Author: | Published: 3 Oct 1999
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France is often cited as the second largest market after the US for fund and asset management. The total amount of funds under management is estimated to exceed euro1,000 billion ($1,056 billion) and new trends, both in the field of distribution and design of the management products keep the business growing steadily. The introduction of the euro is certainly the major event of this and the coming years. Management products and services will inevitably become, if not worldwide, at least European. Yet, despite the UCITS Directive and the Investment Services Directive complete harmonization is still far from achieved. This article focuses on the non-French asset manager who intends to provide portfolio and fund management services in France to private or institutional clients and addresses some of the most frequently asked and crucial questions in this respect.

Regulatory issues

Non European Economic Area (EEA) licensed asset managers who wish to do business in France must obtain a full licence under the same conditions as for a French entity from the French Commission des Opérations de Bourse (COB). The COB's review is essentially focused on the adequacy of the asset manager's means to conduct its proposed business. The asset manager will need to be set up as a French subsidiary of the foreign entity with a minimum corporate capital amounting to FRF1,000,000 ($161,000).

Access to the market for an asset manager already licensed in a member state of the EEA is however much easier. Indeed, according to the Article 74 of Law n° 96-597 of July 2 1996 (the ISD Law), an entity that holds a licence to carry out investment services (as defined in the Investment Service Directive) in its home country may carry out the same investment services in France, either directly from its home country or by setting up a branch in France by using the so-called European passport rules. Certain filing requirements must nevertheless be complied with both in the home country and in France, and the procedure will vary depending on whether the asset manager intends to provide investment services directly from its home country or by setting up a French branch.

In practice, the decision of whether to set up a branch or provide services directly from the home country of the asset manager will depend on the strength and nature of the proposed activity. It should be emphasized that apart from the cost of operating a branch (and the related tax consequences), a branch has financial reporting obligations to the French authorities.

Keeping these considerations in mind, certain non-EEA asset managers decide to initially set up a fully licensed entity in a country of the EEA — often but not always the UK — and then operate under the European passport rules throughout the EEA by providing services cross-border.

Rules of conduct

When providing cross-border financial services the territorial scope of the French rules of conduct becomes complicated. As regards portfolio and fund management, the French authorities have not given official guidance on which French rules of conduct apply and which do not. However, in a number of circumstances it is impracticable to require that foreign investment service providers modify their original rules of conduct to fit the French standards particularly when home country rules are more stringent. Therefore, a case by case analysis — taking into account the home country regulations of the asset manager — is necessary to determine which French rules of conduct are more stringent than the home country regulations of the asset manager and would require that additional compliance procedures be put into place.

The general framework of the rules of conduct applicable to investment service providers such as asset managers is laid down by Article 58 of the ISD Law (cf, Article 11 of the ISD Directive). As regards asset and fund management, these general rules have been supplemented and detailed by COB regulations and by the rules of conduct prepared by a professional body of asset managers known as the AFG-ASSFI. In this context reporting requirements and the content of the agreements to be signed with the customers in France are regulated in particular detail.

The transparency of fees is a matter of considerable concern to the French authorities as well. The basic rules are that the conditions under which the portfolio managers are remunerated must not be in contradiction with the interest of the client and that the frequency of the transactions realized must be motivated only by the interest of the client. Typically, the asset manager's fee will comprise a so-called transaction commission billed to the client upon each transaction and comprising the brokerage fee, a depository and distributor fee and the remuneration of the asset manager. On the other hand, the mechanism whereby the broker remits part of the brokerage fee billed to the client back to the asset manager is prohibited. In order to be permissible, soft-commissions, in addition to client disclosure requirements, must correspond to means or services aiming at improving the quality of the service for the client, but must not entail an increase in the brokerage fees charged by the intermediaries, not have adverse consequences on the quality of the execution service provided by the intermediaries, not be a determining element of the choice of the intermediaries by the portfolio manager and be provided for by a written contract between the asset manager and the intermediaries. It is arguable, however, whether the French rules of conduct regarding the fees charged to clients must be complied with when rendering fund and portfolio management services cross-border. On the one hand, while it is difficult to conceive that a foreign asset manager would need to adapt its global fee structure and comply with the local rules of the country into which it is rendering services, on the other hand, the rules relating to the transparency of fees are designed to protect the French clients and in particular consumers, who should be offered the same degree of protection and transparency as when dealing with a French asset manager. In any event, the better practice would be to avoid remuneration systems that would overtly conflict with the French rules. The rules relating to marketing and advertising are another frequent area of concern for foreign fund managers and distributors wishing to expand their business to France. Internet distribution represents a special challenge for the regulators. The COB has recently published guidelines indicating that when an offer is targeted at French investors the investment products or services and the website must comply with French regulations. Whether a website will be considered as targeting French investors will depend on a number of criteria such as the information on the website, the language and conception of the website or the links to other websites. The COB recommendation goes even further by indicating that information that is simply accessible without restriction by French residents should only concern collective investment schemes the distribution or advertising of which is not prohibited in France.

Management of a French SICAV or FCP

A foreign asset manager may manage funds of French collective investment schemes — the most common being the SICAV and the FCP — without any need to obtain a licence in France so long as it does not carry out any asset management activity in France. On the other hand, the SICAV or FCP will need to obtain approval from the French COB and, when applying for such approval, it must disclose that the asset management has been entrusted to a foreign asset manager. The French fund will have to provide general, commercial, financial and regulatory information on the asset manager to the COB. In practice, well established foreign asset managers with an international reputation should not experience regulatory approval difficulties whereas less well known entities may. The COB will also wish to verify that the contract entered into between the asset manager and the French fund for the management of the fund's assets is adequate from a French law point of view.

Foreign asset managers will, of course, have to familiarize themselves with the investment constraints applicable to the fund in question. Among such constraints one should note that a SICAV or FCP must be invested up to 90% in transferable securities which are traded or listed on a regulated market that functions on a regular basis. The definition of what constitutes a regulated market is somewhat uncertain, especially when non-European securities are concerned, as non EEA markets that one would think highly regulated do not necessarily meet the French understanding of this term of art. As regards financial futures transactions, the common type of SICAV or FCP may only enter into transactions conducted on a list of permissible markets that has been fixed by the French authorities. The current list specifically excludes commodities futures transactions, even on approved markets. Over-the-counter derivative transactions are also permissible under certain conditions, but the total commitments of the fund on futures and derivatives transactions cannot exceed the total amount of the fund's assets. In addition, stringent prudential ratios apply to the common SICAV or FCP types. For instance, subject to some exceptions, a SICAV or FCP cannot hold more than 10% of the same category of securities and cannot invest more than 5% of its assets in securities issued by a single issuer. Stock or money lending and borrowing are also regulated, for instance, cash borrowings or stock borrowings of a SICAV or FCP must not exceed 10% of its assets.

French fund law and regulations were modernized recently opening new opportunities that could be found before only in jurisdictions such as Luxembourg or Ireland. In particular, the master feeder fund structure is now permissible and it is also possible to create funds with multiple compartments, although the tax rules do not yet permit a tax neutral transfer from one compartment to another. In addition, a new category of funds has been created that can only be distributed to qualified investors or high net worth individuals. Such funds do not require a prior regulatory approval (although their creation must be reported to the COB). These new types of funds provide considerable flexibility to asset managers, since they make it possible to set up highly personalized investment vehicles, as they need not comply with a majority of the investment constraints discussed above. For instance, these type of funds can invest up to 50% in securities that are not transferable securities listed on a regulated market whereas the common type of SICAV or FCP can only invest up to 10% in such securities. Cash borrowings are permissible up to 25% of the assets of the fund and investments on non-regulated future markets are also permissible.

Liability issues

Although the French courts do not appear particularly investor friendly and do not tend to award generous damages, disgruntled investors sometimes seek to hold asset managers liable for their losses and there are a significant number of court cases involving the question of an asset manager's liability. However, as one would expect, the cases appear to be more frequent in the field of individual portfolio management than in the field of fund management.

To obtain damages, investors will of course need to prove that the asset manager has committed a fault that caused a loss in value in their investment. The simple fact that the manager has violated a regulation, even in the case where the violation has led to the withdrawal of the authorization of the fund, is not alone sufficient for establishing a valid claim for damages. In an interesting recent case the Paris Court of Appeals held that the loss of the totality of the value of the portfolio does not establish or give rise to a presumption, that the asset manager has committed a fault. However, another and even more recent decision may be construed as indicating that the management results must be appreciated in the light of the general evolution of the market and that, in the case of unusual bad performances, the burden of proof may be shifted to the asset manager, who may have to prove that they are not at fault.

Moreover, both the COB and the Conseil de Discipline de la Gestion Financière (Financial Management Disciplinary Council) have the authority to sanction all violations of the laws and regulations applicable to fund and asset management activity. The sanctions that can be exercised on an SICAV/FCP, the asset manager or their directors includes a warning, a blame or the temporary or definitive withdrawal of the asset managers' licence to carry out the fund management activities. The COB approval of the SICAV or FCP can also be withdrawn. In addition, the authorities can pronounce pecuniary sanctions that cannot exceed FRF5 million or 10 times the expected profit. The authorities are also granted broad powers to conduct routine or specific investigations and every year around 100 investigations of this type are made. In the field of fund management the most frequently noted violations would appear to be the non-compliance with risk division ratios or the fund's investment guidelines and the absence of proper risk monitoring or incorrect valuation of the redeemed shares. However, other causes of liability do arise: for instance, a UK investment service provider was recently found guilty of having sold unit trusts in France that were not approved for distribution by the COB and the French Ministry of Finance. In the field of individual portfolio management the most frequent alleged violations are the failure to provide sufficient information to the client about the risks involved and, more generally, non-compliance with the rules of conduct. Finally one should note that the law and the sanctions mentioned apply both to asset managers operating in France and to foreign asset managers operating cross-border.