Derivatives Houses Expect Go Ahead To Take On Fund Managers

The European fund management industry could be revolutionized if a change to fund regulation concerning derivatives that was proposed last week is approved by individual European regulators. The European Commission proposed rule would allow investment banks to repackage derivatives as funds and sell them across Europe. "It's a really big deal," said Simon Gleeson, partner at Allen & Overy in London. "This clears the way for [Undertakings for the Collective Investment of Transferable Securities] as repackaging vehicles." Wrapping over-the-counter derivatives in different legal forms is a growing market for most investment banks. Tim Hailes, assistant general counsel at JPMorgan in London, said, "It opens up potentially new opportunities for offering derivatives products wrapped in funds form."

Alain Dubois, chairman of the managing board of Lyxor Asset Management, a wholly owned subsidiary of Société Générale with some EUR40 billion (USD48 billion) under management, said, "This is great news." Dubois believes the main benefit of the recommendation is it will clarify the situation because at the moment the regulations governing wrapping derivatives are interpreted differently by each national regulator across Europe.

Derivatives wrapped as funds could be offered to retail investors more cheaply than traditional funds and therefore quickly gain market share if the proposal is adopted. Gleeson explained that entering a traditional fund referenced to the FTSE can cost around 1.5% a year in management fees, whereas the same exposure structured as a derivative will cost around 40bps. Fund managers, however, argue there is a place for both derivatives based funds and true investment funds. Tony Whalley, investment director at Scottish Widows Investment Partners in Edinburgh, believes there is still room for both synthetic and traditional products, but said, "It's similar to an arbitrage. The most profitable [instrument] will come to the fore." For example, the expense of rehedging an option position in a 10-year fund might work out to be more than directly investing in stock and paying stamp duty at the start.