Will IFD/IFR hit fund managers in the pocket in 2021?
After all, there is the end of the Brexit transition period to address first. And anyway, the FCA makes clear that AIFMs and UCITS ManCos will continue to comply with the remuneration Codes in SYSC 19B and/or 19E. Those Codes currently permit many firms to dis-apply, on a wholesale basis, the most intrusive remuneration provisions known as the “pay-out process rules” which deal with performance adjustment, deferral and retention.
So, the theory is that the remuneration changes under the FCA’s new IFD/IFR derived prudential regime should not kick in for fund managers. The trouble is that many UK UCITS Mancos and AIFMs also have MiFID top up permissions (so called CPMI firms) and the DP is completely silent on those, at least when it comes to remuneration.
At the moment, as long as CPMI firms subject to BIPRU comply with SYSC 19B/19E then they will also be deemed to comply with the third, so-called BIPRU Code which, in principle catches them too as a result of the MIFID top ups. So the extension of the AIFM/ManCo’s permissions to include “MIFID top ups” often makes no difference to what goes in directors’ pockets, and when.
Now that the BIPRU and IFPRU Codes seem likely to be replaced by a more prescriptive and less flexible regime, this could all be set to change in January 2022. If the FCA decides that in order to avoid regulatory arbitrage, CPMI firms need to level up to their MIFID counterparts on remuneration as well as prudential requirements, then there is a real risk that a fund manager’s decision to enter into the odd segregated mandate outside of its core UCITS/AIFM management business and seek FCA permissions accordingly, could switch on new rules on performance adjustment, deferral and retention.
There is also a risk that many staff, previously excluded from the scope of Code Staff under the UCITS and AIFM Codes, could now be brought into scope under the new investment firms regime.
At this stage, we are just in “Discussion Paper” territory and nothing is set in stone. As we noted in our previous article, the FCA has also taken care to reserve its position on how closely aligned the UK’s implementation of the IFD/IFR will be. Whilst the FCA’s position is not settled, its further comments in its recent webinar discussed below raise important questions for CPMI firms. CPMI firms should not risk falling asleep at the wheel and missing out on the opportunity to press the FCA for a more tailored and proportionate approach to the new regime.
What are the changes on proportionality under IFD/IFR?
The remuneration requirements under IFD/IFR are broadly similar to those under the AIFMD/UCITS. However, whilst the concept of proportionality is retained, its use is far more prescriptive and limited. This is because the IFD/IFR includes restrictive criteria for the types of firms which can disapply certain of the “pay out process” rules.
The FCA’s approach in the DP is to interpret the existence of these criteria to mean that “proportionality is built into the IFD”. Consequently, firms cannot add a further proportionality test to dis-apply the remuneration principles altogether, solely on grounds of proportionality.
What is the IFD/IFR’s restrictive criteria for relying on proportionality?
The IFD provides exemptions from the retention and deferral requirements for:
- firms where the value of its on/off balance sheet asset is less than or equal to €100m (there is a member state discretion to increase this threshold to €300m subject to certain criteria – the FCA has confirmed it would be appropriate to apply a threshold of at least €300m to investment firms which satisfy the other criteria); or
- an individual whose annual variable remuneration does not exceed €50,000 and does not represent more than one quarter of that individual’s total remuneration. Contrast this with the current AIFMD/UCITS Codes which provide an exemption for an individual whose variable remuneration is no more than 33% of total remuneration and their total remuneration is no more than £500,000.
Unlike the AIFMD and UCITS Codes, there is no exemption from the performance adjustment requirements under IFD/IFR.
Are there any other exemptions?
Smaller CPMI firms may be able to satisfy the criteria to be considered a small and non-interconnected investment firm (SNI firms) which includes criteria, amongst others, to have an on and off balance sheet total of less than €100m and assets under management1 of less than €1.2bn. SNI firms will not be subject to the IFD/IFR remuneration code.
If it’s all so unclear under the DP, why worry now?
In response to a question in its webinar, the FCA expressed its view that CPMI firms should be treated the same as MIFID firms for their MIFID business. The FCA therefore raised the question as to how the remuneration rules could be applied on a partial basis to those firms. The FCA has encouraged stakeholders to respond to the DP with their thoughts on how such a split might work, or whether they consider it might be more pragmatic to avoid the complexities around splitting by applying one set of remuneration requirements to both types of activities.
If the FCA takes the latter approach, it seems likely it will apply the more restrictive IFD/IFR requirements to the whole of a CPMI firm’s business. This could prove expensive for Code Staff and senior management and herald, perhaps ironically at the dawn of Brexit, the entry into force of remuneration rules, derived from EU law, that many in the fund manager industry have so far avoided.
What can firms do now?
The period for responding to the DP has now closed. The FCA has stated that it will issue several consultation papers and stagger topics consulting earlier on the topics it considers firms need the most time to prepare. Firms should prepare to respond to the consultation papers. In particular, depending on a CPMI’s size and the extent of its MIFID business, there are a number of different approaches which may be worth presenting to the FCA.
1 This includes non-discretionary mandates as well as discretionary