trend at both the long and short end during the next 12 months.
STOCK MARKET
Will the show go on?
In terms of volume, the Swiss stock market, with a turnover of approximately Swfr374 billion in 1995, ranks sixth worldwide and third in Europe, behind London and Frankfurt. This is no doubt attributable in part to the market’s outstanding performance.
1995 was an exceptionally good year for the Swiss stock market. The total market posted a 23% rise in Swiss francs, a performance exceeded by only one other market – Wall Street. Expressed in dollars, however, Swiss equities were last year’s best performer, posting a 40% rise in value. A careful analysis of the stock market’s performance shows that investors were not at all caught up in a euphorically bullish sentiment, despite the heady price gains. Investors last year snapped up shares in those companies pursuing a focused strategy backed up by concrete actions. Index gains therefore stemmed primarily from a handful of heavily capitalized stocks, such as Sandoz, Swiss Re and Alusuisse. Blue chips advanced 25% compared to a decline of around 1% for the small-cap segment.
Following this outstanding performance in 1995, several global investment banks have advised their clients to reduce their exposure to Swiss equities and cash in on last year’s fat profits. Another strong surge in prices at the start of this year was followed by a correction, above all by those stocks which had made big gains last year. These volatile swings have made many investors wary and uncertain.
There are three things which investors should consider when looking at the Swiss market:
Firstly, the earnings outlook for listed Swiss companies remains good. This year Bank Vontobel estimates that earnings will grow by an average 18% following 1995’s average 13% increase.
Secondly, in comparison with the expected yields on Swiss-franc bonds of around 4.13%, Swiss stocks are attractively valued at 13.6 times estimated 1997 earnings (earnings yield: 7.3%).
And thirdly, rather than being euphorically bullish, the attitude of foreign and domestic investors regarding exposure to Swiss equities has been marked by caution, which is reflected in the market’s relatively high risk premium.
Taking into account these three points, the bank believes the outlook for the market’s performance in 1996 is good. Investors should pay special attention to the small-cap segment, which has underperformed the market by a wide margin (-1% versus +25% in 1995) and, measured by all standard valuation indicators, is currently trading at a slight discount to the total market.
For more information, please contact:
Hanspeter Lutz
Chief strategist 41 1 283 73 61
ChristophLedergeber
Head of sales 41 1 283 56 94
Thomas Pfyl
Head of research 41 1 283 73 70
Bahnhofstrasse 3,
CH-8022 Zürich
