UK regulator the Financial Conduct Authority (FCA) adopted a light-touch approach in its interpretation of pay rules under the EU Alternative Investment Fund Managers Directive (AIFMD).
EU member states are in the process of implementing the EU-wide directive into national law. In most EU states, GPs must gain authorization to operate under the directive by July 22.
The FCA “has taken a pragmatic approach”, and the final guidance recognizes that “some of the remuneration requirements are not workable for private equity firms”, said one London-based industry lawyer.
GPs were concerned some pay would have to be given to partners and employees as fund shares or a stake in the management firm and that pay would have to be deferred as a way to control risk-taking.
However, final guidance released by the UK Financial Conduct Authority (FCA) last week, revealed most GPs will be able to disapply these rules under the principle of proportionality. Most GPs managing less than £5 billion in assets under management (AUM) can disapply the rules, as can GPs with levered funds with an AUM of less than £1 billion.
“The AUM is the primary mechanism for considering if you are a significant AIFM but there are other factors for calibrating your response to the FCA,” said Bobby Johal, managing consultant at regulatory service provider Cordium.
Other factors include: the number of partners, employees and consultants working for the AIFM in comparison to its peers, whether a significant portion of the firm’s equity is held by investors not working in the business and if the fund has strictly controlled investment parameters.
“The FCA will be looking for managers to justify very carefully why they think they should be able to disapply the rules as the AUM can be a crude measure,” added Johal.
The guidance specifically uses a typical carried interest structure as an example of a large fund manager who can disapply the rules. The standard “2 and 20” fee model used in private equity, in essence, meets the AIFMD’s intent of aligning fund advisors’ interests with their investors. Private equity managers only receive a performance bonus (or carried interest) after investors are paid a pre-negotiated return. Carry is also subject to clawback in the event a fund advisor is rewarded too much should the fund later turn sour.
Larger fund advisors were also concerned the directive would force them to assemble bureaucratic remuneration committees to determine staff pay levels. Here the guidance refers back to EU-level guidance that says GPs managing more than €1.25 billion in assets and have more than 50 employees will need to set up a remuneration committee. However, such funds may disapply the remuneration committee provision if they can justify they are not “significant in terms of their internal organization” and are not engaged in complex investment activity.