ESMA Guidelines on performance fees for UCITS and AIF
On 5 November 2020, ESMA published on its website the “Guidelines on performance fees in UCITS and certain types of AIFs” (hereinafter “ESMA Guidelines”). The ESMA Guidelines include five guidelines regarding performance fees in UCITS and certain AIF.
To whom do the ESMA Guidelines apply?
The ESMA Guidelines are addressed to fund managers and the competent authorities of the relevant Member State. In addition, they shall be observed by AIFM which market shares or units of AIF to retail investors pursuant to Art 43 of the Alternative Investment Fund Manager Directive (“AIFMD”), provided that – as in Austria by transposition into Sec 48 and 49 of the Austrian Alternative Investment Fund Manager Act – the Member State has made use of the option under Art 43 AIFMD. However, closed-ended AIF as well as open-ended AIF that are EuVECA funds (or other types of venture capital AIF), EuSEF funds, private equity AIF or real estate AIF are excluded.
What do the ESMA Guidelines govern?
The ESMA Guidelines include a total of five guidelines to be applied to performance fees in UCITS and AIF falling within the scope. These guidelines concern
- the performance fee calculation method: In ESMA’s view, the performance fee calculation should be verifiable and not offer any possibility of manipulation. The calculation method should be designed in such a way that the performance fee is always in proportion to the actual investment performance of the fund and should include at least the following criteria:
a. the reference indicator to measure the relative performance of the fund;
b. the crystallisation frequency at which the accrued performance fee, if any, becomes payable to the manager and a crystallisation date at which the performance fee is credited to the manager;
c. the performance reference period;
d. the performance fee rate;
e. the performance fee methodology; and
f. the computation frequency which should coincide with the calculation frequency of the NAV.
- the consistency between the performance fee model and the fund’s investment objectives, strategy and policy: The fund manager must ensure that the chosen model of performance fees is compatible with the investment policy, investment strategy and investment objective of the fund. The manager must also ensure that for funds for which a performance fee is calculated by reference to a benchmark, the benchmark is appropriate in the context of the investment policy and strategy and adequately reflects the risk-reward profile of the fund. In general, the benchmark on the basis of which the fund is managed must be identical to the benchmark for the performance fee model. However, in case the fund is managed in reference to a benchmark but the fund’s portfolio holdings are not based upon the holdings of the benchmark, the benchmark used for the portfolio composition should be consistent with the benchmark used for the calculation of the performance fee. “Consistency indicators” specified by ESMA, which should be taken into account by the manager based on the type of investment of the fund (e.g. equities, bonds or derivatives), include without limitation the expected return, the investment universe, the geographical distribution and the credit rating class. All of this must be verifiable by the fund manager and reviewed regularly.
- the frequency for the crystallisation of the performance fee: The crystallisation frequency should not be more than once a year, with payments being made in general on 31 December or at the end of the fund’s financial year. However, this principle does not apply, for example, if the fund employs a high water-mark model or a high-on-high model where the performance reference period is equal to the whole life of the fund and cannot be reset, as in this model performance fees cannot be accrued or paid more than once for the same level of performance over the whole life of the fund.
- the negative performance (loss) recovery: A performance fee should only be payable in circumstances where positive performance has been accrued during the performance reference period. Any underperformance or loss previously incurred during the performance reference period should be recovered before a performance fee becomes payable. The performance fee model should, amongst others, be designed to ensure that the manager is not incentivised to take excessive risks and that cumulative gains are duly offset by cumulative losses. In case the fund employs a performance fee model based on a benchmark, the length of the performance reference period should be at least five years to this purpose. Also, where a fund utilises a High-Water-Mark model, the performance reference period should be set equal to at least five years on a rolling basis.
- the disclosure of the performance fee model: ESMA is of the opinion that investors should be adequately informed about the accrual of a performance fee and its potential impact on investment returns, including in the prospectus and information documents. If a performance fee is also provided for in the event of negative performance (for example, the fund has overperformed its reference benchmark index but, overall, has a negative performance), the KIID should contain a clear warning to investors. The KIID should also clearly set out all the information necessary to explain the accrual of the performance fee, the basis on which the fee is calculated and the cases in which the fee applies. Finally, ESMA is of the opinion that the annual and semi-annual reports and other ex-post information should indicate for each relevant share class the impact of the performance fee by disclosing the actual amount of performance fees charged and the percentage of the fees based on the share class NAV.
When do the ESMA guidelines apply?
The ESMA Guidelines shall apply two months from the date of their publication on the ESMA website. As the publication took place on 5 November 2020, they will be applicable as from 6 January 2021. However, a transitional period shall apply to UCITS and AIF established prior to the date of entry into force: Compliance with the ESMA Guidelines need only be achieved as from the financial year following six months after the date of entry into force. For UCITS and AIF which have the calendar year as their financial year, this means that the ESMA Guidelines will only apply from 1 January 2022.
Reporting requirements
As is always the case with Guidelines issued by European supervisory authorities (in this case ESMA), the competent national authorities (in Austria therefore the Financial Market Authority) have to inform the European supervisory authority within two months of the publication of the Guidelines whether they
- comply,
- do not comply, but intend to comply, or
- do not comply and do not intend to comply
with the Guidelines. In case of non-compliance, the competent authority must also notify the European supervisory authority of their reasons for not complying with the guidelines.
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Please note: This blog merely provides general information and does not constitute legal advice of any kind from Binder Grösswang Rechtsanwälte GmbH. The blog cannot replace individual legal consultation. Binder Grösswang Rechtsanwälte GmbH assumes no liability whatsoever for the content and correctness of the blog.