Exploring the Swiss financial system, history, evolution and DLT innovation.

A small country managing 27% of the total cross border wealth? With 12% of its GDP generated by financial services? They are probably doing something right.

Let’s explore the historical and evolution of the Switzerland financial sector, also known as Finanzplatz Schweiz. A sector composed of banking, securities trading facilities, insurances, long term debt market, real estate, and other financial services. I recently read an open access book called Swiss Finance, which gives a full picture until today. Success factors:

• First you need a solid base. Safety from political prosecution, currency losses, and excessive taxation. A reliable legal system, trustworthy public institutions, and freedom from political, economic, and social uncertainty.
• Then you need few sector specific characteristics, information confidentiality and continuous improvement of its technological structure ahead of the competition, adaptive laws and regulation for new solutions and adequacy to different markets.

I want to go through some history snapshots, carefully understand information confidentiality (i.e. bank secrecy), DLT innovation, and environmental sustainability, which has been part of the national bank objectives since 1996.

Short comment for my Spanish readers: Spain securities trading is much related to Swiss securities trading, as the Spanish stock exchange BME has been owned by the SIX Group since 3 years ago. It is also a bridge for Swiss finance to the rest of the European Union markets.

History

Swiss neutrality

Key factor behind a stable system for centuries, due to its diminutive size and strategic geographic location, the nation decided to maintain military neutrality at an early age. Since the Battle of Marignano in 1515, Switzerland has avoided active participation in all armed international conflicts. Its neutrality was codified in the 1815 Treaty of Vienna.

Bank secrecy or Information confidentiality?

Most nations require banks to protect the confidential information of their customers. On paper, the banking secrecy laws of other countries have been as strict as or stricter than Switzerland’s. The difference has been Switzerland’s proven willingness and ability to deliver on its promises to defend customer confidentiality. To this day there isn't bank confidentiality for foreign residents, transactions and account details can be shared with their country of residency.

Switzerland was founded in 1291 when the three original Swiss cantons agreed to a mutual protection pact against foreign aggression. For hundreds of years before (and after) the Confederation was created, the land regions that eventually became cantons enacted civil, commercial, and criminal laws to address social interactions, among those the ones addressing privacy. For example, the Great Council of Geneva, in 1713, required the maintenance of customer records but prohibited banks from disclosing customer information to third parties unless the Council approved its release.

Market players and capital flows

Banks, pension funds, investment funds, saving Banks and insurance companies funnel the capital from the source to the investments.

Environmental sustainability in its core

Since 1996, the SNB has chosen environmental sustainability as one of its goals by implementing eco-friendly management policies that reduce resource consumption. The SNB’s annual Sustainability Report now contains a separate section on “Environment,” which focuses on conserving natural resources, environmental performance, and climate protection. The SNB’s operational sustainability pays particular attention to the Bank’s interrelationships with employees, society, and the environment.

In 2023 a referendum, with 59% of the votes in favour of carbon neutrality by 2050.

Article 9. Target for climate-friendly alignment of financial flows

1. The Confederation shall ensure that the Swiss financial centre makes an effective contribution to low-emission development that is resilient to climate change. In particular, measures shall be taken to reduce the climate impact of national and international financial flows.

2. The Federal Council may conclude agreements with the financial sectors on the climate-friendly orientation of financial flows.

About technology innovation and DLT-blockchain

In 1998, a partnership between SIX Swiss Exchange and Deutsche Börse AG created Eurex, one of the first exchanges to offer fully electronic trading to its users. Embracing the digital change, while Swiss are known for being conservatives yet they were the first to create a pioneering legal framework for blockchain products (of course voted in referendum): the Distributed Ledger Technologies Act.

With a DLT trading facility, no central securities depository is needed, which makes execution much more efficient, faster, and less risky in terms of counterparty risk. At the same time, trading providers can offer additional services, such as custody, clearing, and settlement. Hence, the Swiss DLT regulation in force since August 2021 has significantly lowered the threshold for incumbent banks and insurance companies to extend their offering toward crypto assets and move into new business models around securities issuance and the trading of digital assets. At the same time, DLT players are likely to challenge established services, such as trading and custody, traditionally provided by conventional banks and asset managers.

In terms of investments, the most important sectors were Financial Technology (FinTech, 28 percent), Biotechnology (25 percent), Information and Communication Technology (ICT, 22 percent), and Medical Technology (8 percent). 30% of FinTechs drew upon their Distributed Ledger Technology (DLT) competencies. Driven by innovative FinTech entrepreneurs, universities, and a conducive legal framework, Switzerland has developed as a hub of Distributed Ledger Technology early on.

Source: IFW Fintech Study 2022. D&L = Deposit and lending, Inv. Mgt. =Investment management, DLT = blcokchain, P/A/R = process, digitlaization, automation and robotics.

Furthermore since 20219 the National Bank has run several experiments assessing the use of Central Bank Digital Currencies (CBDCs).

Macroeconomics

An export economy with a strong currency, a dilemma that pushes productivity of its industry.

Reliable currency and National bank

Its reliable, conservative, and independent central bank, which has played a vital role in supporting the nation’s efficient money and capital markets.

During crises, the Swiss franc has often served as a safe haven currency, causing heavy capital inflows and substantial currency appreciations. During periods of rapid currency appreciation, Swiss companies have struggled to maintain their international competitiveness, but the longer-term effects of the currency’s strength have been generally beneficial. An appreciating franc has forced Swiss companies to remain flexible and innovative. It has dampened the rise in consumer prices by making imports more affordable, and net capital inflows have helped keep Switzerland’s real interest rates among the lowest in the world. Any attempt to significantly influence the Swiss franc’s value can result in sizable changes in the nation’s monetary base and money supply due to the foreign exchange market’s disproportionate size relative to the Swiss domestic markets.

Debt market

The high saving capacity of Swiss individuals and business profits, plus the lowest need of financing by its state and domestic companies (which prefer to use their own cashflows for further investments) create also the adequate environment for several international investors to place their debt in the Swiss markets. Increasing the debt issuing and hte liquidity.

Real Estate

Mortgages are twice valued, first by the commercial bank and then by a governmental authorised institution which brings further investors homogenised. Providing the lowest possible financing as well as a second quality control of the assets valuation - debt issued. Trades made on real estate within 3 years are taxed 60% of gains, this rate is reduced by 0.5% for each additional month thereafter and reaches a floor at 30% starting in the ninth year (example for canton Basel-Stadt).

Conclusion

The Swiss financial system had experienced a careful and steady development through several centuries of stability, with an active role of its citizens which ensures no wide changes a year after as could happen in other well developed countries under politicians' will, overnight. A well known conservative nation that understands the importance of innovation in a competitive business world.

Wherever you are, the Swiss financial system is a good example to learn from and to follow. I think the sensible considerations they have already done for blockchain products are of much use for those building projects around the world.

Swiss Finance: Banking, Finance, and Digitalization. Authors: Henri B. Meier, John E. Marthinsen, Pascal A. Gantenbein, Samuel S. Weber.

Link for book download: https://link.springer.com/book/10.1007/978-3-031-23194-0

Note: some paragraphs are directly taken from the book.