Regulation Update: Amendment creates golden opportunity

Special report: Focus on France


The French retail structured products market is still growing; but only just. According to research by Exane, a Paris-based research and investment company, the retail structured products market grew by 6% in 2005 compared to 2004, with sales of EUR13.3 billon in 2004 and EUR14.1 billon in 2005. Meanwhile, the number of products issued was 172 in 2005, compared to 162 in 2004.

However, some issuers reckon the Fourgous amendment, introduced by the government in July 2005 as part of the Breton Act, could provide a significant boost to what is a stable and mature market. In particular, those who manufacture life insurance-wrapped products are expecting an increase in sales as a result of the law that allows investors to convert their non-unit-linked life insurance contracts into a multi-investment policy without giving up tax benefits. But despite this talk of the golden opportunities that Fourgous could bestow on the market, there will be little impact for issuers of products based on constant proportion portfolio insurance.

Fourgous facts

In a nutshell, the act, named after the French politician Jean-Michel Fourgous, represents a change in the French law that has the lofty ambition of not only increasing investor confidence, but also modernising the French economy.

The amendment effectively allows policyholders to give existing policies greater exposure to equity investments. The advantages of transferring a non-unit-linked policy (typically investing in euro bond funds) to a multi-investment policy (with plenty of room for manoeuvre between asset classes) are attractive. For example, investors can defer social security contributions.

But if investors choose to forgo the traditional 100% investment in non-unit-linked life insurance contracts, and take advantage of the Fourgous changes, they must transfer at least 20% of their savings to invest in pure equity assets. This is where things gets interesting, because the switch requires investors to accept a higher level of risk.

According to Exane, more than 80% of assets in traditional, guaranteed-return life insurance contracts are invested in instruments such as fixed-income bonds and securities, and euro bond funds in particular. While bond portfolios currently offer an annual return of about 4%, the yield on newly issued bonds is unlikely to sustain that level due to expected increases in eurozone interest rates.

Unsurprisingly, several structured products heavyweights have already introduced 'transition' products in an effort to lure euro bond-loving investors to switch into riskier equity-linked investments. It's all about securing first-mover advantage, providers say.

Equity-linked products

Exane, for one, says the profitability of guaranteed-return life insurance contracts is doomed to fall. "The Fourgous amendment is likely to have a great impact on the retail structured products market," says Laurent Roussel, co-head of derivatives research at Exane in Paris.

"The incentive of the amendment is to encourage individuals to reallocate their long-term investments in favour of equities or equity-linked products, while keeping the fiscal advantages of life insurance contracts," Roussel adds.

In order to target investors wishing to take advantage of the amendment and gain more equity exposure, Exane launched an option-based product in February this year. Capital R7 pays a guaranteed coupon of 7% annually over eight years, regardless of the performance of financial markets. The product is designed to provide a return that is higher than funds which invest in euros, with added security in case of a market downturn.

The product is based on a portfolio of 50 international shares that provide equity exposure to the US, Japan, Australia and Europe. At maturity, it offers the initial capital plus 125% of the performance of the shares, with no limit on the upside. Capital R7 can guarantee a minimum of 100% of invested capital starting in the fourth year, once the selection has risen or is stable compared to its initial level on an anniversary date.

Like Exane, CM-CIC Asset Management, the asset management arm of the Credit Mutuel-CIC Group, sees the Fourgous amendment as a good opportunity for its options-based products range. But, unlike Exane, CM-CIC emphasises capital-protected equity index-linked products. "The sales volumes of guaranteed products have increased since the introduction of the amendment," says Dang Co Minh, Paris-based head of quantitative asset management at CM-CIC.

Pierre Martin, Paris-based head of institutional structured products sales for France at BNP Paribas, agrees and expects more investors to transfer their investments to structured products as a direct result of Fourgous. "The Fourgous amendment is beginning to take effect on our business," he says. "We think that some insurance companies will propose structured products to transform the assets in euro contracts in the second part of this year."

Societe Generale (SG) has also launched an aggressive product, targeting investors looking for equity exposure.

"As a result of the Fourgous amendment, we have received strong demand among the retail market participants for a product that can capitalise on gaining exposure to the equity markets," says Paris-based Laurent Besnainou, managing director, head of French desk at SG. "The idea of the Fourgous amendment is to open up single product insurance contracts and to introduce more diversification. This diversification can be gained by directly investing in equities or equity mutual funds, but there is unlimited downside risk."

SG's product, launched in March, is an eight-year investment plan. Optimizf 7.5% offers exposure to a selection of 40 international stocks, and the performance of the product is linked to a reference basket that contains 20 of the worst performing stocks. As long as the performance of the reference basket is lower than a threshold defined for each year, investors receive an annual coupon.

A coupon of 7.5% is guaranteed at the end of year one and year two. However, the product can mature between the third and eighth year if the performance of the reference basket is reaches a defined threshold. If the product does not mature early, investors can receive 100% of the capital invested and 100% of the final performance of the reference basket.

Both Exane's and SG's products offer high income to investors but neither provide 100% capital guarantees. Besnainou is confident that SG's product has the right appeal. It is a useful transition product for the client - between a totally secure investment such as euro funds and (riskier) direct investment in equity markets," he says. "It can deliver performance in the case of a rise in the US dollars but also in the case of stagnant or falling market."

Options vs CPPI

But some market participants question whether the amendment will make any tangible difference to the sales of structured products, questioning whether products such as those issued by Exane and SG are right for investors. "The Fourgous amendment has had only a marginal impact on the structured products market," says Denis Cohen Bengio, director of investor solutions at Axa Investment Managers in Paris, one of France's biggest distributers of CPPI-based products.

In theory, the Fourgous amendment should encourage investors with longer-term views to switch from traditional secure life insurance contracts to unit-linked life insurance products, which offer equity exposure. But Bengio says investors might not be happy with the inherent risk or the return promises so there has not been a huge flow of capital moved into 'risky assets'.

In fact this stagnation is part of a bigger picture. The structured products market in France is more crowded than before, according to Bengio. "The sales of CPPI-based products are still going pretty well in the guaranteed products universe," he says. "But it is getting harder to convince distributors to buy into structured products."

Meanwhile, Dang at CM-CIC believes offering capital guarantee and using equity indexes as underlyings are essential when it comes to attracting investors who may not have invested in structured products before. "As the policy holders are risk averse, they would invest 20% of their units in capital-guaranteed products with indexation on equity market rather than in risky equity funds," Dang says.

CPPI emerged as the favourite structure among product issuers last year, but CPPI-based products have underperformed recently, according to market participants. "In the retail market, investors have been disappointed with CPPI performances," Martin at BNP Paribas says. "Last year the market was very good and the performance of the CPPI this year hasn't met the client's expectation."

The bad news then is that CPPI-based products issuers are unlikely to benefit from the amendment. "The amendment requires the guaranteed product to be fully invested in equity assets. But CPPI-based products are generally based on diversified funds which invest in both fixed income and equity," Dang at CM-CIC says.

Dang says that most CPPI-based products provide exposure to actively managed funds, while option-based products tend to focus on equity indexes or shares. "The impact of the amendment is likely to be more significant on options-based products," Dang adds.

And so, investors who usually invest in CPPI-based products may start buying options-based products if they want to benefit from the amendment. "CPPI-based products are for investors who are much more aware of the market, and they are more likely to be private banking clients," Dang says. "The investors who bought structured products from the retail banks are not financially cultured and they are more risk averse."

Other measures

Other than the Fourgous amendment, the French government has been busy introducing positive measures to modernise its economy, enabling residents to invest in a wider range of financial products. And again these measures could benefit the French structured products issuers.

A bill was implemented in January 2005 that finally recognised a foreign undertakings for collective investments in transferable securities (Ucits) invested in French or EU equities as a qualifying investment for domestic investors.

Previously, a French resident with investments in foreign Ucits could not qualify for the taxation benefits of investment in a Plan d'Epargne en Actions (PEA) - the French name for personal equity plans. In order to access the French market, foreign Ucits managers had to set up funds in France.

Although to a large extent this discrimination has now been removed, some say that foreign Ucits managers still face fierce competition from local providers, which are also providing Ucits-III compliant products. It is particularly difficult for foreign players to enter the market if they do not have a retail presence or network in France.

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