Exchange traded funds are set to reach France soon, in spite of a rearguard battle by bankers. But their chances of long-term success will depend on the tax authorities.

errill Lynch, which launched Europe's first ETFs - called Listed Diversified Return Securities (LDRS) -a few weeks ago in Frankfurt, has already applied to list the same products on the Paris Bourse. It is awaiting clearance from the Commission des Operations de Bourse, the stock market watchdog.

If the regulatory process goes smoothly, the two LDRS - on the Stoxx 50 and Euro Stoxx 50 indices of pan-European shares - could start trading before the summer. They are set to become cheap and efficient instruments for French investors to gain cross-border exposure, for hedging and diversification purposes.

Bankers also believe LDRSs could be launched on domestic indices, such as the CAC 40 index of French blue chips. Other indices that could offer sufficient liquidity include the SBF 120 of large and medium-sized companies and the Nouveau Marche index of high-growth companies.

"In the next few months, we will be assessing the demand for LDRSs based on French stock market indices," says a Merrill Lynch executive. "There is no reason why we could not launch LDRS on the CAC 40 index."

However, analysts warn that liquidity in LDRS will in large part depend on the appetite of retail investors, whose investment decisions are often dictated by their tax situation.

Paradoxically, France's most popular savings products for equity investment can not be listed in the country for regulatory reasons. As a result, so called Sicav funds - the equivalent of open-ended mutual funds - sold to French individual investors by their retail banks are usually listed on less tightly regulated exchanges, such as Luxembourg or Dublin.

"Because ETFs are exchange traded, they raise the wider question of the listing of collectively-managed funds in France," says the Association Francaise de la Gestion, the trade body for the fund management industry. In private, French bankers admit to fears that ETFs might affect their lucrative Sicav sales.

Transaction fees can be as much as 3 per cent of the amount invested. For ETFs offer many of the advantages of Sicavs, such as their index tracking characteristics, and superior liquidity.

EFTs can be traded throughout the day, whereas Sicav investors can only sell their holding at a daily fixing price. ETFs are also expected to be cheaper to trade than Sicavs, although their ability to compete with Sicavs will depend on the attitude of the tax authorities.

Of 5.2m individuals who own shares in France, an estimated 75-80 per cent invest through special tax-exempt savings products. Consequently, retail investors' appetite will depend on whether ETFs qualify to be held in tax exempt schemes.

One of the most popular savings instruments in France is the Plan d'Epargne en Actions (PEA), a special type of savings account set up in the early 1990s to promote long-term investment in French companies.

PEA investors benefit from generous tax breaks, as long as the money is invested in French companies' shares and held for several years. The tax exemptions apply to Sicavs invested in French shares, which can be bought through a PEA.

The planned LDRS on the Stoxx 50 and Euro Stoxx 50 are unlikely to qualify for the PEA, because they consist of a majority of non-French shares. However, similar products based on French indices, such as the CAC 40 or Nouveau Marche, will stand a better chance.

"In France, you always need a tax incentive for a financial instrument to really take off," says a banker in Paris. "This should also apply to ETFs."


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