AIFMD – FCA Publishes its Guidance

AIFMD – FCA Publishes its Guidance


1. Introduction

For the last few months there has been a void in terms of guidance for the fund management sector on how the AIFMD remuneration rules would apply. On 6 September the picture became clearer when the FCA published its consultation on its proposed guidance. The guidance may still change depending on what responses are provided during the consultation period, which closes on 6 November 2013). Firms will need to move quickly to implement compliant pay policies.

2. Who does the AIFMD Remuneration Code (the Code) apply to?

The Code applies to UK/EEA AIFMs with assets under management of:

  • more than €500m if their assets are unleveraged and have no redemption rights in the first 5 years of investment; or otherwise
  • more than €100m.

3. When will the Code apply?

The Code applies as soon as an AIFM becomes authorised as a full-scope UK AIFM. The AIFM must then implement a compliant remuneration regime for new awards of variable remuneration for full performance periods following the date of authorisation. For example, assuming a calendar performance year, if the date of authorisation is 1 April 2014, the rules apply to the 2015 performance year onwards.

Crucially, therefore, the Code will not apply to any remuneration payments earned, allocated or otherwise awarded in bonus periods prior to authorisation. Firms may want to consider carefully the date on which they become authorised if there is an opportunity to authorise after the end of the current performance year.

4. What are the main pay restrictions in the Code?

The Code limits the way in which AIFMs can pay “AIFM Remuneration Code Staff” (Code Staff), i.e. staff whose activities have a material impact on the AIFM’s/AIF’s risk profile. The key restrictions are:

  • At least 50% of variable pay must be paid in: “shares” or “units” of the AIF concerned; or equivalent non-cash instruments, which must be subject to retention period of at least 6 months. This is subject to the legal structure of the AIF, the instrument constituting the fund and whether the management of AIFs accounts for less than 50% of the total portfolio managed by the AIFM.
  • At least 40% of variable pay (60% for those earning over £500,000) must be deferred over a period that is appropriate to the life cycle and redemption policy of the relevant AIFs. This must be at least 3-5 years.
  • Unvested deferred variable pay must be able to be reduced (or in serious cases clawed back) if this is warranted based on the financial situation of the AIFM and the performance of the AIF, the business unit and the individual concerned.

However, there are two key exceptions to these restrictions:

  • the rules do not apply to “low earners”, even if they constitute Code Staff;
  • AIFMs may be able to use the proportionality principle to disapply the rules.

a)    Who is a low earner?

Two requirements must be met for someone to be a low earner:

(i)    total compensation is less than £500,000 p.a. for the relevant year;

AND

(ii)    variable compensation must be maximum 33% of total compensation.

b)    How does the proportionality principle work?

This is one of the most important aspect of the Code as AIFMs may be able to use it to escape the most difficult aspects of the Code. If proportionality applies the key restrictions set out above (called Pay-Out Process Rules in the Code) can be disapplied.
The size of the AIFM is the starting point. The FCA suggests a range of potential size thresholds in the consultation (there will be a single threshold in the final version of the Code) as follows:

4_aifmd - GQ Admin - gqlaw

However, the size of the AIFM does not automatically determine if the rules can be disapplied. AIFMs must then consider other factors (on both a stand-alone basis and compared to peers), including the complexity of their activities and internal structure, which may reverse the initial presumption.

5. What about guaranteed bonuses?

The dominant political view is that guaranteed bonuses are not compatible with effective risk management and this is reflected in the Code.

An AIFMD must not award, pay or provide guaranteed variable remuneration unless it:

(i)    is exceptional;

(ii)   occurs in the context of hiring new staff; and

(iii)   is limited to the first year of service.

This rule applies to all staff (not just Code Staff) and cannot be disapplied.

In practice, there are three main types of guarantee: buy-outs for new hires; sign-ons for new staff; and retention awards for existing staff. The Code does not set out specific guidance on each of these. However, the FCS has previously provided guidance in relation to the MiFID Remuneration Code and it is likely that this guidance will be used in relation to AIFMs as well. The key things to note are:

  • The FCA is most relaxed about buy-outs. Its guidance states that “Although the FSA does not encourage the use of buy out awards…such awards may normally be made without contravening the rule on guaranteed variable remuneration”. The caveat is that:
  • the firm must take reasonable steps to ensure the buy-out is not more generous than at the old employer;
  • the buy-out should contain a similar proportion of non-cash instruments as at the old employer; and
  • the old employer’s deferral/clawback provisions to be replicated as much as possible by new employer.
  • Sign-on bonuses require a stronger justification than buy-outs and the FCA expects that they should be awarded in a “low percentage” of hires only and the firm should have a clear business case to support payment of a sign-on bonus.
  • Retention awards are the hardest to justify and the FCA has stated that they should only be used where a firm is undergoing a major restructuring and a good case can be made for retention of particular key staff members on prudential grounds.

6. Will the EU Bonus Cap apply?

The Code does not specifically refer to a bonus cap. The current expectation is that the bonus cap that is to be introduced for bankers (i.e. 100% of salary (or 200% with special shareholder approval) will not apply to AIFMs.

7. Do Carried Interest and Co-Invest constitute pay?

The starting point is that carried interest is pay, but co-invest (provided it is genuine co-invest, i.e. the member of staff investing their own money) is not.

However, the FCA has provided guidance that an AIFM can disapply the pay-out process rules for the payment of carried interest on the grounds of proportionality if the carried interest structure aligns with the interests of investors and avoids incentives for inappropriate risk-taking. Carried interest plans where AIFMs’ gains come towards the end of the lifecycle of the AIF should satisfy the proportionality principle, especially where the structure has been negotiated with prospective investors.

8. Payments to partners or members of an AIFM

This is one of most difficult and, in many ways, artificial part of the Code. The starting point is that payments to partners/members as owners of the business (i.e. dividends or profit share) should not count as pay.

However, the Code requires partners/members to divide their remuneration into

  • fixed remuneration (drawings in advance);
  • variable remuneration (likely to be based on the bonus that individual would be likely to receive if he/she was an employee rather than a partner/member); and
  • profit distribution (additional pay on top of advanced drawings and variable remuneration).

This will be far from straightforward and will require consideration in terms of how AIFMs will manage this process.

Buzzacott and GQ Employment Law are hosting two events on Thursday 10 October 2013 to discuss AIFMD. This seminar will look at how remuneration rules could effect your business from an employment law and HR perspective. If you would like to attend one of the seminars or would like further details, please click here.