Digital finance in Switzerland: a look back and a glance far into the future
Banks’ long-term prospects and competitiveness depend to a large extent on technological innovation. Frameworks are needed that enable them to employ new technologies and innovative business models. The current hot topics in this context – digital assets combined with digital currencies, the use of artificial intelligence, open finance and a government-supported digital identity – are explained below.
Digital assets are being increasingly regulated and underpinned by various types of digital currency
While cryptocurrency prices have recently been recovering or even climbing to fresh highs, the past year has brought a fair amount of upheaval. The trial of Sam Bankman-Fried, founder of the failed crypto exchange FTX, and a USD 4 billion fine imposed by the US Securities and Exchange Commission on the Binance platform in particular have unsettled the markets.
With these markets increasingly destabilised, regulators and standards authorities around the world have stepped up their already ongoing efforts to monitor the spread of cryptocurrencies and other digital assets in the banking industry. Bodies such as the Financial Stability Board (FSB), the Basel Committee on Banking Supervision (BCBS), the Office of the Comptroller of the Currency (OCC) and the European Central Bank (ECB) have expressed concerns that cryptocurrencies could cause broader contagion in the financial sector before they are properly regulated. The collapse of FTX and the insolvency of Silicon Valley Bank merely confirmed these fears. The relevant supervisory authorities are likely to issue yet more extensive guidelines for banks’ interaction with cryptocurrencies next year. The FSB has already kicked things off with its High-Level Recommendations on global stablecoin arrangements and cryptoasset markets. In the EU, meanwhile, the far-reaching Regulation on Markets in Crypto-assets (MiCA) has been adopted, and the US Congress has debated bipartisan bills on crypto regulation.
Having had the foresight to incorporate this new asset class into its regulations at an early stage, Switzerland has survived this international turmoil virtually unscathed. In fact, a number of Swiss providers have actually seen their assets and customer base grow following the failure of FTX. It nevertheless remains important to keep an eye on global regulatory developments and identify areas in which Swiss regulations need to be updated. Specifically, the implementation of the BCBS standard on prudential treatment of cryptoasset exposures in Switzerland next year will give banks a new set of rules governing digital assets they hold on their own balance sheet. It is essential for the legislature to maintain an innovation-friendly course and ensure that individual rules are practicable for the industry.
The past year, meanwhile, has brought the topic of custody back to the fore. Dismissed as a boring, low-margin/high-volume business in the world of traditional finance, custody has taken on a new dynamism with regard to digital assets, and the Swiss financial sector has established itself as a global player here. The Swiss Digital Asset Custody Report by Homeofblockchain.swiss in cooperation with the Swiss Bankers Association (SBA), the Asset Management Association Switzerland (AMAS) and the Capital Markets and Technology Association (CMTA) confirms this.
«Looking ahead, we think the use of tokenised assets in a smart contract-based financial ecosystem has especially high potential for the financial centre and the economy as a whole.»
Looking ahead, we think the use of tokenised assets in a smart contract-based financial ecosystem has especially high potential for the financial centre and the economy as a whole. However, this potential can only be fully tapped when tokenised money (i.e. digital currencies) is available as well as tokenised assets. This is why the SNB has been working for some time already on a central bank digital currency. The SBA, aided by its members, has presented alternative approaches to implementing a digital currency. We believe, for example, that tokenising existing deposits represents a sensible alternative to provide the new functionality of a digital currency without disrupting the tried-and-tested financial market architecture of our two-tier banking system and creating new risks unnecessarily. Our work on this subject is closely aligned with key stakeholders, including the SNB and FINMA, and the SBA’s Board of Directors has also declared it a priority for 2024. Vital groundwork will be done next year to bring us closer to the vision of a digital, programmable Swiss franc.
The frameworks for applying generative AI are in place – the necessary will and a touch of curiosity are what is needed now
Another topic on everyone’s lips this year has been artificial intelligence (AI), especially given the advances made in generative AI and large language models (LLMs), which underlie applications like Open AI’s Chat GPT and Google’s Bard. This technology has transformed text and image creation, for example, to an impressive degree in the past 12 months alone, and the pace of development is set to increase rapidly over the next few years. However, any new technology can be used for harmful, criminal purposes as well as for good. It therefore comes as no surprise that increasing use of generative AI has fuelled debate on how to regulate it.
If we take a closer look, though, it quickly becomes clear that existing Swiss regulation is sufficient to cover the risks inherent in the spread of AI, as a position paper by economiesuisse stresses. Switzerland has no need for additional legislation, particularly a special law like the EU’s AI Act. What it needs instead are new technical and organisational measures to apply existing laws in a sensible way. Time will tell whether targeted amendments for specific use cases in individual sectors are needed.
«Besides discussions on regulating it, it will be interesting to see how quickly innovative AI applications actually catch on and bring benefits in the financial sector.»
In this context, the Swiss Financial Market Supervisory Authority (FINMA) also discussed challenges arising from the use of AI on the Swiss financial market as regards governance, robustness, transparency and equal treatment in its Risk Monitor 2023. FINMA expects the financial sector to address these risks adequately and plans to monitor how supervised institutions employ AI. Since these risks are already covered by banks’ standard risk management procedures, this is unlikely to cause significant changes in practice, but FINMA does raise some very important points about the use of AI.
The Federal Council decided in November 2023 to examine regulatory approaches to AI. The Federal Department of the Environment, Transport, Energy and Communications (DETEC) will prepare an overview of possible regulatory approaches by the end of 2024 so that the Federal Council can then draw up concrete regulatory proposals and clarify responsibilities in 2025.
AI is thus set to remain a hot topic over the coming months. Besides discussions on regulating it, it will be interesting to see how quickly innovative AI applications actually catch on and bring benefits in the financial sector. We see potential difficulties first and foremost in the lack of qualified staff and acceptance of these applications by the workforce. This will require a gradual approach and the courage to experiment.
Concrete initiatives are driving the adoption of open finance in Switzerland
Viewing and managing accounts with multiple banks via a central login, ideally including securities held in and traded via custody accounts with multiple providers. Adding and viewing your pension accounts with a click of the mouse. Receiving recommendations for insurance solutions or other measures to close potential pension gaps or deal with risks on request. These features and more are covered by concepts like open finance, embedded finance and banking as a service, all of which aim to help customers make the most out of the available data and information.
The industry is pursuing this vision with concrete initiatives, including the SBA’s retail multibanking initiative of spring 2023; the Swiss Fintech Innovations Open Pension initiative of autumn 2023, which is based on the Geneva School of Business Administration’s DIBS (Digital Individual Benefit Statement) project and the federal government’s MOSAR (eOASI); and the ongoing work of the OpenWealth Association. In contrast to the EU, this kind of cooperation and the related access to and publication of data are not regulatory requirements in Switzerland. Instead, they are motivated by market forces and market participants’ freedom to enter into agreements with each other. This requires a certain amount of coordination and collaboration among them in the short term, for example to ensure that common standards are used or that specific use cases are implemented as efficiently as possible by multiple providers. Over the long term, however, this approach promises more sustainable results because it is focused on the market’s needs and avoids costly regulatory interventions and frameworks.
That said, this is an area in which the industry must urgently take action. The Federal Council defined open finance objectives in Switzerland at the end of 2022. It calls in particular for financial actors to demonstrate greater commitment with regard to opening up their data interfaces. A further report is expected in the middle of 2024. The SBA supports these objectives and will continue to work towards achieving them together with its members. However, it continues to believe that government regulation is unlikely to produce the desired effect if it only forces banks to open up their interfaces. Government intervention would stifle the progress made on the market to date and distort competition.
«Government intervention would stifle the progress made on the market to date and distort competition.»
While the players in Switzerland are giving their all, the EU is currently changing the rules of the game. In summer 2023, it proposed amendments to the Payment Services Directive (PSD) as well as the introduction of a Payment Services Regulation (PSR) and a Financial Data Access Regulation (FIDA). This would regulate access to data beyond the scope of banking for a broader spectrum of market participants.
Whether regulated or not, the ultimate goal is to create a fair and secure data ecosystem that adds value for consumers and service providers alike. This requires financial incentives and a level playing field for all market participants as regards data access and use. The pace of progress in both implementation and regulation can thus be expected to pick up in the year ahead.
The implementation of a government-supported trust infrastructure is progressing
Last but not least, the state-sponsored electronic identity, E-ID for short, will form a key part of open data ecosystems. The E-ID is much more than just a digital version of the physical identity card. Combined with a digital wallet stored on your mobile phone, it will enable you to share all sorts of digital credentials, including your name, age and qualifications. This will allow you to identify yourself more easily and securely using a minimum of data in order to use online services. It opens up new scope for banks to gear their processes more effectively to their customers’ needs, for example with regard to onboarding new customers, issuing credit cards or granting and processing mortgages.
A lot of progress was made in this field in 2023. Besides the regular participation meetings hosted by the Federal Office of Justice, the Federal Council adopted the dispatch on the new Federal Act on Electronic Identity Credentials and other Electronic Credentials (E-ID Act) at the end of November. The intention is for the federal government to issue the E-ID, ensuring optimum protection of personal data thanks to concepts such as self-sovereign identity (SSI), privacy by design, data minimisation and decentralised data storage. The E-ID will also be free of charge and voluntary, at least for users and companies. Swiss authorities will be required to accept it as valid proof of identity. However, we are unlikely to be able to store and use a government-issued E-ID in a wallet on our phones before 2026 at the earliest.
«However, we are unlikely to be able to store and use a government-issued E-ID in a wallet on our phones before 2026 at the earliest.»
The legal basis for an E-ID is also being drafted in the EU. The EU agreed plans to implement a European Digital Identity (EUDI) Wallet in autumn 2023. This, too, is not expected to be ready before the end of 2026.
Until then, banks and other financial market players in Switzerland would certainly be well advised to do their research on the opportunities and challenges an E-ID entails for their business. The first successfully concluded proof of concept studies for SSI in Switzerland, including that by Procivis in conjunction with AXA, Swiss Federal Railways, Swisscom and the bookstore chain Orell Füssli, have already shown the potential of digital credentials for use cases in the private sector. More are set to follow.