The “Harmonization” of these two regulatory directives.
Since the early days of the AIFMD (and UCITS V) proposal and the lead up to its implementation, there has been one facet of this directive that has not been well understood. The limitations and parameters around remuneration has been an ongoing conundrum, especially variable remuneration and the entire directive’s unintended consequences to US asset managers who manage either UCITS or AIFs as AIFMs or as unregistered sub advisors to an EU AIFM. How do these remuneration guidelines apply in this extra territorial situation, and how is the US asset manager to align their EU and ex-EU remuneration (especially in regards to variable remuneration)? What is the base “salary” on which a US manager’s variable remuneration is based? If a portion of the remuneration is still to be taken in shares of the fund, how is the asset manager to comply when many EU registered funds disallow US shareholders and if that restriction is removed, it creates an unfair consequence where such a requirement may have significantly negative tax implications? A taxable US holder of UCITS or AIF shares can generate a significant tax exposure triggered through either or both PFIC and/or CFC rules.
My client base is heavily US asset managers. These managers have long-established funds and strategies that service both the retail and institutional client bases in the US. They are searching to establish a more global footprint and service the international market through an offering of these same funds either via UCITS or AIFMD. The increasing regulatory barriers and the continuing uncertainty surrounding the ultimate definition of many of these new rules is met with the decision to “sit on the sidelines” by a number of US asset managers.
Dechert LLP has done a great job in condensing the recent UCITS V and AIFMD harmonization and viewed some of the issues faced by US asset managers living under the new AIFMD and UCITS V. The full text of their write-up can be found at the link below. I have extracted the section on remuneration and added it below as it explores the unique situation facing US asset managers who manage EU registered funds under UCITS V and/or AIFMD.
The issue of remuneration was the major battleground in the negotiation of UCITS V and for a piece of financial services regulation, it became quite politicised, particularly in March 2013, when the European Parliament’s Economic and Monetary Affairs Committee (ECON) voted to cap bonuses for asset management staff at a 1:1 ratio with their annual salary. Unusually, and to the relief of many in the asset management industry, the bonus cap proposal was voted down at the plenary session of the European Parliament.
Consistent with AIFMD, under the final text of UCITS V, UCITS management companies will be required to establish remuneration policies and practices that are consistent with and promote sound and effective risk management. These remuneration policies must not encourage risk-taking which is inconsistent with the risk profiles, rules or instruments of incorporation of the UCITS under management and cannot impair compliance with the management company’s duty to act in the best interests of the UCITS.
These remuneration provisions are subject to a proportionality test and UCITS management companies must comply with the remuneration principles set out in UCITS V in a way that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities.
In addition, UCITS V empowers the European Securities and Markets Authority (“ESMA”) to issue guidelines on the scope of staff to be caught under the new remuneration rules and the application of the new remuneration principles for UCITS management companies. These guidelines are intended to add flesh to the bones of the UCITS V remuneration principles and are expected to be largely aligned with ESMA’s Guidelines on Sound Remuneration Policies under AIFMD (the “Guidelines”), which provided guidance on proportionality, which remuneration would be affected and how to identify categories of staff covered by the Guidelines. The guidelines expected to be issued by ESMA in relation to remuneration policies under UCITS V will not be binding, however, financial regulators and market participants will be expected to comply on a ‘comply or explain’ basis. To date under AIFMD and the Guidelines, the sole proponent of explain rather than comply has been Malta.
Under UCITS V, 50% of any variable remuneration of UCITS management companies must consist of units of the UCITS concerned. During the negotiations, it had been strongly argued that variable remuneration should be in the form of shares of the management company or its parent company. This position was ultimately rejected as it was argued that this would have led to a situation where fund managers were rewarded for increasing profits of the management company rather than the value of the funds under their management.
Under the final text, 40% of variable remuneration will be deferred for at least three years and 60% will be deferred for very high bonuses.
Application to Delegates
In a late change to the text, UCITS V now includes a recital which states that the new remuneration rules “should apply in a proportionate manner, to any third party which takes investment decisions that affect the risk profile of the UCITS because of functions which have been delegated.”
There is no corresponding provision in the operative parts of UCITS V and there is now a significant question of how effect will be given to this recital. It is most likely that, as was the case with AIFMD, the application of the rules to delegates will be dealt with under guidelines issued by ESMA.
This has been a hot topic under AIFMD, particularly for funds that are advised by US advisers, who are not subject to equivalent remuneration provisions and who find the extraterrestrial application of EU regulation troubling.
Close attention will be paid to the consultation process that will precede the issue of any guidelines by ESMA and to the application of the equivalent Guidelines under AIFMD in the period up to the expected implementation of UCITS V in 2016.
There will be a particular focus on how the proportionality rule will be applied by regulators under AIFMD.
The Financial Conduct Authority (“FCA”) produced guidance on AIFM remuneration which provides an interesting and helpful analysis of how the principle of proportionality will be applied by regulators and the Irish Central Bank has indicated that it sees “considerable merit in the interpretations which the UK FCA have provided which align the interests of risk-takers and investors and which seek to ensure that the effective management of AIF assets is preserved.”
Among the factors that will need to be taken into consideration by AIFMs are:
- Assets under management
- Scale and complexity of structure:
- whether listed or not
- having additional permissions such as receiving and transmitting orders
- simple structure e.g. internal v external ownership
- use of AIFM passport
- Complexity of strategies:
- use of leverage
- application of group CRD remuneration requirements to delegates
- limiting investment discretion through strict investment guidelines
- Fee structures aligned with investors’ interests
An additional concern for US managers is whether acquiring shares in a UCITS will be practical or feasible. Many UCITS prohibit investment by US persons, so it might be impermissible for US fund managers to hold the shares. If a UCITS changed its constitutional documents to allow US persons to invest, this could result in extra legal and regulatory registration and compliance obligations for the fund and the investment manager, thereby increasing the costs borne by the UCITS. In any event, even if a UCITS changed its constitutional documents to allow US persons to invest, some fund managers might be ineligible to invest based on the fund’s investor criteria and investor criteria imposed by US securities laws. Finally, holding shares of UCITS structured as a corporate vehicle would result in negative tax ramifications for US fund managers who are US taxpayers.
(Full text of the material referenced can be read here.)