However, recent difficult markets conditions together with the demands of individual investors have led to the increased practice of direct alternative management in France, in parallel with increased international activity in hedge funds and funds of funds. This situation led the Commission des opérations de bourse ("COB", the French regulator that merged with the Conseil des marchés financiers to become the Autorité des marchés financiers – the "AMF") to review its position on such activities. Further to this review, the COB, and thereafter the AMF implemented important changes to the French regulations to allow investors to access all types of direct alternative management on an "onshore" basis. These changes have also helped to promote the competitiveness of the French financial markets with respect to alternative management.
The COB recognised in its relevé de décision dated 03 April 2003 (the "COB's position") that hedge funds were eligible investments for French funds and segregated accounts. However, any investment in such structures may only be made by French investment management companies that have filed a specific business plan with the AMF (the "Multi-Manager Business Plan"). Furthermore, contrary to the French position for 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.
The Multi-Manager Business Plan must demonstrate the investment manager's ability to implement and supervise procedures to select and review the underlying alternative funds including their (i) quantitative risk (performance, strategy, etc); (ii) qualitative risk (control of risks); (iii) operational risks (organisation of the management company and the other service providers); and (iv) compliance with the 13 criteria (see 1.2 below).
By virtue of Decree n°89-623 dated 06 September 1989, as amended (the "Decree"), OPCVM were only allowed to invest in foreign hedge funds that complied with an 11-criteria test and, with respect to certain OPCVM, the COB added a requirement for the foreign hedge funds to also be listed ("Eligible Hedge Funds").
The 11-criteria test related primarily to the structure of the underlying hedge funds (e.g. the requirement to have a separate custodian and management company) but also contained some controversial aspects. For example, one of the problematic criteria obliged the Eligible Hedge Fund to ensure equal treatment of its investors (which many hedge funds did not satisfy) whilst another stipulated that the manager or advisor of the relevant hedge fund should be "registered".
The lack of clarity regarding the 11-criteria, together with the addition of the listing requirement significantly limited the French funds of funds investment universe and thus adversely impacted their ability to achieve performance without high volatility or liquidity issues. As a result, and after much adverse comment from the French funds of funds industry, the AMF agreed to revise the COB's position and released in its general regulations3 new rules relating to investment in hedge funds.
Most importantly, through the publication of these new rules, the AMF has replaced the 11-criteria test with a 13-criteria test. Whilst this hardly appears to be an improvement, in practice, the addition of two new criteria is aimed at facilitating the interpretation of the old 11-criteria.
The AMF has also confirmed that it has contacted the French Treasury, which is responsible for amendments to the Decree, in order to withdraw the listing requirement.
Before the changes to the French investment management regulations, the use of alternative investment strategies was limited. For instance, a standard OPCVM was (and is) only authorised to invest up to 10% of its assets in Eligible Hedge Funds. In addition, although, a simplified procedure OPCVM was (and still is) authorised to invest up to 100% of its assets in Eligible Hedge Funds4 , 50% of such Eligible Hedge Funds must be listed on a regulated market. However, further to the Financial Securities law of 1 August 2003, French law now recognises two new categories of OPCVM structures, namely "Contractual Funds" and "OPCVM ARIA"5:
OPCVM ARIA are French funds subject to more relaxed investment rules than standard OPCVM. There are three types of ARIA: Simplified ARIA ("Standard ARIA"), Funds of Funds ARIA ("ARIA FA")6 and ARIAEL7 ("Leveraged ARIA").
Unlike standard OPCVM, investment in a Standard ARIA or Leveraged ARIA is limited to (i) investors investing at least 125,000 Euro; (ii) private individuals (a) investing at least 10,000 Euro; and (b) declaring either (1) that they have, within the last year, worked in the financial sector in a professional role which has enabled them to acquire a knowledge of the investment strategy of the fund; or (2) that they have assets of at least 1,000,000 Euro; or (iii) qualified investors8.
Subscriptions in ARIA FA are dealt with differently and are permitted by investors who subscribe for at least 10,000 Euro of shares/units9.
From an operational point of view, OPCVM ARIA must calculate their net asset value on a monthly basis (as a minimum) and may impose a mandatory notice period for subscription/ redemption requests that may not exceed 35 days. However, they also benefit from an interesting derogation from standard OPCVM which allows them to draft their informational and constitutional documents in English (in a normal business language other than French) when these funds are offered exclusively to overseas investors.
Standard ARIA are authorised to derogate from the standard OPCVM risk diversification and concentration rules. Thus, a Standard ARIA may invest up to 35% of its assets in shares or bonds of the same issuer.
These structures are however subject to the same investment restrictions and leverage limits as those of Standard OPCVM except for the fact that Standard ARIA are authorised to invest up to 50% of their assets in shares (or units) of Eligible Hedge Funds. It is worth noting that this limit should be raised to 100% once the Decree is amended and that there is no requirement for Standard ARIA to invest in Eligible Hedge Funds that are listed on a regulated stock exchange.
ARIA FA are specifically designed for fund of funds strategies. Unlike standard OPCVM, which can invest only 10% of their assets in Eligible Hedge Funds, ARIA FA, can invest 100% of their assets in Eligible Hedge Funds. However, until the Decree is amended, 90% of such Eligible Hedge Funds must be listed on a regulated stock exchange.
The diversification rules applying to such structures are similar to these applying to standard OPCVM: such structures are authorised to invest in listed Eligible Hedge Funds, with a minimum of 16 underlying funds – respecting the 51040 diversification rule. Thus, in effect, an ARIA FA must have a minimum diversification of 4 Eligible Hedge Funds each representing 10% of the fund's assets and 12 Eligible Hedge Funds each representing 5% of the OPCVM FA's assets.
Leveraged ARIA are authorised both to derogate from the risk diversification and concentration rules and to leverage fund assets by 400% with no restrictions on counterparty risk.
The rules applying to Leveraged ARIA are similar to those applying to Standard ARIA except that a Leveraged ARIA is also authorised to use a prime broker (with rehypothecation limited to 140% of the indebteness of the fund).
(C) Business plan requirements Standard ARIA. Any French investment management company may manage such type of structure as no specific business plan is needed to set up Standard ARIA. However, if the fund adopts a multi-manager approach or if the management strategy relies on the use of complex financial instruments or credit derivatives, a specific business plan is needed.
ARIA FA. These funds may only be established by French investment management companies that have obtained the prior approval by the AMF to their Multi-Manager Business Plan.
Leveraged ARIA. Management of these structures will, however, be limited to French investment management companies that have filed a business plan demonstrating their company's ability to track leverage.
Unlike standard OPCVM, investment in a Contractual Fund is limited to (i) investors investing at least 250,000 Euro; (ii) private individuals (a) investing at least 30,000 Euro; and (b) declaring either (1) that they have, within the last year, worked in the financial sector in a professional role which has enabled them to acquire a knowledge of the investment strategy of the fund; or (2) that they have assets of at least 1,000,000 Euro; or (iii) qualified investors10.
Contractual Funds are defined as structures intended as vehicles for investment in any type of financial instrument or bank deposit. The only limitations on the investment policy applicable to such funds are self-imposed restrictions set out in the constitutional documents of the relevant Contractual Fund. Thus, Contractual Funds are not subject to any general asset diversification rules and may invest up to 100% of their assets in a single investment, or in a single bond issue.
As a consequence, Contractual Funds are able to invest in foreign funds without such funds having to meet the investment conditions applying to all other OPCVM11. Contractual Funds are also authorised to use leverage without limitation, may employ a prime broker and can authorise any amount of rehypothecation by any such prime broker.
Furthermore, Contractual Funds also benefit from a certain number of derogations from the rules applicable to standard OPCVM and to OPCVM ARIA. For instance, although Contractual Funds must calculate their net asset value on a regular basis, such a calculation need only be carried out on a quarterly basis. In addition, their constitutional documents may provide for 3 month notice periods for both redemptions and subscriptions and impose a lock-up period of up to two years on their investors.
The investment management company of a Contractual Fund must have obtained the prior authorisation by the AMF of a specific Contractual Fund business plan. This requirement is aimed at enabling the regulator to supervise (i) the formation procedures for each Contractual Fund created by the management company, (ii) the means of establishing the investment restrictions for each of the Contractual Funds, (iii) the procedures for verifying and supervising the application of such rules and, finally, (iv) the personnel and specific techniques allowing the tracking and supervision of the creation and day-to-day activities of the Contractual Funds.
As well, depending on the investment techniques used by the Contractual Fund manager (e.g. use of credit derivatives, leverage greater than 200%), it may be necessary for additional business plans to be filed with and approved by the AMF.
Most importantly, the establishment of Contractual Funds does not need to be pre-authorised by the AMF. Their management company is only required to notify the AMF after the structure has been set up. As a result they can be rapidly created to react to market opportunities or investor demand.
The recent evolution of French alternative management regulations and the creation of OPCVM ARIA and Contractual Funds offers a real opportunity to create French hedge funds. Such French hedge funds also having a major advantage over their offshore counterparts – as the French hedge funds may be marketed in France whilst foreign hedge funds cannot. However, it remains to be seen whether the AMF's implementing regulations and market practice will enable these new French structures to cope with international standards (such as the use of redemption gates and share equalisation) whose implementation in France still raises some difficulties.