The Financial Conduct Authority (FCA) has published Quarterly consultation No.4 (CP14/4) which, among other things, proposes changes to the FCA Handbook on various AIFMD-related matters. The proposed changes cover certain of the issues which were deferred for further consideration at the time the AIFMD was transposed into national law. The consultation paper, although not extensive, is an important one. This briefing addresses some of the key areas covered by the consultation paper including a proposed relaxation of the remuneration disclosure rules in relation to delegates, an articulation of how third country AIFMs are to comply with the disclosure and transparency obligations and, perhaps most importantly, the process an AIFM is to follow in relation to adding new funds to its management.
1. Changes to AIFMD remuneration requirements
As originally implemented, the UK remuneration and remuneration reporting requirements would have been more onerous (or “super-equivalent”) than the provisions of the AIFMD. The FCA is proposing amendments to the UK remuneration and remuneration reporting requirements that would realign the UK requirements with the AIFMD, as follows.
- The FCA AIFM Remuneration Code (SYSC 19B) currently contains a requirement for AIFMs to set appropriate ratios between the fixed and variable components of remuneration. Whilst this requirement is included in the remuneration rules under the revised capital requirements directive (“CRD IV”), it was not included in the AIFMD and the FCA therefore proposes to delete the provision from the UK AIFM Remuneration Code to avoid super-equivalence. This potentially would have been a difficult provision for UK AIFMs to comply with, as whilst there was no restriction on the ratio which an AIFM could set, once set the ratio would have been binding.
- The FCA also proposes an amendment to the UK implementation of the remuneration reporting requirements (at FUND 3.3.5), to clarify that the remuneration of staff of a delegate does not have to be included in the remuneration disclosures in an AIF’s annual report. This clarification was needed due to the ESMA Guidelines on sound remuneration policies under the AIFMD, which indicate that staff of a delegate can be “Identified Staff” to which the remuneration disclosures would apply. The FCA’s proposed amendment will narrow the scope of the disclosures, and will align them with the requirements of the AIFMD which only imposes a requirement to report on remuneration of staff of the AIFM.
The FCA consultation also recognises the difficulties that firms may face in having to comply with the overlapping provisions of the three UK Remuneration Codes:
- SYSC 19A (the CRD IV Remuneration Code), applicable to firms subject to CRD IV;
- SYSC 19B (the AIFM Remuneration Code), applicable to AIFMs; and
- SYSC 19C (the BIPRU Remuneration Code), applicable to investment firms that were previously subject to CRD III but which now fall outside the scope of CRD IV.
The FCA therefore proposes introducing guidance that an AIFM that complies with all of the AIFM Remuneration Code will also comply with all of the provisions of the BIPRU Remuneration Code. This avoids the administrative burden of demonstrating compliance with multiple codes.
The proposed guidance does not, however, introduce an equivalent provision in respect of any AIFM subject to the CRD IV Remuneration Code. This could be relevant to an AIFM in a wider group that includes CRD IV entities, where the AIFM will need to comply with the AIFM Remuneration Code whilst also being subject to the CRD IV Remuneration Code on a group basis. Certain provisions of the CRD IV Remuneration Code are more onerous than the AIFM Remuneration Code, although the extent to which these may affect an AIFM in practice will depend on how the AIFM and the wider CRD IV group each apply the proportionality principle. It is not clear why the FCA has omitted this element of the guidance, and it would be helpful if the FCA could either extend the scope of the guidance to include this or clarify why this distinction has been drawn.
The UCITS V directive will require ESMA to issue guidance on how the various European remuneration regimes, including under UCITS V, once implemented, should be applied where they overlap. It is therefore possible that the FCA’s approach on this issue will be revisited once that guidance is published.
2. Guidance on third country AIFM compliance with disclosure and reporting obligations
The AIFM Regulations 2013 provide that a third country AIFM marketing an AIF in the UK needs to notify the FCA that “the AIFM complies with the requirements of Articles 22 to 24 of the Directive (i.e. on annual reports, pre-investment disclosures and reporting to regulators) in so far as such provisions are relevant to the AIFM and the AIF to be marketed” (emphasis added).
The FCA is proposing to include guidance on how to determine relevance. The FCA proposes that third country AIFMs will only need to comply with the reporting obligations to the extent that they are required to comply with the underlying operative provisions of the AIFMD. This would mean, for example, that because the operative professional negligence cover requirements will not apply to a third county AIFM, no disclosure would be required on whether professional negligence liabilities are to be met by way of own funds or insurance cover.
The proposed guidance goes on to state that to the extent that a disclosure or reporting provision is relevant, it should be complied with. Of itself, this sounds confusing. To clarify this, the FCA proposes to include an example that an AIFM should disclose the latest NAV to investors, but this is not required to be calculated in the manner prescribed by the Directive. To provide a further example, we would also expect the same principle to apply to maximum leverage limits. If the third country AIFM has, as a matter of fact, historically set a maximum leverage limit for the AIF being marketed, then this should be disclosed. That said, the leverage limit would not need to be calculated using the “gross” and “commitment” methods set out in the Directive; it would be expressed in the manner that the third country AIFM has always expressed it. If the third country AIFM had not already set a maximum leverage level, no disclosure would be required to be made at all.
This guidance represents a welcome validation of the approach that we have seen developing in the market.
It must, however, be noted that this is UK specific guidance and that the regulators of other EEA states into which an AIF is to be marketed may take a different view.
3. Adding a new fund
The FCA has provided drafts of various forms to be used for notifying the FCA of events requiring the notification of the FCA, or its approval.
Nestled amongst these forms is the form required for notifying the FCA of an AIFM managing a new fund or managing a pre-existing fund that had previously been managed by another manager.
The form itself is straightforward. What is, however, of note is that the FCA is requiring documentation and information to be submitted to it one month in advance of the management commencing. The documents and information required, for a full scope UK AIFM, are: instruments of incorporation; pre-investor disclosures; and a confirmation that depositary arrangements are in place. If these are required to be in final form, this may be problematic for deal timetables. Constitutional documentation is often not ready until shortly before launch (in particular in private equity and real estate transactions limited partnership agreements may be finalised late in the day). The same can be said for pre-investment disclosures. Descriptions of investment strategies, for example, are often tweaked prior to the launch of a fund.
In addition to the ‘new fund under management’ notification form, the FCA has proposed forms to cover various other events. We would recommend that readers closely review these forms as they provide an insight into how, and how strictly, the FCA is reading the AIFMD and how it expects compliance to be notified to it and monitored on an ongoing basis.
4. Changes to definition of “funds under management”
As described in a previous bulletin, the FCA had updated its AIFMD webpage to report that it had decided that the definition of “additional own funds” (contained in Article (9)(3) of AIFMD), used to calculate the amount of “additional own funds” that a manager must hold once the value of the portfolio of AIFs exceeds EUR 250m, can lead to disproportionate outcomes in certain circumstances. The FCA reported that it would be consulting on changes to this definition and its proposal is now contained in CP14/4.
The FCA proposes making the change by amending the definition of “funds under management” in the Glossary. The proposed change will allow for derivatives to be valued at their market value rather than notional value. The proposed change will align the definition with that for the additional own funds required to cover professional liability risks, as contained in Article 14(2) of the AIFMD Level 2 Regulation. The FCA has made available a modification by consent to allow firms to take advantage of the proposed change, as well as publishing a new Direction on this modification. The modification by consent will continue to apply until the proposed amendments are brought into force.
5. New rules for AIFMs and UCITS managers relating to over-reliance on external credit ratings
The AIFMD (and UCITS Directive) was amended by way of CRA III Directive 2013/14/EU in June 2013 by requiring that AIFMs (and UCITS managers), as part of their risk management processes, should not solely or mechanistically rely on credit ratings issued by credit rating agencies (as defined in Regulation (EC) No. 1060/2009). The FCA has included its proposal for the implementation of this amendment in this consultation.
6. Additional changes
Finally, CP14/14 also includes the following.
- It includes various forms for notifying the FCA of certain events (including, in addition to the new fund form described above, the form required to be submitted when there has been a ‘material change’ to information submitted and the form required when a delegation, or sub-delegation, is made).
- It clarifies the minimum capital rule for a custodian of a non-EEA AIF (Article 36 custodian);
- It also includes the proposed locations for links within the FCA Handbook to EU guidance and regulatory technical standards which apply to AIFMs to make it easier for such entities to find relevant provisions applying to them.
The consultation deadline is 6 May 2014. The FCA has stated that it expects to complete this workstream, subject to comments from respondents, in mid-2014, with a view to updating the Handbook before 22 July 2014.