SGAM RESPONSE TO CESR'S PUBLIC CONSULTATION ON INDUCEMENTS UNDER MiFID

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1 .. SOCIETE GENERALE.. Asset Management Mr Fabrice Demarigny Chairman of the MiFID 3 Expert Group The Committee of European Securities Regulators Avenue de Friedland Paris 9 February 2007 Your Ref: CESR/ SGAM RESPONSE TO CESR'S PUBLIC CONSULTATION ON INDUCEMENTS UNDER MiFID Dear Mr Demarigny, SGAM wants to thank the CESR which provided its expertise, inputs and time on the preparation of the consultation paper and congratulates its members for their work to consider ail the relevant matters raised by the implementation of Article 26 of the Directive 2006/73/EC. SGAM welcomes the opportunity to clearly express its position and to response to the questions raised in this consultation. Beyond our response, we also support the separate answer provided by our French Asset Management Association, AFG 1, together with the separate answer provided by our European Asset Management Association, EFAMA2. Before expressing our comments on specifie issues and entering into more details we would like to draw to your attention the following major general remarks. GENERAL REMARKS First, in our view, European investment funds (the "UCITS") as weil as nationally regulated funds (the "Non-UCITS") (both the "Investment Funds") are already the most transparent financial instruments sold to the public in terms of product information and cost disclosure, as you know, the prospectus disclose the maximum threshold of fees taken on the relevant product and even more importantly the so-called Total Expense Ratio (the "TER") which includes the marketing fees among others. ln addition, UCITS are experiencing an increasing competition from other financial products and investments vehicles far less regulated such as insurance and structured products - some of them not even subject to MiFID - although pursuing the same or similar investment strategies. Such products are not subject to any disclosure or quality requirements or, when 1 AFG is the Association Française de la Gestion Financière. 2 EFAMA is the European Fund and Asset Management Association. Immeuble SGAM 170, place Henri Regnault Paris - La Défense cedex - France Société Anonyme with registered capital of: Eur 294,337,200 Head Office: 170, place Henri Regnault Courbevoie Registered n' R.C.S. Nanterre

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3 .. SOCIETE GENERALE.. Asset Management they are, these requirements Funds. are less stringent than the one applicable to the Investment While acknowledging the benefits of competition as such to the market and clients, we are deeply concerned by the fact that competition between financial products does not take place on the same level playing field. Further distortions in the competitive environment might contribute to act against investor's protection, by leaving aside the less transparent products. Should MiFID's disclosure regime fail to improve the competitive environment or even worsen it, we expect an increased shift of investment by retail clients into such less transparent product, to the detriment of investor protection. Investors being told of various expenses incurring with the purchase of Investment Funds, will decide to switch to competing products displaying no identifiable cost items. Second, the issue of marketing in the Investment Funds industry, like in any other, is a key issue as it leads to an improvement of the size of the Investment Funds. A raise in the assets under management brings lower costs and/or means higher net returns for investors. For Investment Funds, in ail continental European countries, distribution agreements (including retrocessions) between Investment firms, acting as Investment Funds distributors, (the "Distributor") and the management company (the "Producer") are consubstantial for ensuring the access by the investor to the managed product. ln addition CESR should consider that Distributors provide both advice and infrastructure to enable the purchase and sale of investment funds. They provide both their services to the final investor (the "Client") who might paya fee directly to the Distributor, such as an front-ioad fee or entry fee, and to the Producer who manages the Investment Funds and who pays a retrocession commission to the Distributor. ln the EU, these two approaches are currentjy followed for the remuneration of Distributors: either high front-ioad fees, received directly by the Distributor from the Client (mostly in the UK and Ireland) and/or retrocession of a part of management fees of Investment Funds, given by the Producer to the Distributor. If we compare for instance the structure of remuneration between France on the one hand and the UKllreland on the other hand, we notice a significant gap regarding the level of front-joad fees (see Les Echos newspaper, 05/02/07): France Ireland UK Total Expense Ratio (TER) 1.13% 1.72% 1.32% Front-Ioad fees + TER 1.67% 2.67% 2.32% Retrocession of a part of management fees, as compared to high front-ioad fees, are beneficial to the Clients and are necessary for some types of funds: for the Clients, retrocessions allow for a higher flexibility in moving from one fund to another one - which will be good for him in case of market turmoil; retrocessions are strictly necessary for money market funds to which usually front-ioad fees are not applied; retrocessions are a way for Distributors to maintain in the medium term a significant part of their selling forces to the subscriptions/redemptions and service to Clients after the Investment Funds subscription. 2

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5 .. -SOCIETE GENERALE Asset Management The Distributors must invest a lot in training in order to answer investors' protection - which will be even higher in the coming months through the MiFID requirements. More widely, our value chain requires necessarily on the one hand a Producer and on the other hand a Distributor, that is to say an entity providing access to Clients. ln particular, retrocessions are the fair remuneration of a specific service provided by the Distributor to the Producer, and the Distributor has to be paid for this service. The services provided by the Distributor to the Producer are equivalent to a "placement" activity. It includes several activities: easing the subscription/redemption process for the Client, marketing, advertising, managing the cost of sale forces, informing and advising the Clients (answering to its questions relating to the Investment Funds), being in charge of the management of the Client relationship (assistance in the Client classification and to know the Clients; shareholder record keeping; and shareholder servicing); and of the provision of ail the legal and marketing documentation as long as the Client is invested in the Investment Fund (from the time of its subscription until its redemption)... Any of these services are delegated by the Producer to the Distributor to avoid the Producer to make it by itself. If the Investment Fund or its Producer was to bear the full cost of these services directly by itself, such costs would be incurred directly by the Producer out of its management fee or directly charged to the Investment Fund as it is the case for shareholder record keeping, and shareholder servicing fees in the US. ln continental Europe, many of these services are incurred by the Distributors and the commission paid by the Producer to the Distributor compensates for such services rendered to the Producer. Without these existing arrangements that CESR seems to contest, the European management industry could not live further on. From our point of view, this organisation of the Investment Funds industry, with a close relationship Producer-Distributor, tends to lower costs for the Client. ln addition, in the case of UCITS, the potential Client is weil informed as, as indicated in MiFID, the simplified prospectus provides sufficient information about the costs and charges of the product and the Client is able to assess by him(her)self the overall quality of the service given the cost and TER paid ln any industry the client has to pay simultaneously both the Producer and the Distributor. ln the field of Investment Funds, the marketing fees are included in the costs of the product, as a part of the management fees: they are neither superfluous nor additional. Hence, distribution fees and rebate commission should not be considered as an incentive for an investment firm to act other than in the best interest of the Client, but as proper fees, when they do not impair compliance with the firm's duty to act in the best interest of the Client. Distributors are regulated professionals; they do act honestly, fairly and professionally and in the best interest of their Clients. Their right to be remunerated for the services they provide should be recognized. ln any case, to avoid any risk of conflicts of interest, we could envisage to strengthen professional duties imposed to Distributors, through professional codes of conduct to prevent unfair inducement and any breach to act in the best interest of the Client. 3

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7 1 General.. SOCIETE GENERALE.. Asset Management Third, we strongly contest the view that the distribution of Investment Funds' units (including the process of subscription and/or redemption of Investment Funds' units, especially when they are UCITS' units) is considered as the execution of orders and the reception/transmission of orders, ie. as a mere buying or selling of any financial instrument (through the examples given in CESR's consultation for example). According to CESR's view3, the" marketing is mentioned in the non-exhaustive Annex /1of the UC/TS Directive without any further specification". ln our view, we confirm this interpretation and consider that marketing (ie. subscription/redemption) of units of Investment Funds does not fit with any of the MiFID services as annexed to the Directive, such as execution of orders or reception/transmission of orders for instance with the exception of the "placement" which might be applicable, to a certain extent, to the sole Non~UCITS distribution (excluding the UCITS whose distribution shall be considered only under the UCITS Directive). We are therefore very concerned about the potential interpretation of MiFID by CESR. Fourth, we have a strong doubt on the potential use which could be made by regulators of the list of factors in the context of letter b of Article 26. This list of factors is potentially very dangerous. ln practice, there is a high risk that this list of factors be used by regulators in assessing the compliance or not of practical cases of inducements with the Directive requirements. This could lead to impose regulatory price controls. We consider this list of factors might even become more dangerous for professionals than the provisions of the Directive itself, in particular through the introduction of new subjective elements, such as the sort of "proportionality test". These factors give too much space for interpretation and would lead to a too wide legal uncertainty. Therefore we do not see any added value offered by this list as compared to the relevant provisions of the Directive. SPECIFIC COMMENTS Turning now to the questions raised in the consultation paper, we have the following comments: explanation and relationship with conflicts of interest Q1: Do you agree with CESR that Artic/e 26 applies to ail and any fees, commissions and nonmonetary benefits that are paid or provided to or by an investment firm in relation to the provision of an investment or anci/lary service to a client? Although Article 26 applies to many fees, we cannot not consider this Article applies per se to ail fees in relation to the provision of services to a client. Article 26 could only relate to fees 3 See "CESR's guidelines for supervisors regarding thetransitional provisions of the amending UCITS Directives (2001/107/EC and 2001/108/EC)" - Ref: CESR/04-434b - FEBRUARY p. 10; 4

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9 1 Article 1 Article.. SOCIETE GENERALE.. Asset Management strictly related to the provision of such investment services. An exhaustive list of examples cannot be provided. Second, we object to the narrow interpretation of Article 26 c) as suggested by CESR. The example listed in the Article are non-exhaustive, we see no justification for narrowing the scope of the application to other fees (than those explicitly mentioned). The costs mentioned in Article 26 c) are clearly non-exhaustive but only iiiustrative. For instance the notions of 'placement', 'distribution' and 'business introduction' fit with Article 26 a) or with this Article 26 c), taking into account that (i) the client of the Distributor could be the asset manager Le. the Producer and/or (ii) the placement activity is necessary for the provision of the management of the product and does not give rise to conflicts of interest as they are embedded within the relevant service itself. 02: Do you agree with our analysis of the general operation of Article 26 of the MiFID Level 2 Implementing Directive and of its interaction with Article 21? We agree that investment firms are under the obligation to take ail reasonable steps to arrange a successful management of conflicts of interest (through an effective conflict of interest policy in order to reduce the risk of damage to the Clients' interests to a reasonable minimum). However, we believe that standard commissions or fees for a service should not be deemed potentially detrimental to the interest of Clients or per se give rise to conflicts of interest: as soon as the Client is informed of the total fees (including distribution fees), there should be no conflict of interest issue left vis-à-vis the Client. 26 (a): items "provided to or by the client" 03: Do you agree with CESR's view of the circumstances in which an item will be treated as a "fee, commission or non-monetary benefit paid or provided to or by... a person acting on behalf of the client"? We do not share CESR point of view on interpretation restrictive and limited. of Article 26 a) which we find too The wording of Article 26 a) does not prevent from having a wide interpretation and authorises fees as long as they are paid by the client or a person acting on his/her behalf. For instance in the context of portfolio management, as in this case the product provider remunerates distribution services of an investment firm upon specific instructions form a client, the level of fees (including retrocessions) is already mentioned in the mandates: those mandates set up the transparency and retrocession rules to be followed, and these mentions are disclosed to the client. For other investment services, similar requirements could exist. The wording of Article 26 a) should be widened. 26(b): conditions on third party receipts and payments 05: Do you have any comments on the CESR analysis of the conditions on third party receipts and payments? 5

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11 MI SOCIETE GENERALE.. Asset Management First of ail, in our opinion, 'designed to' means that there must be an ex ante intent, but without any obligation of result afterwards. ln addition, it must cover a general aim of enhancing the service and not an approach on a client-by-client basis. Second, on the examples submitted by CESR, we do not share many of its analysis. We noticed that in a lot of cases CESR seems to make a confusion between the different types of services that are involved in the transactions and, in particular, neglects completely the other services that can be involved between intermediaries. Example 1: "An investment firm gives investment advice to a client to buy a particular collective investment scheme and receives a commission from the management company paid out of the product charges made to the investment firm's clienf': we consider that the idea to introduce a 'proportionate commission test' is very dangerous. As CESR itself mentions it, it is not possible to set a cap on the level of commission. Therefore it will be very difficult to in a position to prove safely that the commissions are proportionate. The difference of appreciation and enforcement from one national regulator to another one might lead in particular to litigation risks by Clients and prosecution risks by regulators. The specific case mentioned fits with Article 26 a), not Article 26 b), as soon as the management company is paid directly by the Client - which has signed for being informed of the existence and the amount of retrocessions. Conversely, if the Clients were not informed, then this case would fall under letter b. Example 2: "An investment firm that is not providing investment advice or general recommendations has a distribution agreement with a product provider, such as the management company of a UCITS, to distribute its products in return for commission": same remark as for example 1, regarding the 'proportionate commission test'. The case mentioned fits with Article 26 a) (direct distribution relation between the Distributor and the Producer) but not with Article 26 b), in the case of a management company distributing the products of a UCITS management company without advice. This case could be even put out of Article 26 if we consider that the UCITS placement activity falls within the UCITS Directive (as part of the collective investment activity as annexed to the UCITS Directive) and is therefore out of the scope of the MiFID. Example 3: "An investment firm acts as portfolio manager (or as a receiver and transmitter of orders) and transmits orders to brokers for execution": this case of retrocession of brokerage fees is prohibited in France. Example 4: "A management company of a UCITS provides training to the staff of an investment adviser that is an investment firm": we are worried about the 'proportionate benefit test', for the same reasons as for the 'proportionate commission test'. ln addition, such a case should not be dealt by Article 26 but through the dealing of conflicts of interest (Article 21) or Codes of conduct. Example 5: "An investment firm G introduces one of its clients to another investment firm F. There is an agreement between F and G that F will pay to G a share of dealing commission or management fees to G, even though G will have no continuing role in F's relationship with the client.»: we consider that introducing Clients to another investment firm does not constitute an investment service as such. As G introduces the Client to F, the provision of the service is between F and the Client and the ex ante relation between the Client and G cannot be considered as an investment service as such. Therefore the relationship between Gand F 6

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13 ... SOCIETE GENERALE.. AssetManagement does not enter the scope of the MiFID. Another approach could be to place this case under Article 26 c) as this service is necessary to the activity of the investment firm F (distribution channel). Example 6: «As example 1, except the investment firm receives a one-off bonus (or "override'') payment under the sole condition that sales of a particular product reach an agreed level.»: as a principle, we would agree to include such case within Article 26 b). But we consider that the mentioned case of a one-off bonus is usually irrelevant: usually retrocession commissions are applied in a progressive way. ln addition, volumes do not usually generate conflicts of interest (as the potential conflicts are identified ex ante and managed). Moreover, volumes may improve the quality of the service (degressive cost of transactions with a higher volume). Higher volumes, for a Distributor means also a closer relationship with the Producer and a better quality of its services. Example 7: «A broker pro vides ta an investment manager general office equipment such as computer equipment.»: we consider that this case is out of the scope of Article 26 as being not linked to an investment service provided to a specific Client. It should be dealt within the context of conflicts of interest or codes of conduct. Example 8: "An investment firm pro vides a portfolio management service ta a client and charges a fee for that service. The investment firm purchases UCITS for the client; the management company of the UCITS pays a commission ta the investment firm that is paid out of the product charges made ta the clienf': we consider this case could be put under Article 26 a), if it is made clear in the portfolio management mandate that the firm is to recover such commissions on behalf of the Client from the UCITS management companies to partly remunerate the portfolio management service. CESR comments also seem to imply that in the context of portfolio management services such fee would necessarily create a conflict of interests between the firm and its Clients. With regards to the firm's duty to act in the best interest of its Client, we believe that there are various mechanisms that can be set up to manage such conflicts of interests and it should not be presumed that portfolio managers cannot manage such conflicts. Q6: Do you have any comments on the factors that CESR considers relevant ta the question whether or not an item will be treated as designed ta enhance the quality of a service ta the client and not impair the duty ta act in the best interests of the client? Do you have any suggestions for further factors? See our reply to Question 5 and our general remarks. [Article 26(b): disclosure Q7: Do you agree that it would not be usefui for CESR ta seek ta develop guidance on the detailed content of the summary disclosures beyond stating that: - such a summary disclosure must provide sufficient and adequate information ta enable the investor ta make an informed decision whether ta proceed with the investment or ancillary service; and, that - a generic disclosure which refers merely ta the possibility that the firm might receive inducements will not be considered as enough? We agree for having a summary disclosure. 7

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15 1 Softing El SOCIETE GENERALE.. Asset Management However, we contest the fact that this summary disclosure must provide "sufficienf' information in order for the Client to make an informed decision: this summary disclosure should be only one of the pieces of information to be taken into account by the investor, but it should not be required to provide "sufficient information". Otherwise professionals might be at legal risk vis-àvis their Clients. On the other hand, a generic disclosure would not be enough as it would not comply then with the last paragraph of Article 26. We therefore suggest CESR not to provide any guidance on disclosure, as the Level 2 provision gives in itself enough guidance. Q8: Do you agree with CESR's approach that when a number of entities are involved in the distribution channel, Article 26 applies in relation ta fees, commissions and non-monetary benefits that can influence or induce the intermediary that has the direct relationship with the client? ln our view, Article 26 should only apply to payments provided or obtained by investment firms having the direct relationship with the Client. The other payments in the distribution chain between professionals should be excluded from Article 26 and be dealt through the provisions of conflicts of interest (Articles 21 and 22). and bundling arrangements Q13: Would it be helpful for CESR ta develop that common approach? Considering the current work carried out at global level by 10SCO, it might be useful to have a common approach at EU level on these issues. But for the time being it does not seem necessary to ask CESR for more details on these topics in the context of Level 3 MiFID guidance. If you wish to discuss the content of this answer with us, please do not hesitate to contact us, myself at ( 10ic.leqouet@sqam.com) and Damien Lukacs at ( damien.lukacs@sqam.com). Yours sincerely, 8

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