FRANCE: asset servicing at the sharp end

Custodians and asset servicers in France operate in a thorny and risky environment because they run the highest risks for the lowest fees. Will European regulation level the playing field?

Angele Spiteri Paris reports:

Though treated with apprehension by most of the industry, the Alternative Investment Fund Managers (AIFM) Directive, albeit with the right amendments, may bring some relief to asset servicers and custodians operating in France where currently the custody risk is at the highest level in Europe, but fees are among the lowest.

Alain Closier, global head of securities services at Société Générale Securities Services (SGSS), says: “France is a challenging market due to rigorous regulation and relatively low fees.”

The major difference between France and the rest of Europe is the way French custody banks have to return assets that are lost in cases of, say, fraud or counterparty failure to clients even though it was not their fault.

Under French law, depositary banks have to immediately return to investors any assets lost by other parties. This was brought into sharp relief following the Lehman Brothers collapse. SGSS and RBC Dexia were the two custody banks that were slapped with immediate restitution orders by the Paris Superior Court.

The strict rules about restitution, therefore, make France a particularly tough jurisdiction for providing depositary services – although the AIFM Directive could extend the ‘strict liability’ fule across all of Europe.

For now, though, this draconian rule applies to France alone. Philippe Legrand, managing director of RBC Dexia France, says wryly: “You could see asset managers moving to domicile more of their assets in France because they get the highest level of regulation for the lowest fees!”

Closier says that rather than fighting against rules and regulations, a custody business has to be set up in such a way so as to insulate against the risks that have hit SGSS and RBC Dexia in France in the recent past.

The SGSS chief says: “The depositary has certain responsibilities and we have to act as insurers for [clients]. Events like the Madoff scandal and the Lehman collapse are typical examples of where the depositary needs to stand up and take responsibility. And to make sure you can do this, you need care for the solidity of your network.”

But Legrand says: “The French regulator realised that you cannot have a perfect world where banks are insurers for the asset management industry. They also need to be careful to not instigate greater systemic risk by forcing the immediate restitution of assets. In France, we need to find a way of keeping investor assets safe, but it also needs to be viable for both custodians and the asset managers.”

Similarly, Patrick Colle, CEO of BNP Paribas Securities Services, says: “We want to avoid custodians becoming insurers for the asset management industry.”

But the truth is that in France, until European regulation comes into force, depositaries are effectively insurers and this has not come without repercussions.

Closier, of SGSS, says: “The obligation of restitution according to the French regulation had a commercial effect on our business. Now, we don’t even analyse certain funds in the French market because of the way the set-up is being suggested by the fund manager. We’re more cautious and have to be ready to accept the risk. To do this we therefore have to be aware of that risk.

“We’re reluctant to take business from small asset managers. The asset manager has to have a Luxembourg fund at least, because if it’s too small then nobody will be able to provide the depositary service in the French market, because the risk will be too high.”

At BNP, Colle says: “We’ve always been careful about the clients we take on. This has only served to reinforce that.”

Interestingly, François Marion, CEO of Caceis, says: “We haven’t turned down more business in recent times. This is probably because we were always cautious. Actually I would say we’ve said ‘no’ fewer times because structures being now proposed are somewhat less risky than before.”

Legrand at RBC Dexia also says the firm has not become more choosy about the way it takes on business in France in light of the strict obligation of restitution.

You also have to bear in mind that RBC Dexia is a relatively new player to the French market and its brand has not yet reached the same level as that of the other French actors.

But whether it has made a significant difference to business flow or not, the fact remains that the immediate restitution obligation, and all the responsibility that goes with it, is a bit excessive.

Colle says: “The problem is not really the immediate restitution, but rather the fact that you have to be able to control your responsibility. Custodians cannot be responsible for situations they have no control over. We’re not trying to evade our responsibility by any means but we need to be able to have control over what we’re liable for.”

And making them liable for the actions of other firms is stripping them of that control.

Marion, of Caceis, says: “The industry has somehow lost control of its own fate. It is now legislators and regulators who are in control of what will happen and, if not thought through carefully, the outcome could be unexpected. If investors are not made to bear any risk and someone with deep pockets is made to bear that risk on their behalf, then this is very dangerous.”

Fees
It stands to reason that in light of the additional responsibility, custody and depositary fees could increase, especially considering that in France these services command the lowest fees across Europe. But it’s not as simple as announcing a fee increase. Stiff competition in the country means a rise in cost is highly unlikely, despite the need.

Closier, at SGSS, says: “I don’t think fees will rise, especially not in the short term. It’s difficult to imagine fees increasing at all. There will certainly be adjustments made to the business, but no increase in fees will be introduced.

“The French market has relatively low fees so it makes sense for them to increase. But I don’t see this happening as no one wants to be the first to make that increment.”

Legrande, of RBC Dexia, says: “Although we don’t see fees increasing as yet, they will have to go up if we’re to act as insurers for the asset management industry, simply because of the increased responsibility.”

But this all depends on the pending regulation due out from the European powers that be.

Colle says: “We might see a possible increase in fees in connection with heavier regulation, but this is assuming we nevertheless come to a reasonable set of regulations where we have control over what we are responsible for because otherwise we might have to reconsider altogether under what circumstances we wish to offer the service.”

Marion says: “The price will adjust once all the rules are the same for everybody [across Europe]. We won’t see any change for at least two years – that’s one year for the legislators to agree on the text of the regulation and another year to enforce that regulation. Plus, due to higher competition in France, prices are much lower, so that needs to be taken into consideration as well.”