France
18 January 2011
The French securities lending industry is in reasonable health, but is under fire from many quarters.
Image: Shutterstock
As one of Europe’s financial powerhouses, France was hit hard by the economic turmoil that engulfed the markets in 2008. Some government support was needed for a couple of the country’s major banks, and the country was also hit by two major frauds - it was one of the major losers from the Madoff affair, and Societe Generale also faced heavy losses when trader Jerome Kerviel lost almost five billion euros arbitraging discrepancies between equity derivatives and cash equities.
That said, France is a relatively stable market, indeed some may say boring. Earnings on equities have risen, with Data Explorers saying the TRTL reaching over 40 basis points in 2009/10. Utilisation has fallen slightly, but remains at just under a quarter of lendable assets. Government bonds have seen a slight fall in interest, and returns are not as strong as with equities, but they still see a utilisation of around 30 per cent.
“After the downturn in 2008 that carried over to 2009, we had quite high hopes for the market last year,” says a head of securities lending trading at one of France’s major banks. “In fact it was quieter than expected, but this has not necessarily been a bad thing - it’s kept the market on an even keel and we have not had any nasty surprises to deal with.”
Equities
Unsurprisingly, the main lendable assets in France represent many of the country’s largest companies. Short selling restrictions mean that the banking sector is relatively unrepresented, but the likes of telecoms, retail and oil firms dominate. France’s securities lending activities remain quite conservative; specials don’t play as big a part as in other markets, and because takeover activity has been muted, the main targets have been the stable multinationals that investors feel comfortable with.
The players
While the French banking sector undoubtedly has an international outlook, the key players within the country’s securities lending industry tend to be local providers. The likes of HSBC and some of the American banks have a significant presence, but it’s BNP Paribas, Natixis, Société Générale and the like who dominate the market.
“France has always had a strong banking sector and while it’s relatively straightforward for a bank to set up in the country, it’s tough for it to gain a foothold in this market,” says one local. “The funds that want to invest in France like to see an entrenched local knowledge, while the domestic beneficial owners prefer to deal with French banks. This is not restricted to securities lending, or even institutional banking - French companies tend to prefer to deal with other French companies in general, and the same can be said for the consumer market as well. It’s just the way France is.”
The funds industry has taken a bit of a battering over the past couple of years, and this is not just because of any losses as a result of the downturn. It’s also about the behaviour of the French funds in the light of new regulation.
Funds of funds became popular at the start of the millennium, with investors - particularly hedge funds actively pursuing opportunities in this market. Growth of up to 30 per cent a year was seen for several years, but when the financial crisis hit and the hedge funds looked to withdraw their investments, the problems took hold. Not all funds were able to repay the cash immediately.
One fund, AGS Group, allowed investors to get their money back on a daily basis. But the structure of the fund - and the funds it invested in - meant that liquidity was monthly or quarterly. AGS Group went to the Autorité des marchés financiers (AMF), the French regulator, to say it could not fulfil its redemption requests. Other funds followed suit.
The AMF then allowed funds of funds managers to retrospectively change the terms of their prospectuses to reduce outflows of capital. This, says one fund manager, has irreparably “tainted the image of the French funds of funds industry as a whole”.
And they still haven’t really recovered - investment is still down, although that’s partly due to the market downturn rather than any trust in the fund managers - and France is seen as a less attractive destination for investment by some. But it’s not all bad news, the derivatives industry is starting to see activity grow, and new types of funds are also launching. Multi-strategy funds of funds, hybrid products and customised portfolios are becoming increasingly popular.
Other investment options are almost treading water at the moment - the markets are certainly not falling, but the confidence that was seen at the beginning of 2010 did not live up to expectations. And while 2011 is expected to be a year of growth, the optimism has been tempered by the experiences of the past year.
“The French scrip trade that was quite lucrative in 2009 proved disappointing in 2010 due to falling markets,” says Stephen Rudland, desk head, European trading at RBC Dexia Investor Services. “With reinvestment prices being greater than market prices, most scrip trades were ‘out of the money’, resulting in zero revenue from the profit sharing that was arranged with a select number of borrowers. There has been limited new deal activity and, consequently, a particularly low number of stocks trading special.”
Regulation
As an enthusiastic member of the European Union, the French regulators work closely with their counterparts in Brussels, and are often the driving force behind some of the regulations that affect all members.
Nationally, the regulators placed short-term restrictions on short selling in 2008, as the crisis threatened to envelope some of the country’s largest financial institutions. These restrictions have been extended regularly, and there remain some controls in place even now.
But even before the crisis, securities lending was under the spotlight, less because of short selling and more because there were concerns that some organisations were able to exert undue influence through securities lending when it came to shareholder voting on listed companies.
A working group on securities lending before general meetings of shareholders, chaired by AMF Board member Yves Mansion, published its report on 6 February 2008. The report recommended fuller disclosure of the type of interests held by shareholders, with the aim of curbing the influence that can be wielded during the general meeting season by shareholders with no permanent exposure to the economic risk of share ownership. In general this effort reflects the concerns – widely shared internationally – voiced by the industry groups representing listed companies.
France’s notoriously complicated tax structure is actually pretty favourable to the securities lending industry. Securities lending arrangements in France are normally structured as two sales and as such are considered fully taxable transactions.
However, there are two main types of securities lending transactions which benefit from a favourable French income tax regime that levies no taxation on capital gains. First is the pret de titres, a securities lending agreement, while pension livree, equivalent to a repo contract has the same status.
To qualify for either of the tax-neutral concessions, the transactions must not have a dividend giving rise to a foreign tax credit distribution during the lending period; and the securities lent must be returned to the lender, even if they are not exactly the same securities, at the end of the transaction. Fees remain taxable.
The future
There remains a sense of optimism about the market in France, perhaps more so than in other European countries. The industry has come out of the recession, and the associated financial scandals, relatively unscathed, and the strength of the financial sector means that confidence in the banks is high.
Regulation of course remains an issue. Short selling restrictions are always on the horizon, and both the French and the European regulators are looking to tighten up controls. The strength of the euro also has some investors remaining cautious - the problems in Greece and Ireland have damaged the currency’s reputation and there are fears that other markets will remain under pressure.
“We’re confident about the securities lending activity rising in France in 2011, but we don’t expect any big moves this year,” says one expert. “We’re seeing more inflows in from the hedge funds and there is confidence that activities will rise. But we’re still waiting to see what the effects of the new pan-European regulation will bring.”
That said, France is a relatively stable market, indeed some may say boring. Earnings on equities have risen, with Data Explorers saying the TRTL reaching over 40 basis points in 2009/10. Utilisation has fallen slightly, but remains at just under a quarter of lendable assets. Government bonds have seen a slight fall in interest, and returns are not as strong as with equities, but they still see a utilisation of around 30 per cent.
“After the downturn in 2008 that carried over to 2009, we had quite high hopes for the market last year,” says a head of securities lending trading at one of France’s major banks. “In fact it was quieter than expected, but this has not necessarily been a bad thing - it’s kept the market on an even keel and we have not had any nasty surprises to deal with.”
Equities
Unsurprisingly, the main lendable assets in France represent many of the country’s largest companies. Short selling restrictions mean that the banking sector is relatively unrepresented, but the likes of telecoms, retail and oil firms dominate. France’s securities lending activities remain quite conservative; specials don’t play as big a part as in other markets, and because takeover activity has been muted, the main targets have been the stable multinationals that investors feel comfortable with.
The players
While the French banking sector undoubtedly has an international outlook, the key players within the country’s securities lending industry tend to be local providers. The likes of HSBC and some of the American banks have a significant presence, but it’s BNP Paribas, Natixis, Société Générale and the like who dominate the market.
“France has always had a strong banking sector and while it’s relatively straightforward for a bank to set up in the country, it’s tough for it to gain a foothold in this market,” says one local. “The funds that want to invest in France like to see an entrenched local knowledge, while the domestic beneficial owners prefer to deal with French banks. This is not restricted to securities lending, or even institutional banking - French companies tend to prefer to deal with other French companies in general, and the same can be said for the consumer market as well. It’s just the way France is.”
The funds industry has taken a bit of a battering over the past couple of years, and this is not just because of any losses as a result of the downturn. It’s also about the behaviour of the French funds in the light of new regulation.
Funds of funds became popular at the start of the millennium, with investors - particularly hedge funds actively pursuing opportunities in this market. Growth of up to 30 per cent a year was seen for several years, but when the financial crisis hit and the hedge funds looked to withdraw their investments, the problems took hold. Not all funds were able to repay the cash immediately.
One fund, AGS Group, allowed investors to get their money back on a daily basis. But the structure of the fund - and the funds it invested in - meant that liquidity was monthly or quarterly. AGS Group went to the Autorité des marchés financiers (AMF), the French regulator, to say it could not fulfil its redemption requests. Other funds followed suit.
The AMF then allowed funds of funds managers to retrospectively change the terms of their prospectuses to reduce outflows of capital. This, says one fund manager, has irreparably “tainted the image of the French funds of funds industry as a whole”.
And they still haven’t really recovered - investment is still down, although that’s partly due to the market downturn rather than any trust in the fund managers - and France is seen as a less attractive destination for investment by some. But it’s not all bad news, the derivatives industry is starting to see activity grow, and new types of funds are also launching. Multi-strategy funds of funds, hybrid products and customised portfolios are becoming increasingly popular.
Other investment options are almost treading water at the moment - the markets are certainly not falling, but the confidence that was seen at the beginning of 2010 did not live up to expectations. And while 2011 is expected to be a year of growth, the optimism has been tempered by the experiences of the past year.
“The French scrip trade that was quite lucrative in 2009 proved disappointing in 2010 due to falling markets,” says Stephen Rudland, desk head, European trading at RBC Dexia Investor Services. “With reinvestment prices being greater than market prices, most scrip trades were ‘out of the money’, resulting in zero revenue from the profit sharing that was arranged with a select number of borrowers. There has been limited new deal activity and, consequently, a particularly low number of stocks trading special.”
Regulation
As an enthusiastic member of the European Union, the French regulators work closely with their counterparts in Brussels, and are often the driving force behind some of the regulations that affect all members.
Nationally, the regulators placed short-term restrictions on short selling in 2008, as the crisis threatened to envelope some of the country’s largest financial institutions. These restrictions have been extended regularly, and there remain some controls in place even now.
But even before the crisis, securities lending was under the spotlight, less because of short selling and more because there were concerns that some organisations were able to exert undue influence through securities lending when it came to shareholder voting on listed companies.
A working group on securities lending before general meetings of shareholders, chaired by AMF Board member Yves Mansion, published its report on 6 February 2008. The report recommended fuller disclosure of the type of interests held by shareholders, with the aim of curbing the influence that can be wielded during the general meeting season by shareholders with no permanent exposure to the economic risk of share ownership. In general this effort reflects the concerns – widely shared internationally – voiced by the industry groups representing listed companies.
France’s notoriously complicated tax structure is actually pretty favourable to the securities lending industry. Securities lending arrangements in France are normally structured as two sales and as such are considered fully taxable transactions.
However, there are two main types of securities lending transactions which benefit from a favourable French income tax regime that levies no taxation on capital gains. First is the pret de titres, a securities lending agreement, while pension livree, equivalent to a repo contract has the same status.
To qualify for either of the tax-neutral concessions, the transactions must not have a dividend giving rise to a foreign tax credit distribution during the lending period; and the securities lent must be returned to the lender, even if they are not exactly the same securities, at the end of the transaction. Fees remain taxable.
The future
There remains a sense of optimism about the market in France, perhaps more so than in other European countries. The industry has come out of the recession, and the associated financial scandals, relatively unscathed, and the strength of the financial sector means that confidence in the banks is high.
Regulation of course remains an issue. Short selling restrictions are always on the horizon, and both the French and the European regulators are looking to tighten up controls. The strength of the euro also has some investors remaining cautious - the problems in Greece and Ireland have damaged the currency’s reputation and there are fears that other markets will remain under pressure.
“We’re confident about the securities lending activity rising in France in 2011, but we don’t expect any big moves this year,” says one expert. “We’re seeing more inflows in from the hedge funds and there is confidence that activities will rise. But we’re still waiting to see what the effects of the new pan-European regulation will bring.”
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