Proposed FCA Guidance - What do the changes mean?
Earlier this year, the European Securities and Markets Authority ("ESMA") published guidelines on the remuneration policies managers of alternative investment funds should implement to comply with the requirements of the Alternative Investment Fund Managers Directive ("AIFMD"). The guidelines introduce new standards for alternative investment managers, some of whom are not currently subject to any remuneration requirements.
BIPRU firms, including most hedge and debt fund managers are in fact already subject to remuneration requirements set out in the Capital Requirements Directive ("CRD") and the FCA's Remuneration Code. AIFMD and ESMA's AIFM remuneration guidelines are based on, but not identical to, the CRD provisions.
On 6 September, the FCA published its quarterly consultation paper, including proposed supplemental guidance (some of which will sit within the Systems and Controls Sourcebook and some of which will sit outside the Handbook) to help firms interpret the ESMA Guidelines. The proposed guidance deviates from the existing CRD/BIPRU Remuneration Code in two important aspects:
i) It suggests hard financial thresholds for the application of proportionality to AIFM's renumeration structures; and
ii) It deals specifically with remuneration through limited liability partnerships.
Proportionality
Proposed AUM thresholds
Much like the Remuneration code, AIFMD allows firms to comply with remuneration requirements in a way which is proportionate to their size, internal organisation, and the nature, scope and complexity of their activities. The proposed FCA guidance suggests how a firm should implement the remuneration principles (in particular, the payout rules and the requirement for a remuneration committee) proportionately.
The FCA suggests size thresholds based on the net amount of alternative investment fund assets under management. Where a firm's assets under management exceed the threshold, the presumption would be that it would be subject to all the AIFMD remuneration requirements. AIFMs falling below the threshold, however, may consider disapplying certain rules on grounds of proportionality. Although the FCA is planning to specify a single threshold in the final guidance based on responses to the consultation, it has suggested a range of potential thresholds for discussion:
a) £500 million - £1.5 billion for AIFMs managing portfolios of AIFs including assets acquired through leverage; and
b) £4-6 billion for AIFMs managing portfolios of unleveraged AIFs with limited redemption rights.
This single threshold is different to the three level approach applied to the CRD-based Remuneration Code. Fund management firms who think that the thresholds should be towards the upper end of these suggested ranges are advised to submit their evidence in response to the consultation.
Other determining factors
The FCA notes that size is not the sole issue to consider and there are other factors that will have a bearing on the proportionality analysis applicable to each firm, including:
a) the numbers of partners, members, employees and consultants performing services for the AIFM;
b) whether the AIFM is listed and traded on a regulated market;
c) the number of investment strategies / styles, the level of risk and the number of AIFs under management;
d) the nature of a delegation arrangement between the AIMF and its delegate performing portfolio or risk management; and
e) the nature of certain fee structures such as carried interest.
Although an AIFM's assets under management may be above the threshold, it would still be expected to review the other criteria to determine whether there are characteristics of the firm that, notwithstanding its size, merit disapplication of some or all of the remuneration requirements on the grounds of proportionality. Equally, firms below the threshold should still review the other criteria to determine whether there are characteristics of the firm that merit full or part application of the rules. Firms should also undertake peer group comparisons when making their assessments.
Ultimately, the FCA believes it is the AIFM's responsibility to assess how to apply the remuneration principles to its business. AIFMs will have to be able to justify the rationale behind their application of the proportionality principle.
Limited liability partnerships and payments to partners
Limited liability partnerships are a UK-specific concept and it is ostensibly difficult to apply some of the AIFMD remuneration requirements to them. While the ESMA guidelines define remuneration broadly to include all forms of payments or benefits paid by the AIFM in exchange for professional services rendered by the AIFM staff, they specifically exclude dividends or similar distributions that partners receive as owners of an AIFM.
Currently, payments from the AIFM to partners or members working in the business are classified as a profit share or distribution, primarily for tax purposes, and no part is classified as a fixed or variable remuneration. However, as significant risk takers, partners may well fall to be treated as persons to whom the AIFMD remuneration rules apply. As such, the FCA's proposed guidance suggests that firms must make some determination of the portion of payments to partners that is considered remuneration within AIFMD scope and the portion that is a return on equity.
The approaches suggested in the consultation for allocating payments to profit share, fixed remuneration or variable remuneration include:
a) looking at existing payments to partners – additional profit share for senior partners would be likely to be considered as profit distribution outside scope, whereas discretionary profit share to all partners would be likely to be variable compensation;
b) benchmarking against others performing similar tasks or working in similar businesses as the partner in question and/or against the return on equity expected for a similar investment;
c) looking at the amount of time spent by the partner in the business – part-time would suggest a greater proportion of profit distribution rather than remuneration.
What next?
The consultation paper is an opportunity to shape how proportionality will work in practice and AIFMs may therefore wish to respond, particularly with views on the mooted thresholds. The consultation closes on 6 November 2013.
The FCA guidance will apply to all full-scope authorised AIFMs with the expectation that each firm will implement the AIFMD remuneration regime for new awards of variable remuneration to relevant staff for performance periods following that in which the firm becomes authorised (i.e., the regime will only apply in the first full performance period after authorisation and not to payments earned, allocated or awarded beforehand).
Firms should start reviewing their existing or proposed remuneration structures in light of this new guidance. In addition, it is important that even if the proportionality factors enable some firms to disapply some of the remuneration requirements, general requirements such as reporting remuneration in the annual reports will continue to apply.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
