The FCA has now published the long awaited consultation on the implementation of the AIFMD remuneration rules in the UK as part of its general quarterly consultation document.
The guidance given by the FCA is clear and pragmatic, and resolves many, although not all, of the issues that firms have been considering.
This briefing summarises the areas covered by the Consultation and highlights some of the outstanding issues.
We will be discussing these issues in detail in our Webinar on 24 September 2013: please click here for further information.
The Consultation is open for responses in respect of the remuneration aspects until 6 November 2013, and the Consultation paper is available here (the main sections dealing with the remuneration aspects are Chapter 14, at page 50, and Appendix 14B).
The Consultation proposes that AIFMs will first be required to comply with the AIFM Remuneration Code in respect of the first full performance period after becoming authorised. An AIFM with a calendar financial year that becomes authorised between 1 January 2014 and 22 July 2014 will therefore have to apply an AIFM remuneration policy in respect of the year beginning 1 January 2015 (covering bonus payments to be made in Q1 2016). However, notwithstanding the delayed start date for the policy, it appears that the policy will still need to be adopted by the AIFM prior to making its application for authorisation.
The Consultation sets out guidance as to when AIFMs may be able to disapply the requirements relating to payment in instruments and retention, deferral, and performance adjustment (collectively referred to in the Consultation as the "Pay Out Process Rules").
The proportionality test proposed is a two stage process; firstly, AIFMs must compare the total AuM of their AIF portfolio (excluding non-AIFs and assets managed under a delegation) to a specified threshold, which creates a presumption as to whether or not the Pay-Out Process Rules must be applied. A different threshold applies depending on whether the AIF portfolio includes assets acquired through leverage, and whether the AIFs are open- or closed-ended. Secondly, the AIFM is then required to consider all other factors that may affect its risk profile, and these other factors can override the original presumption.
The FCA has set out potential thresholds that could apply in respect of two types of fund (leveraged; and closed-ended, unleveraged), but in doing so has therefore not covered other fund structures. For example, the case of an AIFM managing a portfolio that includes unleveraged, open-ended funds is not dealt with. It is not clear whether the thresholds set by the FCA are the two extremes of the FCA's risk spectrum, such that AIFMs which do not fall clearly into either of these two categories would be expected to determine an appropriate threshold between the two levels given by the FCA.
The exact quantum of the thresholds has not yet been determined and the FCA is inviting firms to comment on what the thresholds should be.
The ESMA Guidelines provide that where an AIFM delegates portfolio and/or risk management, the AIFM must ensure that the delegate is subject to regulatory requirements that are "equally as effective" as those applicable under the AIFMD, or that appropriate contractual arrangements are put in place to ensure that there is no circumvention of the AIFMD remuneration rules.
The FCA proposes that the CRD and MiFID remuneration regimes will be treated as equally as effective as the requirements of the AIFMD for this purpose, which is a helpful approach that should avoid unnecessary compliance costs. Certain questions as to how the rules apply in the case of a delegation remain unanswered, including whether (as indicated by the ESMA Guidelines) staff of a delegate can be Code Staff of the AIFM (a question that is particularly relevant when it comes to the remuneration disclosures in an AIF's annual report).
4. AIFM Code Staff
The Consultation addresses a number of the "problem cases" that firms have already been facing in determining their AIFM Code Staff. The Consultation proposes that AIFMs will be able to apportion remuneration of staff who perform both a role related to the management of AIFs and a non-AIFMD role. Again, this is a very helpful approach that recognises the limited scope of the AIFMD regime. There are certain issues that firms will need to consider, however, in relying on this principle. These include the interaction with the CRD IV regime: the Consultation addresses this in part by stating that each regime is to be applied at its appropriate proportionality level, but a number of issues remain due to the increased scope and severity of the CRD IV remuneration rules.
5. Payment in the form of fund units or other instruments
The Consultation addresses two issues in respect of the requirement to pay 50% of an AIFM Code Staff member's variable remuneration in the form of units or shares of the AIF concerned, or equivalent ownership interests, or share-linked instruments or equivalent non-cash instruments.
Firstly, the Consultation addresses cases where it may be disproportionate, or impracticable, for the AIFM to apply this requirement due to the characteristics of the relevant AIF. Secondly, the Consultation separately considers when it may be proportionate to modify the requirement in respect of particular types of AIFM Code Staff or where the AIFM manages multiple AIFs.
The consideration of whether it would be disproportionate to apply the requirement due to the characteristics of the AIF would need to be applied on an AIF by AIF basis, and an AIFM would need to justify why it would not be proportionate to use either actual fund units or phantom, cash-based arrangements.
Where an AIFM can disapply the instruments requirement on grounds of the characteristics of an AIF the Consultation confirms that the AIFM is not required to use alternative arrangements, but the FCA nonetheless recommends using shares in the AIFM or its parent company, or an index of AIFs (although using an index of AIFs may be problematic where investment into the AIFs is not possible as the AIFM would be unable to hedge the liability). Where this situation arises the AIFM then has much more flexibility in the way employees are paid. The AIFM could, for example, choose to operate payment in the form of corporate-level shares only in respect of the deferred element, allowing it to pay upfront remuneration fully in cash and the deferred element fully in shares.
Different considerations apply in respect of the ability to modify the instruments requirement on grounds of the type of AIFM Code Staff and/or the number of AIFs under management. Firstly, where this ground is relied on the instrument requirement is not disapplied; instead, the AIFM is required to use corporate-level shares or an index of AIFs (rather than fund units), and the 50% minimum would also still apply. Secondly, although the choice between using corporate-level shares and an index of AIFs is presented as an equal choice, AIFMs have to justify how the approach chosen aligns with the interest of investors in the AIFs, which in some cases may create a presumption in favour of using an index of AIFs (although other proportionality factors will be relevant). Different considerations again apply in the case of staff in control functions, where the focus is on avoiding conflicts of interest.
The Consultation attempts to clarify the position of AIFM Code Staff who are partners in a partnership or members in an LLP, and this element of the Consultation appears to have been driven, at least in part, by the recent HMRC consultation on taxation of members of LLPs (itself another potentially key issue for affected firms).
The underlying principle is that the AIFMD remuneration rules apply to "remuneration", which is widely defined (and is much wider than salary) but which excludes returns on ownership (ie. dividends on shares and partnership returns on capital). The Consultation therefore proposes a process whereby a partner's profit share is notionally divided between a return on ownership (for example, calculated by reference to returns on investments in equivalent businesses), fixed "remuneration" (monthly advance drawings), and "variable remuneration" (the balance).
This element of the Consultation is unhelpful for partnerships consisting solely of individuals, who may have been expecting to be able to take the view that partners' profit share would have been outside the scope of the AIFM Remuneration Code in full, and also creates issues for these firms in how they will apply the deferral and malus/clawback rules.
For LLPs including a corporate member the guidance is more helpful, in that it provides clear guidance as to the desired approach to categorising partner drawings.
Disclosure is the most significant issue not addressed by the Consultation. The Consultation nonetheless resolves some issues in respect of disclosure, particularly around the consideration firms have been giving as to whether remuneration can be apportioned for this purpose, but does leave other points outstanding.