France at a Turning Point

France at a turning point in alternative investment industry

Philippa Aylmer

One of the largest hedge fund firms in France, ADI Alternative Investments, has received approval from the regulators for a multi-strategy hedge fund. The landmark decision has been supported by some big names in the fund services business: Credit Suisse First Boston (CSFB) will act as prime broker and Credit Agricole-Investor Services (CA-IS) as administrator.

The Autorité des Marches Financiers (AMF) has approved what looks to be the first singlemanager hedge fund for French retail investors. It gives the fund the status of ARIA; the result of the most recent round of new regulations ratified by the AMF late last year. The changes represent a significant step forward and have given the French alternative investment industry the edge it needs to compete in the markets. With over $12 billion in hedge fund assets, France is the second largest and fastest-growing market in Europe's burgeoning hedge fund industry.

Provided they meet the right criteria, funds can now attract new investors such as institutions that cannot currently buy offshore products. Funds created under French law will be able to obtain the financing necessary to implement their strategies by retaining the services of a prime broker. CSFB's appointment means it is the first prime broker to a leveraged French onshore hedge fund.

Intense negotiations pay off

The approval is the result of two years intense work between the three parties: ADI Alternative Investments, Credit Agricole-Investor Services and Credit Suisse First Boston. The AMF was keen to release a product competitive with offshore conditions. It has been a complex process, but the tri-partite agreement has been declared a success by all parties. They have worked within the legal and operational parameters and have released an onshore product that competes effectively with offshore offerings.

Alain Reinhold, Chief Financial Officer of ADI explains that with the help of CA-IS and CSFB, they addressed the issues raised with the AMF: "Their ability to co-operate meant that we successfully reached an agreement. The AMF did not try to set the rules. They listened to the industry and worked with our needs".

Muriel Danis, Vice President of CSFB in Prime Services agrees that the AMF was ready to listen and highly co-operative with fund managers. Says Danis: "We have been really impressed by the attitude of the regulator. They understood right from the beginning that this would only work if an onshore product could compete effectively with offshore products and the AMF ensured that they provided the right investment conditions with respect to leverage effect".

The recently formed AMF is an amalgam of the Commission Des Opérations De Bourse (COB) and the Conseil Des Marchés Financiers. Charged with the implementation of changes to French regulations, it allows investors to access all types of direct alternative managementon an 'onshore' basis.

Key characteristics

The creation of the ARIA structure is a key factor in the development of alternative asset management in France. French funds and segregated accounts can now invest in hedge funds, subject to AMF approval.

Reinhold sees the approval by the AMF as very positive. "The regulations will encourage a wider client base and allow the French hedge fund industry to develop internationally," he says.

French law now recognises ARIA as a new category of OPCVM (Organismes de Placement Collectif en Valeurs Mobilieres). OPCVM ARIA are French funds subject to more relaxed investment rules than the standard OPCVM: management activities can only be delegated to other French investment management companies or to foreign companies within the same group as the French manager. This is contrary to the French position for standard OPCVM.

There are three types of ARIA: Standard ARIA; ARIA FA (funds of funds) and ARIA EL (leveraged ARIA).

ARIA EL are authorised to use a prime broker and to both derogate from the risk diversification and concentration rules and leverage fund assets by 400% with no restrictions on counterparty risk. Funds must calculate their net asset value on a monthly basis and a have a mandatory notice period of no more than 35 days.

ADI has obtained the first ARIA EL agreement from the AMF. As an ARIA EL, the ADI fund will have certain restrictions. Investment will be limited to a minimum of €125,000 and individuals will have further restrictions: before investing, private investors must prove that they have financial assets of over €1 million or are qualified investors with over one year of working in the industry. However, once proved, their minimum investment is €10,000. ADI has raised that amount to €100,000 in order to reduce the volume of trading.

Provided they have a balance sheet of over €20 million, a turnover of over €40 million or a capital base of over €2 million, there is no minimum investment limit for banks and institutions, and no restrictions on the type of institution.

Within the institutions themselves there may be restrictions; for example, specific areas within insurance companies and local retirement plans. The ARIA EL is considered as non-listed and would be included within the 10% ratio. However, the insurance industry is recommending that this be raised to a ratio of 30% of all investments.

The AMF requires investment managers to submit a 'Multi-Manager Business Plan' in order to demonstrate their ability to implement and supervise cohesive management strategies while ensuring that the funds operate with sufficient control over their quantitative, qualitative and operational risk.

Danis explains: "We have laid the foundations, but it is the first project of its kind and we will be continuing discussions in order to ensure that it remains workable" adding "ADI was very positive towards helping the regulator and the industry to move forward".

The new type of fund does not come without its costs. There will be additional personnel charges and registration fees which will inevitably have an impact on profitability. Many believe that these will outweigh the benefits, but Reinhold believes that there is real added value in establishing a regulated fund. "The custodian has a duty of control on a day to day basis to ensure that we comply with the prospectus. This opens up the client base to those who do not have the capacity to do due diligence".

The new regulations have the added advantage in that funds may be marketed in France whilst foreign hedge funds cannot be.

The first of its kind

The ADI fund is the first complete and organised French regulated leveraged fund in France requiring the action of a prime broker. Says Reinhold: "In setting up a multi-strategy fund we can draw from the experience of our other funds and maximise returns. To start with, we will develop organically as it is vital that all the support processes work in line with the regulations".

The fund will be launched in the next few weeks once the decree has been ratified. Discussions are still under way regarding share equalisation, a process that is not standard practice in France.

France already has a number of established hedge fund firms and it is Danis' belief that the country will see an increase of new entrants saying, "Our huge commitment to France in terms of resources will enable us to take advantage of further opportunities in the industry", adding, "We have a good relationship with French regulators and local custodians and we will continue to serve our French client base, but use leverage to support growth".

CA-IS, will act as custodian, depositary bank and fund administration provider. It operates the Fastnet fund administration network in partnership with the Fortis Group. It is the first custodian for this kind of service, but with more than €470 billion in assets under administration in the European securities services business and €61 billion in alternative investment and structured products, it has experience in this field. CA-IS has won custody mandates from hedge funds, funds of hedge funds and structured products in Luxembourg and Dublin.

Patrick Lemuet, Head of Sales and Relationship Manager for CA-IS, says: "We already have a strong presence in Europe and feel that it is a positive move. It is good for the French market and it is good for us. It proves to our clients that we are committed to the business and that we can anticipate the market".

Good news all round?

The new regulations will help investors gain access to more sophisticated products in the asset management market while benefiting from a regulated framework. They should attract institutions, independent houses and new entrants to the market.

But by tradition, France tolerates low levels of risk, with a focus on fixed income, so there has been concern that while developing an onshore market, local issues may take precedence, and in the longer term lead to the fragmentation of the European market.

However, France has a proven track record in alternative investments, with plenty of local expertise to draw upon, and the hedge fund industry has become well-established prior to the new regulations, with a strong institutional investor base. The new regulatory framework will serve as a significant step forward for the local industry, and will be watched closely by other European regulators considering similar moves.

As Reinhold states, "There is no doubt that hedge funds are complex but we believe that there is real added value in regulation. It will open up opportunities to those clients previously unable to access these products and develop the industry".

ADI, CSFB and CA-IS have been quick to seize the opportunities offered by the AMF. They have established regulations in a country which is fast becoming a major player in the hedge fund industry, but which had been under fire from managers for its confusing and seemingly contradictory alternative investment regulations, particularly with reference to funds of hedge funds. It remains to be seen whether the implementation of these regulations and ongoing market practice will comply with international standards, but it is a positive move. As Danis explains: "Regulation is an ongoing process and we are ready to discuss further in order to reach a workable solution".

This is welcome news for a rapidly expanding industry.