What’s certain is that the French authorities are sensitive about developments in the UCITS space. Already, many French asset managers have moved operations to Luxembourg. With the increasing use of the UCITS wrapper by alternatives managers, the growth of Luxembourg as a fund centre looks well positioned to go further.
Against this, France is keen to retain its very large and well developed funds sector. Several French asset managers are not only major players at home, but the owners of leading asset managers based elsewhere around the world. The interplay between the AMF and these global giants gives the regulator a uniquely well informed take on developments across the investment management sector.
Editor Bill McIntosh recently spoke to Edouard Vieillefond, who in mid-2009 became managing director in charge of the Regulatory Policy and International Affairs Division of the AMF. The following is an edited transcript of their conversation.
Q: What are the reasons for AMF having a consultation on the UCITS regime?
A: It is always part of our process to hold a consultation when there is a new directive or regulation in Europe. It’s something that is compulsory for any legislation, European regulation or directive, and so we are doing that for UCITS.
Q: Are there any particular policy goals?
A: It was a collective effort, involving the Treasury, AMF and the industry. We tried to take advantage of the implementation of UCITS IV (which came into effect on 1st July). We tried to improve the regulation and to maybe alleviate the burden on certain points where the legislation could be changed. We adopted a literal approach to the implementation in the sense that we tried to avoid as much as possible gold-plating and as much as possible to translate directly the directive into legal text.
We have also managed to take advantage of this new directive to help the industry to develop in France, and we had a number of discussions with the industry to discuss fine details and to have a good balance between investor protection and the development of the financial centre and of investment management companies and UCITS in Paris. Next year, we will do the same with the AIFMD and look for an appropriate adaptation of the regulation. In this case, the overhaul and change will be greater as the AIFMD changes the way hedge funds, real estate funds and other funds will be managed.
Q: Does the AMF aim to promote the development of alternative funds, domiciled and managed in France?
A: Yes, it’s part of our policy. But when you look at our strategic plan, it’s clearly said that our main objective remains – as usual – investor protection. This is the traditional remit of the market regulators, and though we work on a lot of issues, this is the most important one. That is why we have created, within the AMF, a new division in charge of retail investor relations. We are quite active on supervising a number of products and we have taken a very tough stance on highly complex projects in recent months. We also strongly support the European initiative regarding legislation such as PRIPs (Packaged retail investment products).
The second goal is to strengthen our risk policy. Before the crisis, systemic risk surveillance was mainly considered as the traditional remit of bank regulators of central banks. After the crisis, that is not the case anymore. All financial regulators have become aware of the fact that they need to do something on this. So, you have a new IOSCO standard saying that market regulators should be competent in presenting, supervising and trying to mitigate risks to the system.
And the third goal is to promote Paris and France as a financial centre where there is a good balance between investor protection and having a vibrant financial market. It is important for trading and clearing, and for market infrastructure, and is clearly present in our strategic plan.
Q: It is noted in the AMF paper, ‘The Priorities for Financial Markets,’ that the interpretation of the UCITS directives vary so much that protection falls far short of the levels that retail investors deserve. Please explain and distinguish between retail investors and institutional investors. Is it the case that with retail investors, the AMF is referring to more than just private investors, but also to local authorities or other institutional investors that aren’t particularly experienced?
A: That is right. We think that we need to distinguish the level of protection we want for the retail sector and professional investors. It doesn’t mean that professionals should not be protected; after all sellers should behave in a fair, non-discriminatory manner.
But for UCITS, of course, it is about targeting funds and managers that are selling products to the retail sector. So, the amount of protection should be graduated. This is why we have taken quite a tough stance on certain products at the national level in France, for very highly complex structured products. But, as far as UCITS is concerned, the problem is that we have had very different rules implemented at national levels.
This is the case with risk management or eligible assets and, importantly, depositories. If you look at the differences in the role of the depository and the definition of what they should do, it is very, very different from one country to another. The survey by the European Securities and Markets Authority shows this. So, we need a new directive that includes an additional layer of regulation, including rules on depositories. This will be part of UCITS V.
We hope that ESMA will be in position to impose the single rule book with all the new powers it has on binding mediation, on implementing binding technical standards, so that we don’t have the situation in Europe where you have very different and diverging interpretation of Level One measures.
Q: How would you characterise the Commission’s work to harmonise and strengthen the principles underlying the rules relating to UCITS depositories?
A: First of all we welcome the European Commission initiative, because it’s a very good and interesting work. We hope UCITS V won’t be delayed too much. We know that the regulatory agenda of the European Commission is significant, to say the least. So, we need to work on UCITS V quite quickly to cover the full scope of depositories. We already have rules, within AIFMD on depositories, and we are working at Level Two to implement on a technical level those measures concerning depositories.
The fact that there is a possibility of discharge or transfer of responsibility from a depository to a sub-custodian, is not a problem for us, because it’s between professionals. But, in UCITS V, we won’t accept that. In UCITS V, we think protection should be much tougher and, as a rule, the responsibility of the depository and the safekeeping of the asset should not be transferred to anybody else. With due diligence and the risk management as a whole it should be very close to the system we have in France today.
Q: One of the things that obviously happened in the UCITS regime that might have been unexpected was the development of Total Return Swaps, and I wondered what the AMF position on this was, and if there are concerns, what are they?
A: We have several concerns with this. Like many people, we think UCITS is a very good brand and that we should protect the brand. But not at all costs, i.e., we should not accept everything in the UCITS envelope. We think that some UCITS funds are either too technical or they are stretching the limits of the boundaries of the regulation. So, first, we should not accept things that are not in the spirit of the UCITS regulation, for instance, concerning the eligible assets.
Secondly, for us it’s clear that not all UCITS are simple. Many UCITS are simple, but many of the recently launched ones are complex. There is an important debate at European level now to try to delineate between non-complex and complex. Clearly, some products should be considered as complex, but not be banned from being in the UCITS envelope.
Turning to Total Return Swaps, ESMA is working on the development of guidelines to see if these TRS instruments do not create additional risk or do not decrease the degree of protection investors have. We think the use of TRS requires certain specific safeguards because of two potential difficulties.
The first is that if TRS may be highly correlated with the strategy of a bank trading desk; such delegation is no longer asset management. In terms of risk management, competence and knowledge, we have a strong view in France that only true asset managers, not a trading desk, should manage products for clients. The second difficulty is the potential conflict of interest. If you have a TRS that is based on the strategy of a bank trading desk there may be a conflict of interest. We are looking at additional guidelines to mitigate and prevent those conflicts of interest from occurring. The more a fund uses a complex strategy and the more it approaches a bank trading desk strategy, the bigger the risk for a conflict of interest.
Q: One hedge fund executive whom I spoke to recently said that, if the whole point of UCITS funds is to make them safe for investors, limiting complex strategy is a good thing, but allowing access to a more diverse range of assets, including liquid commodity features, is good, too. What is the AMF’s view?
A: First, I think it is important to understand that risk and complexity are very different things. Risk should not be banned for the retail sector. We need some degree of risk. Today, in France, for instance, retail investors don’t have a sufficient level of risk in their portfolio. For the financing of the economy over the long term, it’s not a good thing. So, we are not here to ban risk in the portfolios of the retail sector, because they need to have risk assets, such as equities.
Complexity is a different issue. We have taken a stance whereby when it becomes too complex to be understood by a household, by an individual shareholder or investor, then asset managers, banks, and so on, should refrain from selling those products. So, we think that risk and complexity are very different things. There is acceptable risk for the retail sector. It’s part of the financing of the economy. But there shouldn’t be too much complexity, and the more complexity you have for the retail sector, the higher the level of protection that is needed.
Complex UCITS may still be UCITS and may still be marketed to the retail segment, but there should be some specific rules to accompany the funds, involving advice, knowing the customer and so on. And, for a very small number of very complex products, we even think that marketing to the retail sector would not be a good thing. This is not a ban on the products themselves, because those products could be sold to institutional investors. With the combination of EU passports and product approval done at national level by different regulators, regulatory authority shifts from the approval of the product to the approval of the marketing procedures.
A last point on this is that we are also quite worried by the development of products that are not in the UCITS envelope, for instance, exchange-traded products. For instance medium-term notes are bonds, which are also sold to the general public, but may be very complex and aren’t subject to the same detailed UCITS rules. We want to make it more difficult to have regulatory arbitrage between those different regulatory wrappers.
Q: With respect to commodities futures, which were excluded from earlier UCITS regulations, obviously, now that commodities investing has become much more important mainstream, is there a place for liquid commodities in UCITS?
A: With commodities, let’s look at the political background. Today there is a lot of discussion on the appropriateness of the retail investing in commodities. Derivatives have existed for decades and even more around commodities futures markets. The new thing is that those derivatives are not used for hedging anymore. More and more, they’re used by people who take very strong positions, and not only by hedgers. The problem is that commodities – I’m talking about oil, gas, energy, metals, and, of course, soft commodities – are becoming financial products and included into ETFs, for instance.
This development raises a certain number of questions. If you want more liquidity, this may be positive. But, at the same time, there may be excesses and more correlation between those products, and equity or bond financial markets. There is also the question of whether those prices should depend on investors or on the fundamentals and the supply and demand on the spot market side. In addition, we should be wary of having too much correlation between different investment products.
There are strong rules in UCITS about diversification around financial instruments and in particular commodities futures. We need to be cautious so that there is diversification in these products. An oil future on WTI and the share of an oil major may not be the same product, but as they are much correlated and you run the risk of having huge problems in the future with those UCITS. There is more and more correlation between financial assets and commodities, and more and more correlation among commodities themselves such as oil, gas, electricity, and even the soft commodities. Perhaps the only exception is gold. We need therefore to be very cautious on the correlation between different products, and if there are commodities in some UCITS, we should be sure that there is not only one product or equivalent product in the same basket, in the same UCITS.
Q: Has the AMF received complaints, either from investors or traditional fund management groups, about the development of UCITS funds by alternative investment managers?
A: I think that many traditional UCITS managers, and not only in France, are fearful not because of the competition or the new people coming to the UCITS business; they’re afraid of the risk that the new funds will damage the UCITS brand. Their point is that the brand could be damaged if some of the new UCITS funds spring surprises on investors because the strategies are too complex. There is a worry that UCITS rules may be too limiting for such funds, but that if the limits are stretched beyond what the UCITS envelope allows, we will then lose the spirit and the letter of this regulation. This would imply that investors will be disappointed at some point.
Risk to the UCITS brand is significant because it is an important brand for each investment industry in each European member state. But it is more than this as UCITS is also a very important brand internationally. Thus, one of the goals of the UCITS directive is to have better conditions for exporting these products outside of Europe. UCITS funds have a good reputation both in France, of course, but also in many European countries. This is why concerns have been expressed through ESMA. I think the main thrust of these concerns is not really about new competition, but about the damage that could be done to the UCITS wrapper.
Q: One French prime brokerage executive said to me, swaps in UCITS aren’t new and that some regulators are just reacting to press attacks over the lack of oversight, and predictions that there will be a blow-up of a UCITS fund. What’s your take?
A: I would come back to what I said on complex UCITS. I agree that derivatives are not new in UCITS. They are not new in France either. In the beginning, UCITS worked quite simply, based on shares and so on. Now you have a great deal of innovation that has been created around UCITS, including derivatives and much more complex products. We are not against financial innovation, obviously. For retail sector or for households, we think that as soon as the UCITS become too complex, there should be specific rules to protect the individual investor.
But the idea is not to go back to the level of financial innovation that existed 20 years ago. This is not the idea at all. Instead, the aim is to accompany this innovation and the development of new products by an appropriate level of regulation. It means that for complex products there are rules targeted at protecting investors in terms of the advice given by the asset management company and the know your customer rules. In very specific cases, (a few occurred in France a few months ago), for very complex products, we want the national regulator to have the power to say to banks or an asset manager that a product is too complex to be marketed to the retail sector and can only be marketed to professional or institutional investors.
Q: With AIFMD coming into effect soon, and UCITS IV, how do these regimes position themselves vis-à-vis the other, and how does the AMF plan to administer them in France?
A: I think those directives have very different goals. I don’t think it is that difficult to harmonise the implementation of those directives, but it will be a heavy workload. The change in the UCITS directive is not a revolution. It’s targeted at retail investors in order to keep a high level of protection. The AIFMD is targeted at professional institutional investors, so the rules would be, in any case, lighter.
I think there are some challenges, though, that we need to face in European countries, including in France. This will, for instance, raise the question of the classification of our funds. Indeed AIFMD is very different from UCITS IV, because it only regulates and supervises the managers, not the funds themselves. There are very different funds in Europe, and this will probably lead us to re-think the regulation of our own funds in France.
Another issue is the AIFMD passport. We’ll need to adapt to the passport, which will be first a European passport and then a global passport, and then there may be the total disappearance of the private placement regime. So, we need to adapt to all of this.
We will need also, perhaps, to re-think some of the fund classifications in France, which have a historical dimension. We have started to do that with the implementation of the UCITS IV, but, of course, with the AIFMD we’ll need to do much more, because everything that’s not UCITS will be AIFM. Thus we need to think about what AIF we want to create in France, and whether we want to stick with the present system or change the classifications.
It should be a very interesting debate. And normally, in terms of the timetable, there should be for AIFM, a working group launched in September or October, to reflect on the implementation of AIFM, exactly as we did one year ago for UCITS. The aim will be to try to define the main guidelines so that we can implement the AIFMD on time. The directive should be operational by the middle of 2013. Given the time needed to implement, the technical implementation needs to start in the summer of 2012. It means that we will have one year to think about the changes we want to make regarding hedge funds, real estate funds and private equity funds in France. We’ll take advantage of the AIFMD to reflect, overhaul, and improve our national framework.
Q: What is the AMF’s view on minimum investment levels for retail share classes? Does the AMF have a strong view on minimum investment levels for retail share classes of UCITS funds?
A: For UCITS, there is no minimum investment. Today, the situation is different for some of the French (non UCITS) hedge funds, where you need a minimum investment, so that you are considered as professional or wealthy enough to invest in those funds.
Q: Some funds do put a minimum investment on a UCITS allocation, because they don’t want to market to retail investors, so they’ll have a minimum of, say, €100,000.
A: This is a voluntary position of the investment management company itself and a different proposition. I am talking here about the regulation where there is nothing on this. For the investment management company, it may be different. But if you look at what exists in France, for UCITS, of course, there is no minimum, but products on which we say, well, you need to have to invest more than €10,000, €50,000, this is precisely the area of hedge funds which are non-UCITS.
I mentioned earlier the policy we have concerning very highly complex products. We have more or less banned the marketing of these very highly complex products to the retail sector. This is true, but with some exceptions. One is for funds which are marketed with units of more than €50,000. When units of those funds represent a big amount, such as more than €50,000, the ban I mentioned on those very complex products, does not exist anymore, because we consider that they are addressed to more qualified people.
We have this category and we use it in very specific circumstances. But, this is for very specific circumstances that apply to very complex products, be they UCITS or not. But for products that are only complex, we would not impose the same kind of rules. For a complex product there is an explanation, advice due by the seller from the investment management company, and a number of things around that. The question is not having a threshold. What we are seeking to do is aim towards a more unified and harmonised framework between the various UCITS and AIFM directives. A useful fleshing out of the European regulatory framework would be to have a more harmonised definition of who is a professional and who is a household or member of the retail sector.
Q: Finally, are there any specific hedge fund or alternative fund strategies that you think are particularly unsuited to being put into a UCITS wrapper?
A: We can’t see any broad strategy which would be forbidden or banned from using a UCITS wrapper at the outset. Of course, a thorough case by case analysis is needed and this would need to be followed and monitored. One of the goals of the AIFMD would be precisely to monitor and supervise hedge funds, and specifically target those which have the more risky strategies, including the biggest funds that use a lot of leverage. The idea isn’t to ban or to give detailed guidance on permissible strategies. But we do want to monitor through ESMA those hedge funds which may be risky because of the level of correlation between different funds or strategies.
I don’t think there is a list of broad strategies that would be specifically targeted and decreed as impossible to include in a UCITS wrapper. But very complex strategies based on TRS or some ETFs, where there are risks in terms of competence and, above all, risk of conflict of interest would be among the strategies we would look at with the most attention. As well, everything that is very highly complex and very difficult to understand for the UCITS wrapper, we would look at specifically, too.
Within UCITS, there will be complex strategies and there will be risk. We need to limit both. That is why there are rules about diversification and these rules of diversification should be respected. Using a basket of very correlated products to create a UCITS is not acceptable for us. It is also very difficult to accept something that would be closely linked to a very complex strategy of a trading desk of a bank, which would be very complex for the investor to understand and where there would be a bias giving rise to a conflict of interest.
But I want to conclude by emphasising that there is not any rule on accepting or excluding strategies per se. There is an analysis to be done, product by product, strategy by strategy. These are the guidelines we will use to check whether products are too complex or too risky to be included in a UCITS wrapper.
