On 16 July 2019, ESMA launched a public consultation on draft guidelines for performance fees in undertakings for UCITS ("Guidelines"). ESMA also asks whether the Guidelines should also apply to alternative investment funds marketed to retail investors. ESMA invites feedback by 31 October 2019.

The Guidelines aim to harmonise across the EU the way in which performance fees can be charged to UCITS while ensuring common standards of disclosure by setting out five key elements to promote supervisory convergence in the following areas:

• General principles on performance fee calculation methods;

• Consistency between the performance model and the fund's investment objectives, strategy and policy;

• Performance fee crystallisation frequency;

• Circumstances where a performance fee should be payable; and

• Disclosure of performance fee model.

Background

One of the key priorities included in ESMA's 2019 Supervisory Convergence Work Programme was to enhance supervisory convergence on performance fee structures and the circumstances in which they are paid.

In developing the Guidelines, ESMA was guided by its 2018 mapping exercise with national competent authorities, which identified that current practices on performance fees vary among EU Member States creating regulatory arbitrage risks and inconsistent investor protection levels. Considering the importance of UCITS cross border distribution, supervisory convergence on this issue is essential to ensure a level playing field in the EU. ESMA also reviewed IOSCO's good practice for fees and expenses of collective investment schemes – FR09/16 August 2016 that are considered best practice.

The Guidelines are preceded by the Central Bank of Ireland 's ("CBI") thematic review of the application of performance fees in Irish Irish UCITS and subsequent letter to industry in September 2018, and the codification of performance fee guidance in the Central Bank UCITS Regulations 20191 ("Regulations") in May 2019 (which contain transitional provisions for existing UCITS to comply with the requirements by 27 November 2020 or such later date as the CBI may specify).

Scope

The Guidelines relate to provisions in the UCITS framework (a comprehensive list of which is set out at Annex II of the Guidelines). They apply to UCITS management companies as defined under Article 2(1)(b) of the UCITS Directive and national competent authorities. They also apply to self-managed investment companies (i.e. UCITS which have not designated a separate management company authorised under the UCITS Directive).

The Guidelines would be without prejudice to ESMA's Guidelines on sound remuneration policies under the UCITS Directive2.

Proposed Guidelines


Guideline 1

The performance fee calculation method should include, at least, the following:

• A reference indicator;

• A crystallisation period and crystallisation date;

• A performance reference period;

• A performance fee rate;

• A performance fee methodology; and

• A computation frequency.

The performance fee calculation method should ensure that performance fees are always proportionate to the actual investment performance of the fund.

Current CBI requirement
:
Guideline 1 is similar to current prospectus disclosure requirements in the Regulations. A gap analysis by in scope entities should be straightforward.

Guideline 2

There should be consistency between the performance fee model and the fund's investment objectives, strategy and policy.

For funds that calculate the performance fee with reference to a benchmark, the benchmark should be appropriate in the context of the fund's investment policy and strategy and adequately represents the fund's risk/reward profile.

Current CBI requirement:
This seems largely in line with the Regulations and a gap analysis with the Regulations should be straightforward.

Guideline 3

The minimum crystallisation period should be linked to the recommended holding period of the fund and the performance fee should ideally be charged to each investor when exiting the fund.

The frequency for the crystallisation of the performance fee should be defined to ensure alignment of interests between the portfolio manager and shareholders and fair treatment among investors.

Performance should be assessed and remunerated on a time horizon that is, as far as possible, consistent with the investor's holding period.

The crystallisation period should not be shorter than one year, and generally, it should end either on 31 December or at the end of the financial year of the fund.

Current CBI requirement:

The proposed one year crystallisation period aligns with the Regulations which require that the calculation of the performance fee does not crystallise more than once a year and performance is not paid more than once a year. Further consideration of the broader principles may be required to consider consistent application of the proposed rules.

Guideline 4

A performance fee should only be payable in circumstances where positive performance has been accrued during the performance reference period.

Any loss incurred must be recovered before a performance fee becomes payable.

Where a fund uses a high-water mark ("HWM") model, it should only be reset where during the performance reference period (i) the new HWM exceeds the last HWM; or (ii) the fund has undergone significant structural changes. On resetting the HWM, ESMA requests views on how the performance reference period should be defined (e.g. should it be based on the whole life of the fund, the recommended holding period of the investor or the investment horizon set out in the prospectus).

The performance reference period should not apply to the fulcrum fee model, as in this model the level of the performance fee increases and decreases proportionately with the investment performance of the fund.

Current CBI requirement:
This appears reasonable and aligns with the Regulations which mandate that performance fees are payable only on achieving a new high net asset value over the life of the UCITS and on the basis of out-performance of an index. A gap analysis against the Regulations should be straight forward.

Guideline 5

Investors should be adequately informed about the existence of performance fees and about their potential impact on the investment return.

The disclosure in the prospectus, KIID and marketing materials should include specific reference to parameters and the date when the performance fee is paid.

The KIID should set out all the information necessary to explain the existence of the performance fee, the basis on which it is charged and when it applies.

The annual and half yearly reports should clearly display (i) the actual amount of performance fees charged: and (ii) the percentage of the fees based on the share class net asset value.

Current CBI requirement:
This broadly aligns with the Regulations and the gap analysis with the current disclosure requirements in the Regulations should be straight forward.

Transitional Provisions


Any new UCITS created after the date of application of the Guidelines that includes a performance fee, or any existing UCITS at that date that introduces a performance fee for the first time after that date, should comply with the Guidelines immediately.

Existing UCITS operating a performance fee before the application date of the Guidelines should align their procedures with the Guidelines within 12 months of the application date of the Guidelines.

Next Steps

The deadline for responses to this consultation is 31 October 2019. ESMA will consider the feedback in Quarter 4 2019 with a view to publishing final guidelines, together with a report with a feedback summary, possibly in Quarter 1 2020. Next, the final guidelines have to be translated into all EU official languages and then most likely will enter into force within two months of the date of the publication of those translations on ESMA's website. From that date, existing UCITS would have one year to adapt their performance fee models to comply. Under this projected timeline, this should not be sooner than Quarter 1 2021.

While the Guidelines appear broadly consistent with the Central Bank's requirements, a detailed gap analysis between the final guidelines and the Central Bank's requirements would need to be carried out to ascertain if there are any updates required to the fund's documentation. Further, the Guidelines may require an update to the Regulations in due course.

Further Information

If you would like further information, please liaise with your usual Maples Group contact or any of the contacts listed below.

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[1] ESMA/2016/575

[2] S.I. No. 230 of 2019 Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1)) (Undertakings for Collective Investment in Transferable Securities) Regulations 2019


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