The Financial Conduct Authority has published a draft of the variation of permission form for depositaries of AIFs. This is to gather feedback on the form and the deadline for feedback is 28 June 2013. The FCA confirms firms that are not authorized persons and are interested in acting as the trustee or depositary of an AIF are not able to use the transitional arrangement. Such firms will need to apply to the FCA for authorization and receive the necessary Part 4A permission. The FCA expects to issue the forms to apply for authorization to act as trustee or depositary of an AIF by 22 July 2013. However, the FCA intends to accept draft applications from unauthorized firms prior to 22 July 2013 to ensure applications are processed as quickly as possible.
The full update can be found on the FCA website by clicking here.
The European Securities and Markets Authority (ESMA) has approved co-operation arrangements between EU securities regulators, with responsibility for the supervision of alternative investment funds, and 34 global jurisdictions. ESMA has negotiated the agreements on behalf of all EU Member State securities regulators. Switzerland, USA, Cayman Islands, Bermuda, British Virgin Islands, Guernsey, and Jersey are all included in the list.
These co-operation arrangements are a key element in allowing EU securities regulators to supervise efficiently the way non-EU alternative investment fund managers (AIFMs) comply with the rules of the Alternative Investment Fund Managers Directive (AIFMD), and are a pre-condition in allowing non-EU AIFMs access to EU markets or to perform fund management activities on behalf of EU managers. These arrangements will apply to non-EU fund managers that manage or market AIFs in the EU and to EU fund managers that manage or market AIFs in third countries. The arrangements also cover co-operation in the cross border supervision of depositaries and AIFMs’ delegates.
It is important to note that although ESMA has negotiated the co-operation agreements centrally, they are bilateral agreements that must be signed between each EU securities regulator and the non-EU authorities. The actual supervision of AIFMs lies with the national securities regulators, therefore each authority decides with which non-EU authorities it will sign an agreement.
To view the full ESMA press release click here.
ESMA has published the long awaited consultation on guidelines on reporting obligations required of AIFMs in respect of the portfolio of the AIFs they manage or market in the EU. A reporting template is set out in the AIFMD level 2 delegated regulation, but ESMA would like to standardise the format of information AIFMs send to their home state regulator. The proposed guidelines set out the information that AIFMs should report to home state regulators as well as the timing of making reports. ESMA recommends that reporting periods be aligned with the calendar year. The consultation is open until 1 July 2013.
The full consultation text can be found by clicking on this link.
On 23 February 2012, ESMA published a discussion paper on key concepts of the Alternative Investment Fund Managers Directive and types of AIFM, which was followed on 19 December 2012 by the publication of a consultation paper on guidelines on key concepts of the AIFMD. The consultation set out formal proposals for guidelines ensuring common, uniform and consistent application of the concepts in the definition of ‘AIF’ in Article 4(1)(a) of the AIFMD by providing clarification on each of these concepts. This final report contains an explanation of the concepts used in the definition of an AIF, including the meaning of collective investment undertaking, raising capital, and the number of necessary investors.
The full text can be read by clicking here.
Much has already been written about the potential impact the Alternative Investment Fund Managers Directive Remuneration Guidelines will have on UK hedge fund managers. To put it simply, UK hedge fund managers could be required to defer between 40%–60% of the variable remuneration of a potentially large proportion of staff. The remuneration would be deferred for a minimum of three years and be subject to vesting and forfeiture conditions.
In the UK, the Financial Conduct Authority (FCA) is now expected to consult with the industry on how it will apply the Remuneration Guidelines in July 2013 (at the earliest). Many think it is unlikely the FCA will be able to apply proportionality to the extent that managers are not subject to mandatory deferral.
The Guidelines state that distributions of business profit in the form of dividends or similar distributions from partnerships are not remuneration but there is an anti-avoidance provision to prevent circumvention of the rules. It is not clear yet how large numbers of hedge fund managers structured as Limited Liability Partnerships (LLPs) will determine what element of LLP profit will represent variable remuneration vs. profit and therefore be subject to deferral.
Deferral by a hedge fund manager organised as a LLP causes a significant tax challenge. Since LLPs are typically tax transparent all the profits of the business are taxable on the partners regardless of whether the profits are actually distributed to them. A mandatory requirement to defer up to 60% of profit can result in a partner being required to fund a cash tax payment to HMRC without receiving sufficient cash from the LLP. This is sometimes referred to as being a ‘dry tax charge’. If the deferred remuneration is clawed back or forfeited in future, the partner will have paid the tax on the amount and no credit will be received.
To date, the Financial Conduct Authority and HMRC have not addressed the fundamental question of how regulatory requirements can work sensibly alongside tax legislation.
Despite the tax challenges a significant number of, but by no means all, UK hedge fund managers already operate some form of deferred remuneration policy for strong commercial reasons, which include meeting regulatory expectations for sound and effective remuneration policies, investor pressure to ensure alignment of interests, and for staff retention purposes. In a practical attempt to address the tax issues, and despite incurring additional cost, complexity and tax risk for themselves and their businesses, many managers have had no option but to use some form of corporate member planning. This can result in a lower overall tax inflow for HMRC since LLP profits often end up being taxed at corporate tax or capital gains tax rates that are lower than the income tax rates which apply to allocation of profits to individual partners.
Despite the genuine commercial reasons for managers to use corporate member planning, HMRC has just published a widely anticipated consultation document which will review the use of corporate members by LLPs. Early reviews of the consultation suggest HMRC is not seeking to limit the scope to aggressive tax planning and that bona fide use of corporate members as a tax efficient means of retaining capital in the business or to enable the deferral of remuneration may also be caught.
Which brings us to the main purpose of this article. That is, how can HM Treasury, HMRC and the FCA, work in partnership and agree a pragmatic solution to this issue?
One solution might be to enable those LLPs that are authorised by the FCA as AIFMs, and therefore subject to deferral, to elect not to be transparent for tax purposes, such that the dry tax charge goes away. The taxation point for deferred remuneration would move to the point of receipt. Whilst this defers the tax paid to HMRC, it would remove the need for many managers to employ corporate member planning, and therefore the overall tax inflow to HMRC would ultimately increase. AIFMs could be required to report details of the profits deferred and the period and conditions of deferral to HMRC, thus enabling HMRC to forecast future tax revenues. HMRC have introduced a cash basis for small business and therefore they may be willing to consider this. It may also be a much simpler way for HMRC to address the issues it sees with certain corporate member planning techniques employed to date.
Alternatively, the FCA could agree that where AIFMs are structured as LLPs and subject to deferral, an adjustment is allowed to the amount subject to deferral reflecting the tax paid. Deferral would therefore be on a post-tax basis. Where amounts are forfeited or clawed back, HMRC would need to allow a tax credit.
These are just two suggestions. There are no doubt other ways to address the issue and, as always, the devil is in the detail. But what seems obvious to many hedge fund managers and their advisors is that there are pragmatic solutions to the problem which would be welcomed by the industry. There are solutions which could be a ‘win / win’ for all and, for many managers, help ease the pain and complexity of compliance with the AIFMD regulations. All that would be required is the collective will of the regulator, tax authority and government to make it happen.
This article was also published in HFM Week which can be accessed by clicking here.