Why the Swiss Spat With EU Is Spilling Into Stock Markets

(Bloomberg) -- A political rupture between Switzerland and the European Union led to a regulatory breakdown that forced EU-based traders to change where they buy and sell shares of Swiss companies. While it's not yet clear how the standoff will play out in the long term, the markets adapted smoothly to Switzerland's decision to adopt unprecedented contingency plans that redirected trading in some of the world's most widely held stocks.

1. How big a deal is this?

Though Switzerland isn't part of the EU, about a third of trading in Swiss-based companies took place on exchanges and trading platforms within the bloc before the nation's stock-market lost EU recognition. Switzerland is home to Nestle SA, Novartis AG and Roche Holding AG, the three most-heavily weighted companies in the benchmark Stoxx Europe 600 Index. The expiry of the SIX Swiss Exchange's so-called equivalence status -- the regulatory framework that allowed EU traders to trade on stock exchanges in Switzerland -- became a bargaining chip in a broader political flight. It officially expired on June 30.

2. Who's affected?

London-based trading venues run by the London Stock Exchange Group Plc, Cboe Global Markets Inc., UBS Group AG and Aquis Exchange Plc stopped trading shares of companies based in Switzerland from July 1st. That's the date Switzerland's contingency plan forced all trading in Swiss shares by EU-based entities to be re-routed to Zurich. Over time, that may mean higher trading volumes at the SIX Swiss Exchange, the nation's main exchange where most of the activity is already generated by traders in the EU, and lower volume in Swiss stocks for other venues. But on the first day of the changeover, volumes in Switzerland were in line with activity on other indexes.

3. What's the potential fallout?

The moves are likely to cause “some disruption, market fragmentation and increase costs over time,” according to a European Commission note. For example, the European Fund and Asset Management Association warned that about 5,000 EU-based index funds could face limited liquidity and bad pricing because they won't be able to trade Swiss shares on established venues. There are also expectations that traders will move part of the trading from European venues to systematic internalizers, which are not covered by the rules, rather than to SIX.

4. How did the changeover go?

As the new rules came into effect, trading in Swiss companies, including food giant Nestle and pharma company Novartis, was smooth. A question remains for companies with dual listings in EU markets, like engineering giant ABB Ltd., which is also traded in Stockholm, and cement company LafargeHolcim Ltd., which is also listed in Paris. Such companies are exempt from the Swiss countermeasures, meaning that EU traders are only able to trade them in EU primary markets where any lack of liquidity could potentially lead to abnormal price swings. In the first trading day after Switzerland lost equivalence, EU traders from Milan to Paris said they didn't have trouble with their trades in Swiss companies.

5. What could be the longer-term impact?

There are concerns that any continued escalation in Swiss-EU negotiations could mean Switzerland will end up losing its attractiveness for investors, hurting the market value of Swiss companies and making it harder to raise money through initial public offerings. Heightened tensions with the EU, by far the nation's biggest trading partner, could also eventually weigh on the Swiss economy.

6. How did this happen?

Under the EU regulatory reforms called MiFID II, if a stock is regularly traded on an EU-regulated platform, the bloc's investment firms must transact all their dealing there or on a foreign venue deemed equivalent. While the U.S. and other locations were granted indefinite equivalence by the EU at the start of 2018, Switzerland wasn't. The country's relations with the bloc are governed by more than 120 bilateral treaties that cover everything from agriculture to civil aviation and the free movement of people. They are supposed to be replaced with a new umbrella accord that is facing opposition in Switzerland. The European Commission, which handles such matters for the EU, extended Swiss market equivalence once, from an original deadline at the end of 2018. It then tied a further extension to progress on talks with Switzerland over the new political accord.

7. Does this have anything to do with Brexit?

Not directly, but the difficulties encountered by Switzerland in its negotiations signal the potential risks to the London financial center in the event the U.K. leaves the EU without a withdrawal agreement. For the industry, it highlights the shortcomings of the equivalence system, under which the European Commission can grant and withdraw access to its market unilaterally and at any time. Brexit made exasperated Brussels officials unwilling to grant any concessions that risked setting a precedent.

8. How important is Switzerland?

The SIX Swiss Exchange is the fourth-biggest in Europe. Its annual turnover is about 1 trillion Swiss francs ($1 trillion), the lion's share of which is being generated by EU-based investors. Europe's Stoxx 600 Index includes 55 Swiss companies, accounting for about around 15% of the index's weight. This makes Switzerland its third most-important contributor, after the U.K., whose companies account for 25% of the Stoxx 600's weight, and France, with around 17%. The government in Bern has said that without the emergency measures, and without EU equivalence, the Swiss stock exchange would suffer a 70% to 80% drop in trading volume.

The Reference Shelf

• Bloomberg Opinion: Switzerland's stock market is taken hostage
• A QuickTake on how “equivalence” stands to shape post-Brexit banking.
• Swiss government statement on contingency measures and more details on the Swiss contingency plan.
• Swiss Bankers Association insights on the stock market equivalence process.
• An explanatory piece on how systematic internalizers will change trading

--With assistance from Alexander Weber, Catherine Bosley, Jan Dahinten and Viren Vaghela.

To contact the reporter on this story: Albertina Torsoli in Geneva at atorsoli@bloomberg.net

To contact the editors responsible for this story: Jan Dahinten at jdahinten@bloomberg.net, Leah Harrison Singer, Melissa Pozsgay

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