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Talking head: hurdles remain as UCITS V talks rumble on
A little more than 12 months on from publication of initial proposals in July 2012, UCITS V – the latest European mutual fund reforms – remains a work in progress.
Originally intended as a relatively uncontroversial alignment of UCITS and AIFMD requirements in the areas of depositaries, sanctions and remuneration, the most heated discussions to date have focused on proposed caps on fund managers’ remuneration and restrictions on performance fees.
The bonus cap and performance fee proposals were introduced at a late stage in March by the special rapporteur charged with guiding the UCITS V package through the European Parliament, MEP Sven Giegold. The proposals were then narrowly adopted by the Economic and Monetary Affairs Committee, setting alarm bells ringing in the European asset management industry and sparking a period of sustained engagement with EU legislators.
The proposals would effectively have prohibited the charging of performance fees to UCITS and placed a 100 per cent cap on managers’ bonuses.
The response of the asset management industry was two-pronged. First, asset management associations made the case that remuneration structures designed to address risk taking in the banking sector would not necessarily be appropriate or relevant in the asset management context. Considering that no EU fund received state support over the course of the financial crisis, it seemed counter-intuitive that UCITS managers should be subject to rules that, in some respects, were tougher than those proposed for the banking sector.
Secondly, industry also provided legislators with practical examples of the potential impact of the proposed changes. In the case of performance fees, for example, the most likely result of a ban on performance fees would be a commensurate increase in management fees. This fee is typically charged as a percentage of assets under management and payable even in circumstances where a fund experiences negative performance. By contrast, performance fees are typically not paid in circumstances where the manager fails to beat the previous high water mark or outperform a benchmark plus hurdle. By removing performance fees, investors in UCITS could ultimately be subjected to a higher fee burden in a time of underperformance, whether due to declining markets or other factors.
Similarly, a bonus cap could simply create a new set of problems. In many cases, asset management companies provide for a low fixed salary to staff with a higher bonus component, depending on performance. If the proposed 1:1 ratio between fixed and variable compensation was implemented, asset managers of UCITS would effectively be forced to increase the fixed component to retain staff.
This increase in fixed overheads could remove the ability of such managers to react to market pressures. For example, a manager operating a long-only equity mandate is likely to see income streams decline in a sustained period of falling markets and could ultimately be forced to wind up operations if it is unable to control fixed salary costs.
These arguments, and others, ultimately proved sufficiently persuasive as the plenary vote of the European Parliament, held on July 3, rejected the bonus cap/performance fee proposals.
However, it may be a mistake for asset managers to believe that they are now out of the woods. UCITS V will now move into the trilogue process, with the aim of reaching a final agreed text between the commission, parliament and council. While many of the remaining proposals are workable, others will cause significant challenges.
Requirements that an individual’s variable compensation should be in the form of units in UCITS managed by such individual may result in increased compliance costs, as the issue of units to a member of the staff will trigger the need to assess and comply with securities laws, tax laws and market abuse requirements (depending on the role of staff member and jurisdiction of residence). Furthermore, the requirement does not take account of the personal circumstances of individual staff members, forcing them to hold units in UCITS inconsistent with their own risk profile. Staff members may, depending on their jurisdiction of residence, incur an immediate tax deduction in respect of a deferred interest in units but find that the deferred interest may never vest due to clawback provisions. Requirements to summarise remuneration policies in the KIID of each UCITS are also likely to prove an insurmountable task, given the challenges already experienced incorporating all required information into this two-page document.
Ultimately, the parliament vote represented a positive outcome of the engagement between industry and legislators. However, the devil may be in the detail when it comes to resolving some of the remaining technical issues.
This article originally appeared in the Financial Times on 2 September 2013.