Wednesday, November 25, 2009

AIFM Directive Update: The Swedish Compromise and Fund Pay Code

On November 12, 2009, the Swedish Presidency of the Council of the European Union, published an amended draft (the "Compromise Draft") of the proposal for an EU Directive on Alternative Investment Fund Managers (the "Original Proposal"), which was originally published in April 2009.

The Alternative Investment Management Association had voiced concerns about the Original Proposal as being "rushed through" and "subject to undue political pressure" and warned about possible negative consequences. The Compromise Draft has softened the language of the Original Proposal on some of the more contentious issues. However, the most significant change introduced by the Compromise Draft is a proposal to regulate the compensation of fund managers to ensure that it is consistent with and promotes sound risk management, and does not encourage excessive risk-taking.

Particular emphasis is given to performance-related compensation (such as performance fees and bonuses), where some of the applicable principles include the following:

  • at least 40% of the variable compensation component should be deferred over no less than 3 years, and should vest no faster than on a pro-rata basis. In case such variable component is "particularly high," at least 60% of the amount should be deferred;

  • performance-related compensation should be based on a combined assessment of the performance of the individual and the business concerned, and the overall results of the fund manager;

  • the performance assessment should be set over a multi-year framework suitable to the life cycle of the fund managed;

  • guaranteed variable compensation arrangements should only be allowed in limited circumstances;

  • fixed and variable components of the compensation should be appropriately balanced; and

  • the variable component of the compensation should only be paid if sustainable according to the fund manager's overall financial situation, and justified by the performance of the related fund.
While the proposed compensation restrictions in the Compromise Draft have been characterized as controversial, other proposed amendments can be seen as progressive. This is particularly true for the removal of general leverage restrictions that the European Commission could impose on all funds covered by the Directive under the Original Proposal. Under the Compromise Draft, the use of leverage by a fund manager may only be restricted by the national competent authorities of a particular fund manager (in most cases this will be the UK FSA), on a temporary basis, and only when such measure is required in order "to ensure the stability and integrity of the financial system." In addition, the Compromise Draft allows EU fund managers to market, within the Community, third-country funds managed by such managers, under applicable national laws in each country of distribution. Further, specific requirements of closed-ended funds (such as private equity funds) have been taken into account, and the requirement for the appointment of an independent valuator for each fund has been removed.

The Directive is currently being considered by a subcommittee within the European Parliament, which is expected to produce a revised draft itself. A combined compromise proposal will then be submitted to the European Parliament for a vote, which is expected to occur in mid-2010.