ESMA hedge fund remuneration proposals attacked
Plans by European regulators to extend proposed restrictions on remuneration at investment banks to hedge funds have been branded “ill thought out” and “impractical” by an industry expert.
The proposals, which are contained in AIFMD, intend to force hedge fund employees to defer between 40% and 60% of their bonuses over several years while a substantial portion of their pay packages must be paid in shares. According to Steven Maijoor, ESMA chair, these restrictions would protect investors and disincentivise short-termist behaviour.
The industry expert, who wanted to remain anonymous, said policymakers had “copied and pasted sections on remuneration contained in the Capital Requirements Directive, the rules designed for investment banks, into AIFMD. Regulators have failed to acknowledge hedge funds do not pay bonuses but performance fees. Unlike an investment bankers’ bonus, a performance fee is not arbitrary but dependent on performance, which is obviously aligned with investors’ interest.”
Hedge funds, for example, often apply high water marks to their performance fees, which means they will not get paid if their investments go awry – an undoubtedly alien concept to most investment banks. “Hedge funds’ remuneration policies are structured very differently to investment banks,” he said.
There are also practical concerns to ESMA’s proposal. “It is simple to pay employees of investment banks in shares but that cannot be applied to hedge funds where a lot of the businesses are partnerships. How can regulators apply the same measures to hedge funds? It is not the regulators who think it is straightforward. They are just trying to make sense of what has been handed to them by politicians. I suspect ESMA will keep the provisions curbing bonuses but might drop the requirements demanding a bulk of the remuneration package be paid in shares,” added the expert
These pay restrictions would also not just be limited to traders and senior management at hedge funds, but compliance professionals and risk management personnel.
The UK Financial Services Authority (FSA) updated its remuneration code in early 2011 although the majority of hedge funds, unlike investment banks, are exempted from deferring bonuses and paying employees in shares. However, ESMA’s proposals could frustrate that. “Hedge fund managers have seen this argument before. ESMA is usually incredibly technical but was dealt a bad hand as the initial proposals were drafted very badly by politicians,” said the expert.
ESMA’s consultation period is open until September 27, 2012 while the rules look likely to be implemented from July 2013.