Buried in the recent consultation paper on the Alternative Investment Fund Managers Directive (AIFMD) are stringent rules on pay that will have far reaching consequences for the asset management industry, say experts at PwC.
The rules, from the European Securities and Markets Authority, will affect alternative investment firms which escaped the FSA’s regulations on bank pay, including many private equity houses and hedge funds. They will also mean more onerous restrictions for those investment firms already caught by the FSA requirements, and could even hit some firms outside Europe.
The rules are in line with those introduced to other financial services firms in Europe via the Capital Requirements Directive and implemented in the UK by the FSA. The main measures, aimed to align pay more closely with risk, restrict the cash element of bonuses, enforcing at least half to be paid in shares or equivalent instruments. A large chunk (at least 40% and up to 60%) of variable pay must also be deferred for around three to five years. Firms must also disclose total pay for the financial year, with a break-down for senior management and other key staff.
Tim Wright, reward director at PwC, says: “The rules will mean sweeping changes to the pay policies and practices of many asset management firms. Many thought they’d escaped the brunt of banking pay regulations, but they’re coming back to bite.”
While many asset managers had been caught under the FSA rules, they had fallen into the most leniently treated group – tier 4 – with minimum use of deferral and equity. Others escaped entirely. While the AIFMD rules will apply to a varying degree depending on a firm’s risk profile, most alternative investment fund managers will ultimately face far tougher restrictions.
“The rules could arguably put EU regulated firms at a disadvantage not just for recruitment and retention of workers, who tend to be internationally mobile, but for investment opportunities. The Directive is not only aimed at funds based in Europe but those marketed in Europe, which may lead some firms outside the EU to rethink targeting investors here. A US asset manager, for instance, would need to weigh up whether the UK market is worth deferring a sizeable part of their pay for.” Greater disclosure on pay is likely to be a particular concern.
“Disclosure goes against the grain of the asset management industry, with information on pay seen as highly market sensitive. Moreover, given the small size of many firms, disclosure in this sector becomes much more personal. If the total pay disclosure covers just two employees, you’re as good as naming them.”
For private equity firms, there will be concern that the Directive explicitly says that carried interest will be targeted by the rules.
“It is something of a surprise that it looks like carried interest will be included. Carried interest is directly linked to realisations made in the fund managed and there are likely to be conceptual difficulties in calculating the annual amount," says Wright.
The AIFMD remuneration regulations will come into effect from the summer of 2013. Given the scope of the AIFMD, this leaves very little time for firms to prepare for the changes. Key to the practical effect of the regulations will be the manner in which the FSA implements them (most likely as part of the existing FSA Remuneration Code). In particular, whether the FSA is able to apply the rules in a proportionate manner, reducing the impact for certain firms.
Equivalent regulation for managers of UCITS funds will not be in place until UCITS V is implemented some time after AIFMD, putting alternative investment managers at a disadvantage in the meantime.