UPDATE: note the important clarifying point from “Mr B” in the comments below…
Says the international law firm of the report by French parliamentarian Jean-Paul Gauzès on how hedge funds should be regulated by the EU:
This is not good. This is not good at all.
Actually, that’s just a liberal digest of a Clifford Chance briefing note dispatched to clients this week – Alternative Investment Fund Managers Directive: implications for remuneration strategy.
The European Union’s AIFM Directive, promising a crackdown on the pay of hedgies, private equity partners and the like, is still in draft form and not likely to be implemented until 2012. But the serious tweaks introduced by monsieur Gauzès in his report on the matter last month explicitly link the draft directive to the principles on pay agreed at the G20 meeting in Pittsburgh in September.
As far as sector-wide remuneration is concerned, Clifford Chance seem to think this goes way beyond anything else currently on the table in terms of sticky red tape and hard-wired rules.
Here’s a selection of the “problems” identified by the firm:
Although the Directive states that the Annex II principles should be “taken into account” rather than adopted wholesale, they are couched in the form of a relatively stringent set of rules. This contrasts with the approach taken by the FSA in their Remuneration Code, which adopts an over-riding principle supplemented by non-binding guidance, and leaves the implementation very much up to the discretion of the affected firm. For example, though there is guidance suggesting this may be appropriate, there is no “rule” in the FSA Code that banks must pay at least 40% of the variable remuneration component over a period of three years. This position may change as a consequence of new powers in the Finance Bill that will allow the FSA to require relevant BOFI to revise their remuneration policy. In the meantime, however, if and until such powers come into effect it would be an odd outcome if the alternative investment sector (which has not been in receipt of state aid) ended up with more stringent pay rules than those affecting mainstream Banks and financial institutions (which have);
A number of the proposals simply ignore or overlook the way in which individuals in this sector are paid. For example Hedge Fund managers tend to receive a bonus based on performance and management fees earned by the Investment Manager. Private Equity Funds tend to use carried interest vehicles which pay out to managers based on investment criteria determined when the Fund is established, based on the performance of the underlying investment/assets. Neither of these models can easily be adapted to the meet the requirement that any payment “includes an adjustment for all types of current and future risks”.
If they are intended to apply to carried interest, it is not clear how the Principles could apply to what is effectively a return on an investment rather than remuneration for services as an employee or director of the AIF.
It is also unclear how the Principles apply to other types of payments made to key staff of Private Equity Funds – it is difficult to see how a return on a “co-investment” (i.e. where a limited partner in a fund has invested directly in the company that the fund itself has invested in) could amount to remuneration, but Annex II does not currently distinguish between payments which are akin to returns on investment and salary and bonus payments.
The requirement that the “variable remuneration…is paid or vests only if it is sustainable according to the financial situation of the AIFM as a whole” could also impact adversely on the ability of a firm to pay a fund manager based on the performance of the fund he/she oversees, if the business as a whole does badly. Moreover this Principle is not consistent with the way that e.g. hedge funds pay out managers, who tend to be rewarded based on the management fee/performance fee generated by their fund.
Lot’s more alarming stuff in the usual place.
Related links:
EU seeks pact on hedge funds – FT
Gauzes report on AIFM directive – Hedgies table in the Long Room
jeanpaulgauzes.com