French Funds & OTC Derivatives

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French Funds & OTC Derivatives

In February the French regulator enacted a decree operating an in-depth reform and update of the legal framework for French funds, known as organismes de placement collectif en valeurs mobilières (OPCVMs), to enter into derivatives transactions. This follows the European Union's Council of Finance Ministers directives on harmonised investment funds, know as undertakings for collective investment in transferable securities (UCITS). The 2002 Decree further amended the provisions of decree (no. 89-624 September, 1989).

 

What are OPCVMs? OPCVMs = French UCITS

French law, passed in 1998, distinguishes between two structures of OPCVM, namely sociétés d'investissement à capital variable ("SICAVs ") and fonds communs de placement ("FCPs ").

* SICAVs are a form of open-ended investment company incorporated with limited liability as a special type of commercial company governed by Book Two of the French Commercial Code. Their purpose is to manage a portfolio of securities, and their capital is equal at all times to the net asset value of their portfolio, less the amount paid out to shareholders.

* FCPs are defined by law as a co-ownership of securities withno legal personality and therefore not subject to French insolvency rules. An FCP is created on the joint initiative of a management company (a limited liability company licensed by the Commission des Opérations de Bourse, managing the FCP and its assets and representing the FCP vis-à-vis third parties) and a custodian.

Despite these differences, both structures have to comply, as regards their capacity to trade derivatives, with the same legal principles.

In addition to plain-vanilla OPCVMs (OPCVM à vocation générale), a counterparty may occasionally run across other more exotic OPCVMs that were more recently introduced in France, such as simplified procedure OPCVMs (OPCVM bénéficiant d'une procédure allégée), umbrella OPCVMs (OPCVM à compartiments multiples) or master-feeder OPCVMs (OPCVMs maîtres et nourriciers). The special regulatory regime applicable to these OPCVMs is not addressed herein and needs to be checked on a case-by-case basis.

 

Principle: OPCVMs Can Trade OTC Derivatives

Article 28 of the 1988 Act provides that the constitutive documents of an OPCVM may entitle the fund to enter into derivatives transactions on regulated markets. The terms and conditions were determined by decrees and the French ministry of the economy has laid down a list of the markets. Implementing the 1988 Act, the 1989 Decree, as amended, enables OPCVMs to enter into derivatives traded on regulated markets and, by analogy and under certain conditions into OTC derivatives transactions.

 

The Nine Conditions

* The constitutive documents of the OPCVMs must expressly provide for entering into OTC derivatives. Such documents,aimed at informing the public, are the notice d'information and respectively the statuts for a SICAV or the règlement for an FCP, containing key information such as the OPCVM's legal category and investment policy. The COB has published standard forms of documents, containing a specific paragraph to be used in arèglement of an FCP if the latter intends to use derivatives. Likewise, the AFG-ASSFI (a professional association of fund managers) has also issued a specific model wording to be provided in notices d'information of FCPs intending to use derivatives.

* The types of authorised OTC derivatives are the forward financial instruments defined by the French Monetary and Financial Code, a category encompassing virtually all types of derivatives transactions. It is however to be noted that the sale of options by OPCVMs has been expressly prohibited by the COB, on the basis that such transactions do not respect "the principle of termination at any time" mentioned below.

* OTC derivatives may be entered into to hedge the OPCVM's assets or the performance of the OPCVM investment objective. While the lack of a precise legal definition for hedging purposes should lead counterparties to examine the contemplated transactions carefully, the management objective can be considered by reference to specific category to which the relevant OPCVM belongs, as mentioned in its constitutive documents.

* OTC derivatives entered into by OPCVMs must be capable of being unwound or terminated at any time at the request of the relevant OPCVM, at market value of the transactions or at a determined value, such as in accordance to the provisions of a master agreement. This reflects the legal requirement for an OPCVM to be able at any time to refund the investment made by any holder of its shares or units.

* OPCVMs may only enter into OTC derivatives with the following three types of eligible counterparties: institutions qualifying as depositories for OPCVMs, credit institutions having their registered offices within the Organisation for Economic Co-operation and Development and, under certain conditions, investment firms having their registered office in a European Union member state or a party to the European Economic Area.

* The aggregate amount of OPCVM's derivatives' commitments must not represent more than 100% of its total assets. According to COB's instructions, commitments in respect of derivatives transactions, whether OTC or exchange-traded, must be appraised on a net basis, i. e. on the basis of the liquidation value of the transactions after payment netting and set-off, taking into account any collateral constituted in favour of the OPCVM.

* The credit risk exposure of an OPCVM on a single counterparty must not exceed 10% of its assets. Such risk (defined as the risk that a counterparty fails to meet one of its obligations under the derivative transaction and causes a subsequent financial loss for the OPCVM) is calculated on the basis of the net exposure, at market value of the relevant transactions, taking into account any collateral constituted in favour of the OPCVM. However, under certain conditions, the credit risk exposure per counterparty may begreater than 10% for OPCVMs offering a guaranteed performance, income or capital and themselves benefiting from a guarantee, or whose unit-holders or shareholders benefit from a guarantee given by an OECD credit institution. It should be noted that the 10% requirement does not apply to OTC derivatives transactions which were outstanding on Feb. 28, and shall otherwise be applicable after Nov. 28.

* OTC derivatives transactions executed by OPCVMs must be subject to a certain level of control and monitoring. This means that the management company must have the techniques and human resources, and set up all relevant procedures, for permanently managing and following-up OTC derivatives transactions. In particular, it should restrict itself from entering into transactions that it cannot value independently, a minimum requirement being the ability to compare between several valuations.

* Finally, the COB recommends to OPCVMs the use of French standard documentation (the AFB/FBF master agreement, officially published in both French and in English versions) for OTC derivatives.

 

Regarding developments to come, it is to be noted that all issues relating to the capacity of OPCVMs to enter into credit derivatives--particularly as a protection seller, which have been considerably discussed so far in France, have for the time being been left aside from the greatly clarified framework described above. The French ministry of finance has created a working group dedicated to these issues and a decree relating specifically to credit derivatives and OPCVMs is expected in the near future. In addition, the COB is expected to release an updated instruction relating to OPCVMs and derivatives.

This week's Learning Curve was written by Alban Caillemer du Ferrage, partner, and Andreja Fajgelj, associate, in the international capital markets department of Gide Loyrette Nouel in Paris.

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