ESMA Publishes Final Guidance on Performance Fees

Background

At the beginning of 2018, ESMA conducted a mapping exercise among National Competent Authorities (NCAs) in order to analyse the current practices in the different EU Member States in relation to some aspects of performance fees. The results of that exercise showed a lack of harmonisation as regards Member States’ approach to performance fees and, subsequently, ESMA consulted on draft guidelines, with the aim of introducing minimum standards for performance fee models (see our briefing here). ESMA has now published its final Guidelines, together with a Final Report (here) which provides an overview of the feedback received in response to the consultation and explains how ESMA took this feedback into account.

The Guidelines

The Guidelines apply to managers of UCITS and to managers of AIFs marketed to retail investors subject to certain exclusions (such as closed-ended AIFs and open-ended AIFs that are EuVECAs or EuSEFs) (“Managers”).  Their objective is to promote greater convergence and standardisation in the field of performance fees and promote convergent supervision by NCAs. The Guidelines comprise five guidelines as follows:

• Guideline 1: Performance fee calculation model;
• Guideline 2: Consistency between the performance fee model and the fund’s investment objectives, strategy and policy;
• Guideline 3: Frequency for the crystallisation of the performance fee;
• Guideline 4: Negative performance (loss) recovery; and
• Guideline 5: Disclosure of the performance fee model.

A Manager will be required to comply with the Guidelines from the Applicable Date if it manages:

• a new fund created after the Applicable Date that has a performance fee, or
• a fund existing before the Applicable Date that introduces a performance fee for the first time after the Applicable Date.

A Manager of a fund with a performance fee existing before the Applicable Date must comply with the Guidelines in respect of that fund by the beginning of the financial year following 6 months from the Applicable Date. This means that an existing fund with a performance fee which has a financial year end of 31 December 2020 is likely to be required to comply with the Guidelines from 1 January 2022.

Alignment of Central Bank Rules on Performance Fees with New Guidelines

As set out in our previous briefing (here), at the end of May 2019, the Central Bank of Ireland (“CBI”) published its Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1))(Undertakings for Collective Investment in Transferable Securities) Regulations 2019 (the “Regulations”), which among other things, codified the CBI’s Guidance on UCITS performance fees.

While the Guidelines generally reflect the CBI’s rules on performance fees, they are considerably more detailed and UCITS Managers may need to introduce additional measures to comply with them. For example:

• Guideline 1 contains a list of elements which must be included in the performance fee calculation method whereas there is no equivalent list in the Regulations;
• Guideline 2 requires a Manager to ensure that the performance fee model is consistent with the fund’s investment objectives, strategy and policy.  In contrast, Regulation 40 of the Regulations only requires consistency with the fund’s investment objectives where performance fees are payable on the basis of out-performance of an index;
• While Guideline 5 and Regulation 70 of the Regulations each prescribe certain disclosures of the performance fee model to be made in the prospectus, unlike Regulation 70, Guideline 5 specifically provides that “[t]he prospectus should include concrete examples of how the performance will be calculated to provide investors with a better understanding of the performance fee model.” Moreover, the Guidelines also address disclosures to be made in the Key Investor Information Document (KIID) and in annual and half-yearly returns.

As Retail Investor AIFs (“RIAIFs”) are not currently subject to rules similar to those set out in the Guidelines, a Manager of a RIAIF with a performance fee will need to review its performance fee model to ensure compliance with the Guidelines.

Given that the CBI’s policy is to comply in full with ESMA guidelines and opinions, it is expected that the Regulations will need to be amended or supplemented in order to comply with the Guidelines.