France develops new code of conduct for alternative investment

France could become one of the first European countries to allow hedge funds to be regulated and sold according to the same rules governing the country's more retail vehicles.

French investment boutiques will be the beneficiaries of a planned relaxation in the country's fund regulations, leading to a move away from large asset managers and banks being almost the sole providers of hedge portfolios.

Regulatory changes and political moves to create a private pension industry could be the catalysts to a boom in the French hedge fund industry over the coming years.

The highly regulated French financial industry has been largely closed to single-manager and boutique-oriented funds for some time. Although the industry began around 10 years ago, it has been confined to a few major players with a relatively small amount of capital under management. Hedge funds became an offshoot of the futures market developments more than a decade ago. This market has remained somewhat immature and has been cited as holding back developments in the French hedge fund universe, with the number of players in the futures market estimated to be between just 10 and 20 groups.

Bernard Dennery, managing director of BNP Paribas Fauchier Partners and French delegate on the board of the Alternative Investment Managers Association (Aima), says the hedge fund industry in France is characterised by a high level of regulation from which few sector or vehicle escapes.

This means there are a limited number of French fund vehicle types that can accommodate alternative investments which, by their nature, need a flexible environment and structure.

alternative Strategies

Only two types of alternative strategies can exist easily within the present regulatory environment ' CTAs and fund of funds.

CTAs can exist because French regulation allows for a type of non-Ucits vehicle called FCIMT (fonds commun d'investissement sur les marches a terme) for investment in the futures market. Its specificity resides in a daily liquidity and a restriction to distribution to the public (no publicity or solicitation). Consequently, the assets involved are marginal.

Investment funds of funds were made possible by the 1988 Fund Law and have grown in popularity over the past three years, much off the back of the increased Europe-wide popularity of hedge multi-manager products. Funds of funds are the only hedged vehicles available in France for a wide distribution.

Fund of funds are treated differently under French regulations and as such have matured and grown at a faster pace. Historically, they have been dominated by boutiques and small independent fund houses, like HDF Management and Olympia Capital. Although in recent years, banks have moved into this area of the market trying to capitalise on the growing popularity of multi- manager strategies.

Under French regulations it is possible to run fund of funds if the underlying funds are listed on a European exchange. There are about 50 funds of this type in the French market with around E3bn in assets under management.

However, the interpretation of a collective investment vehicle as similar to a stock, contradicts a new European directive which, in an effort to create uniformity across the European funds market, will mean even a listed fund must be treated by regulations as a fund.

This regulatory change could open the door, over the next one or two years, for the emergence of something similar to the Titre II structure in Luxembourg. A Titre II is a specific part of Luxembourg fund law that gives non-Ucit funds more freedom.

Single manager/hedge regulation

There is a clear distinction between regulations governing single strategy hedge funds and fund of hedge funds in France, according to Dennery.

The regulations governing single strategy or single manager hedge funds are extremely tight so there has been little development of them.

There has been development on products running on an enhanced cash basis. This is a strategy where a manager tries to achieve returns of Euribor plus 100 to 200 basis points using alternative strategies.

They have used some alternative investment techniques ' primarily convertible arbitrage but also merger arbitrage and others. The biggest players in this market are Dexia and Adi.

In single manager or strategy hedge portfolios there are a number of houses that have developed significantly through managing offshore products, mostly based in Ireland or the Cayman Islands.

In France, there are very few single strategy fund managers who are not with banks or asset management firms, instead the big players in this market are companies like CPR, SocGen and BNP Paribas.

Again, regulations are changing to free up the French hedge fund industry. A few years ago a new law created OPCVM allégés (light funds). These vehicles are accessible to institutional investors and private investors with a minimum of E500,000 to invest. Investment ratios are more flexible and they have been a privileged sector for exposure to some alternative strategies such as convertible arbitrage.

France has also long been active in the capital guaranteed market. This began with BNP Paribas and later SocGen through a company called Lyxor. BNP Paribas and SocGen are still big European players in structured products today. Guaranteed structures have been popular throughout Europe and players like Société Générale have been competitive across the continent as demand for these structures has grown rapidly over the past few years.

Regulatory easing will have a two-stage knock-on process to the industry, according to Dennery.

The first stage will probably be to 'put the house in order,' he says. France is in the process of developing a code of conduct, which will apply to all alternative asset management.

The French professional association and the regulator (the Commision des Opérations de Bourse) are currently working on a framework of best practice standards, which will become the basis for regulation and official registration of all portfolio management companies involved in alternative asset management. This will make France one of the few countries where alternative management is officially regulated. Issues covered include firms' resources and expertise, risk control, investor information and reporting.

The second stage affects funds that in the UK or Ireland would be called qualified investor funds. In the past these have been restricted by rules governing leverage and borrowing. The regulatory changes will likely see a sweetening of those rules in terms of added flexibility.

Three-dimensional regulation

'The view of the French authorities is probably that they do not wish Paris to become a major centre for hedge fund management like London,' says Dennery.

Suggestions have been made that the French authorities may look to allow a type of vehicle called contractual funds, where the investment rules will not be set by the regulation itself but by contractual arrangements defined in the fund prospectus.

If such a law is passed, France should have a three-dimensional regulation ' common funds, fonds alleges and contractual funds ' similar to Irish regulation.

There was some intention to adopt contractual funds earlier than now but lack of time prevented the necessary legislation being passed in Parliament.

According to Jean Francois Flot, COO of Olympia Capital Management and chairman of the Alternative Investments Working Group, AFG-ASFFI (French Fund Managers Professional Association): 'The demand in France is growing strongly. Institutions have been keen recently to invest in such products ' whether directly or through structured products ' due to weak traditional financial markets for those with constraining regulations, such as retirement institutions or insurance companies.

'Those investments represent only a few percent of a very large asset base, but growth has been significant over the past two to three years, and constitutes a very large potential.'


Perhaps the biggest impact on the French hedge fund industry over the coming years will be the creation of a pension fund industry. France, with a few exceptions, currently runs on a pay as you go system.

'The first thing we have to remember is that we do not have any pension funds, the savings fund market is not a huge market in France,' said Dennery. 'This could change with a new government because they will have to tackle pensions.'

This could increase the level of institutional business.

'The French hedge funds industry is currently in the hands of the big houses, but that could change,' added Dennery. 'We haven't seen the emergence of a lot of individual hedge fund managers like we have seen in London,' he said. 'Is it because the French are less entrepreneurial for regulatory aspects, or for other reasons ' I don't know.'

This could change as more money flows in to the French hedge fund industry possibly opening up the market to new funds and managers.

Key Points

France is planning to relax its fund regulation becoming the first European country to govern hedge funds under the same rules as the country's more retail vehicles

French investment boutiques will be the beneficiaries of a planned relaxation in the country's fund regulations

Suggestions have been made that France will adopt a three-dimensional regulation ' common funds, fonds alleges and contractual funds ' similar to Irish regulation.

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