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Caveat AIFMD
By Michael Crossan
The PwC article on AIFMD and its impact on private equity remuneration is interesting, but hats off to Michael Crossan, an employment partner at Clifford Chance law firm in London ([email protected]) for tackling the subject several weeks earlier in an article which the firm has now greenlit for use here.
Much has been written about the European Commission’s Alternative Investment Fund Managers Directive (AIFMD) before and since its final text emerged from the European Parliament approval system on 11 November 2010. Little has appeared in detail about its possible impact on remuneration practices in the private equity world.
Most private equity firms fall outside the scope of the Financial Services Authority (FSA)’s earlier Remuneration Code (the Code) though limited numbers of firms fall into Tiers 3 and 4. The industry is also generally well positioned in relation to the requirements of AIFMD. However, unlike the Code, it has far broader application to PE Houses and raises some issues on application to an industry with its own financial alignment to investments and incentive structures.
Whilst we await regulations to implement the provisions of AIFMD in the UK (not due to come into effect until mid 2013), PE Houses would be well advised to begin planning their strategy and tactics relating to complying with the Directive sooner rather than later.
For 2010, the Code initially covered just 26 banks and building societies. As the backlash against the industry intensified, its remit expanded. Following amendments to the EU’s capital requirements directive, the Code currently applies to an estimated 2,500 FSA-authorised firms. In summary under the Code:
The institutions caught by the Code are divided into four tiers. The most onerous requirements are placed on tier one institutions. Tier four firms, (limited licence or limited activities firms) which may capture some PE firms, are affected least. Where applicable they need to identify Code staff, adjust their remuneration policies and comply with certain reporting requirements but the financial structures outlined above do not need to be applied to variable compensation payments.
So after an initial flurry of excitement, concerns about the Code and its relevance to private equity quickly eased. But some might say the industry has been lulled into a false sense of security. Those players caught by the Code will need to consider with care the way they identify their Code staff in particular as this may fetter their interpretation of similar provisions when identifying Code staff for AIFMD purposes. Others not caught by the Code may be surprised by the sweeping application of AIFMD (to an alternative fund manager which has its registered office in the EU, manages an alternative investment fund authorised in or having its registered office or head office in the EU, or which markets an alternative fund in the EU). Furthermore the eventual requirements of AIFMD will be not be as relaxed as those of the Code as they are designed to apply to a broader sector beyond the banking community.
We expect any UK regulations implementing AIFMD to impose similar requirements to the Code. There are three key elements to focus upon in considering the impact of the AIFMD for private equity firms: one, the treatment of variable remuneration, and in particular in the case of private equity, how carried interest fits to discharge the related obligations; two, the translation of theory into practice and three, the identification of the key risk-taking employees whose packages will fall within the scope of the Directive’s provisions.
Carried interest presents particular challenges. It is clearly to be treated as variable remuneration for the purposes of AIFMD but application raises some questions. As it is by definition paid only when it has been earnt, and therefore already deferred, it is well aligned with investors’ interests. How, though, should it be valued in the years between its award, at nil value, and its eventual payment? How also can the performance of the fund manager be taken into account as a whole when awarding carry when paying carry in respect of a separate fund? These are important questions, on which the industry will need further guidance from the FSA in the interim stage as work proceeds on the details of the implementation legislation.
We are yet to learn the details but we already know the broad thrust. The trend for private equity to become less private continues. Remuneration policies must be reviewed to ensure they meet the demands of the new AIFMD regime.
Private equity is largely a responsible and compliant industry, with a positive story to tell. It will likely be able to adjust relatively easily to the new legislation, and show that the interests of investors and key risk-taking employees are properly and accurately aligned. But consideration does still need to be given to the AIFMD regulations to ensure that theoretical compliance is translated into practical compliance.
Firms which are uncertain about their own readiness might wish to consider seeking appropriate advice and clarification.
Michael Crossan is a partner (employment) at Clifford Chance law firm in London ([email protected])
Posted at 04:20 PM in News & Comment | Permalink