A Better Grasp of Non-financial Risks

The European Fund Management Industry Needs a Better Grasp of Non-financial Risks — December 2010

3. Risks and Responsibilities in the Fund Industry

The lack of a depositary in the US, together with the possibility for brokers to be custodians, has given brokers a prominent role in the American fund landscape. With light regulation, brokers have also been involved in the Madoff case (Madoff Securities was an authorised custodian for funds for which Madoff acted unofficially 20 as an advisor). 3.1.3.2 France: A Consumer Country with a Napoleonic Code and a Fund Industry Developed in the 1990s France, with its Napoleonic code, has civil- law origins. France is the second largest market for funds in Europe and assets under management amounted to € 1.42 trillion at the end of 2009 (ALFI 2010). As Luxembourg produces funds for export, France is the largest domestic market in Europe. That the assets under management of French funds are more than twice those of British funds can be explained partly by the lack of pension fund vehicles for funded retirement savings in France, as well as by a tax system that favours holdings of investment funds. The obligations of parties to the fund industry are described in the French Financial Market Authority General Regulations and in the Monetary and Financial Code. Depositary rules are defined in articles L. 214-16 and L. 214-26 of the monetary and financial code, and fully described in articles 323-1 and following of the AMF General Regulations. In France, responsibilities lie first with the investment firm and then with the depositary.

merely signs accounting documents, prepares an annual report, and monitors regulatory changes; most of the work is done by the investment manager. Contractual funds (FCP) have no board of directors, but are jointly supervised by the investment firm and the depositary—an indication of the little importance accorded oversight by the board in this country. The valuator is not explicitly recognised, and the monetary and financial code (article R. 214-19) requires that the regulated fund or the investment firm be able to value accurately all on- and off-balance-sheet assets (see also UCITS regulation). Depositaries currently shoulder much of the ultimate liability for large non-financial risks in spite of the first-hand responsibility of the investment firm. Depositaries are fully responsible for any activity they choose to or are required to delegate. France, with much of its law a legacy of the Napoleonic code, has detailed the liabilities of each party rather rigidly; for instance, there is an unconditional responsibility of restitution 21 that dates to the times when safekeeping involved storage of assets in a locked safe and when, quite naturally, a bank could not attempt to shed liability by resorting to a sub-custodian. This responsibility does not apply to financial derivatives, which depositaries need only book; it applies to assets that can be safe-kept, and, following the order of 23 October 2008 and the decree of 24 July 2009, which allow depositary banks to reduce their liability to OPCVM ARIA and OPCVM contractuel 22 that use a prime broker, it can be lessened in limited cases. These laws can be seen as investor- friendly but are clearly unsuited to the changing fund management landscape.

20 - The official advisor of Luxalpha was Access Partners. 21 - In UCITS, “the assets of a common fund shall be entrusted to a depositary

for safe-keeping” and “a depositary shall, in accordance with the

national law of the State in which the management company's registered office is situated, be liable to the management company and the unit-holders for any loss suffered by them as a result of its unjustifiable failure to perform its obligations”, but there is no unconditional obligation to return the assets. 22 - There are, in addition to the investment funds for retail investors, investment funds in which only institutional investors can invest ( i.e. , the OPCVM contractuels). Such OPCVM contractuels are very flexible because they can invest in any assets, which do not need to be financial instruments (for example, debt) and they require only notification to

the French regulator (no pre-approval required).

With respect to funds structured as companies (SICAV), the board of directors

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An EDHEC-Risk Institute Publication