As managers start to grapple with the implications of Alternative Investment Fund Managers Directive (AIFMD), many are finding their greatest challenges relate to remuneration. In this edition of AIMFD Insider News, we look at why managers are suffering from remuneration consternation and what they should be doing to move ahead of the challenge.
Thanks to the European regulators’ European Securities and Markets Authority (ESMA) delegation principle, many managers around the world are now grappling with the regulatory implications of remuneration for the first time.
Indeed, those EU-based managers subject to the entire AIFM Directive (and, in many cases, the Capital Requirement Directive) will now be facing some pretty tough remuneration questions. Who should be categorized as ‘identified staff’ and therefore subject to more onerous remuneration requirements? What are the tax implications of deferred payments? Who should be on the Remuneration Committee? How will changes to remuneration policies impact competitive positioning in the market?
What makes this all the more difficult for managers is that each EU member state is responsible for setting their own date for compliance and creating their own proportionality regime (which essentially allows particular firms or individuals to be excluded from some or all of the rules).
Ultimately, the existence of different deadlines, requirements and regimes has created additional complexity, particularly for ‘cross-jurisdictional’ managers. The more savvy players are now giving serious thought towards how best to structure their deferral and instruments payment arrangements to ensure they are compliant yet still tax-efficient.
One of the biggest challenges inherent in AIFMD is that a portion of the variable remuneration will need to be deferred. For example, the UK Financial Conduct Authority (FCA) have included in their Rulebook that at least 40 percent of variable remuneration must be deferred for somewhere between 3 to 5 years; if variable remuneration is above a half million pounds, the proportion needing to be deferred must be at least 60 percent.
Across the European Union, however, most jurisdictions have set their remuneration threshold much lower (often at just 100,000 Euros) meaning that a significant number of individuals will likely fall into the ’60 percent’ category for variable remuneration deferrals.
This gets particularly tricky in cases where payments are required to be made in instruments (such as shares) of the fund itself. Funds that are closed-ended, for example, will need to do significant work ahead of the deadline to structure vehicles that satisfy the AIFMD requirements (by, for example, linking cash payments to the performance of the portfolio or the AIFM itself).
For most firms, tax and other commercial implications will almost certainly come into play, as will the need to pay close attention to how claw-backs and malice are enacted (if required) once deferred awards have been made or even paid.
So why have fund managers been reluctant to make a start on their AIFMD-compliant remuneration policies? In part, it’s because many managers falsely believe that – since their remuneration policy won’t come into effect until 2015 at the earliest – this issue can be put on the back burner for later in the year. But many jurisdictions (including the UK) now require an AIFMD-compliant draft remuneration policy be submitted at the same time as the authorization application. That leaves precious little time for managers to properly look at the implications of tax efficient remuneration structures and deferrals.
Others seem to be more focused on building a convincing case for disapplying some of the more onerous requirements under the proportionality models in their relevant jurisdictions. But in many cases this will prove risky, especially if their case is later rejected by the regulator leaving little time to effectively ensure proposals are commercially viable. It is worth remembering after all, that a proportionality model is designed to only exclude some firms and individuals, not all, as has been confirmed by the FCA’s expectation expressed in January 2014 that ‘managers of the majority of alternative investment fund (AIF) assets in the UK will be subject to the full regime’.
Ultimately, what our experience suggests is that managers – both inside and outside of the EU – need to start giving serious thought to how their business will be affected by the remuneration requirements of AIFMD.
To date, many have been focused on how to build sufficient substance to achieve a compliant AIF portfolio; now they will need to quickly turn their attention to reforming their compensation structures and identifying and informing the staff that will be affected.
And any lack of attention given to the tax, legal and commercial implications of these changes may come back to haunt them in the long-term. Not surprising that remuneration is now bolting up the fund manager’s agenda.