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The long awaited FCA guidance (CP13/9) on the Remuneration Code under the AIFMD, (the “AIFM Remuneration Code”), was released on 6 September 2013. This second consultation paper provides UK alternative investment fund managers (“AIFMs”) further direction on self-assessment of proportionality methodologies to determine the extent of the AIFMD’s effect on the Remuneration Code.

The paper proposes to annex the guidance to SYSC 19B of the FCA Handbook to reflect the UK’s compliance with the ESMA guidelines on sound remuneration policies under the AIFMD.

Proportionality:

In light of the vague concept of proportionality introduced by the AIFMD, the FCA has provided guidance to take into account when weighing proportionality elements. This will help determine whether or not to disapply various AIFMD remuneration requirements.

Potential Remuneration Code Exemptions & Thresholds:

The remuneration requirements eligible for exemption, given the appropriate proportionality requirements, are the ‘Pay-out Process’ (retained units, shares or other instruments; deferral; & performance adjustment) and the formation of a Remuneration Committee - which is only required if the firm is considered “significant”. Firms should note however that the disapplication of the rules requiring the Pay-out Process and the formation of a Remuneration Committee would never be automatic. The AIFM should perform a proportionality assessment of each rule, as shown in the below step-by-step plan.

Step one: Examine the AIFM in terms of whether the assets under management fall below the relevant thresholds (yet to be finalised). If so, the AIFM may, subject to step two, be unrestricted by the Pay-out Process rules.

  • For AIFMs managing AIFs with leveraged assets: [£500 million-£1.5 billion]
  • For AIFMs managing unleveraged AIFs with no redemptions rights exercisable for 5 years following date of initial investment: [£4-6 billion]

The thresholds are left open in the Consultation Paper and firms are invited to respond and offer their views on the appropriate threshold amounts within each range.

Step two: In addition, it is expected that the AIFM reviews other criteria to determine whether it would merit the disapplication of any rule. These additional criteria may include, but are not limited to: number of employees, listing status of shares, ownership structures, number of investment strategies, fee structures, level of risk and any delegation arrangements.

Third Parties and Other Staff:

Full-scope AIFMs are firms that are subject to the full requirements of the AIFMD either due to their size or via their own election, in exchange for the added benefits under the AIFMD (e.g. passporting). These full-scope AIFMs are expected to apply the AIFMD Remuneration Code, in observation of the FCA’s new guidance, to the remuneration of ‘relevant staff’ in the first full performance period. Relevant staff includes those whose “professional activities have a material impact on the risk profiles of the AIFM or of the AIFs the AIFM manages”. The guidance provisions add that in assessing proportionality, AIFMs may take into consideration staff’s AIF management responsibilities. Therefore, it is justifiable that staff falling under the AIFM Remuneration Code but having no involvement in the management of an AIF may be exempted from the Pay-Out Process Rules.

The principle of proportionality is also applicable to the remuneration of any delegated portfolio or risk managers. However, as a practical assurance, an AIFM should have contractual arrangements in place with the third party to ensure the remuneration of their relevant staff is compliant.

Remuneration vs. Profit Share:

The new guidance provisions set out a clear distinction between ‘remuneration’ and ‘profit share’. While this distinction is clear in some cases (e.g. dividends which are excluded as remuneration), the FCA anticipates cases, such as those pertaining to UK partners, where the division between profit share and fixed/variable remuneration might not be as categorical. In these cases, an assessment of what is remuneration and profit share should be conducted either based on past pay-outs or return on equity or other staff’s remuneration structures.

Pay-out Process Rules:

Remuneration in the Form of Units, Shares or Other Instruments:
The FCA recognises that it may not always be practical to comply with the requirement that 50% of variable remuneration consists of units or shares of the AIF concerned, such as:

  • Where the legal structure of the AIF and the instrument constituting the fund  makes this application impractical – e.g. closed-ended AIF where there are no units available to acquire; legislation prohibits this; or the cost would be so great it would outweigh the benefit
  • Where the management of AIFs accounts for less than 50% of the total portfolio managed by the AIFM.

The guidance strongly recommends that AIFMs pay their staff in shares, interests or instruments linked to the AIF to ensure the incentives of relevant staff and AIF investors are aligned.

Minimum Retention Period:

The FCA’s position on units forming part of a variable remuneration award is that they should carry a minimum retention period of 6 months, provided that AIFM’s risk management is managed in a way that is sound and effective.
In anticipation of the PAYE system application, the FCA also confirms that the rule on retention may be applied on a ‘net of tax’ basis in which all tax owed may be deducted at the source.

Conclusion:

The FCA is looking to publish final guidance on remuneration rules in early 2014. The delay in the guidance is leaving some firms hesitating about how to finalise their internal compliance policies and when to submit their variation of permission application to the FCA. There has been a lot of debate about the January 2014 submission date which the FCA has recommended for existing managers. The FCA has specified that managers should submit their variation of permission application no later than 22 January 2014. Despite the delay in finalising the remuneration guidelines, the FCA has not adjusted this timeline, therefore firms should aim to meet the deadline in order to avoid possible business disruption.

Jerome Lussan

Jérôme de Lavenère Lussan is the CEO and founder of Laven. Jérôme’s background includes acting as a COO of a hedge fund and as a financial lawyer at Jones Day.

Jérôme has a broad degree of expertise in the hedge fund and fund management industry and is an advisor to many international financial services firms specialising in operations, legal and regulatory matters. He is a member of the Law Society of England and Wales, the International Tax Planning Association and of the CFA Society of the UK. Jérôme holds an LLB from University of Edinburgh.

In 2010 and 2011, Jérôme was named by Financial News as one of its 100 Rising Stars, and in 2011 and 2012 one of its 40 under 40 Rising Stars in Hedge Funds. He is the author of the FT Guide to Investing in Funds.

Website: www.lavenpartners.com

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