Following its September 2013 consultation (CP13/9), the Financial Conduct Authority (“FCA”) has published finalised guidance offering clarification of how it intends to apply the EU level AIFMD remuneration requirements as set out in Chapter 19B of the Senior Management Arrangements, Systems and Controls Sourcebook (“AIFM Code”).
The guidance, which became effective on 31 January 2014 is directed “principally” at full scope-UK AIFMs.
An AIFM should apply the AIFMD Code to the first full performance period following its authorisation.
The FCA has adopted a flexible approach to the potential situation whereby certain disclosures are required to be set out in the AIF’s annual report where it is due to be published before AIFM has completed its first full performance period. In these circumstances, any disclosures which cannot be provided may be omitted from the report and replaced with an explanation as to why they are unavailable.
The Guidance sets out the following proportionality size thresholds under which there is a working assumption that it is appropriate to disapply the pay-out process rules:
- £5bn for AIFMs which manage portfolios of AIFs that are unleveraged and have no redemption rights for five years from initial investment; and
- £1bn for AIFMs which manage portfolios of AIFs in other cases, including any assets acquired through the use of leverage.
The FCA cautions against the use of these thresholds in isolation. The Guidance requires full scope UK AIFMs to consider the other proportionality elements identified by the FCA and ESMA guidelines prior to concluding that the pay-out process rules do not apply.
The Annex to the Guidance contains a list of scenarios which illustrate how these rules may be applied in practice.
The AIFM Code need not be applied to employees of a firm to which the AIFM delegates material portfolio management or risk management if the delegates are subject to other rules and guidelines which are “equally effective”.
Exact equivalence is not necessary in order to qualify for this exemption. Firms subject to the rules and requirements of MIFID or CRD IV for example will be considered subject to an “equally effective” regime, however other regimes, such as UCITS rules which have not yet been finalised, or mere G20 commitments to the concept of remuneration restrictions, are not “equally effective”.
LLPs and Partnerships
The AIFM Code applies only to remuneration (compensation for the management of an AIF and carried interest) and not to profit shares (dividends or similar distributions that partners receive as owners). In addition, the AIFM Code applies differently to fixed income and variable remuneration.
The Guidance sets out two methods open to AIFMs in order to differentiate between payment types:
- Firstly, the FCA provides suggestions as to the type of payment likely to fall into each category. It concludes that advance drawings are likely to be considered fixed remuneration and that discretionary profit shares distributed to all partners, particularly if performance related, would normally be treated as variable remuneration. Additional profit shares for senior or founding partners on the other hand would normally be treated as profit shares (especially if structured as an automatic allocation with no adjustment for performance) and are therefore not considered remuneration.
- Secondly, the FCA suggests using benchmarks, including consideration of the remuneration structures for those performing similar tasks in other organisations or the return on equity/capital expected in a similar investment context to that of the partner.
Other considerations, such as the time that the partner spends working for the AIFM, how the fixed and variable components of the remuneration are balanced and whether compensation is provided disproportionately through profit shares in order to avoid the AIFM Code, should also be considered.
Form of remuneration
The Guidance notes that for many AIFMs it is not possible to provide variable remuneration in units or shares of the AIF due to the very nature of the AIF that they manage (for example AIFs that are closed-ended or where the contents of the AIFs constitutive instruments are prohibitive).
Firms which are not able to apply the AIFM Code, in whole or part, or for particular staff are recommended to elect to pay staff in shares, interests or instruments linked to the AIFM or its parent (where the performance of the AIFM business is relevant to the parent company's valuation) or in shares or instruments linked to the performance of a weighted average of the AIFs managed by the AIFM or its affiliates. The FCA stipulates that these instruments should ordinarily be held for a minimum of 6 months.