Response to consultation Paper on Draft RTS on classes of instruments that adequately reflect the credit quality of the investment firm as a going concern and possible alternative arrangements that are appropriate to be used the purposes of variable remuneration
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We welcome the principles underlying the provisions in the draft Article 6, in particular that alternative arrangements should contribute to the alignment of variable remuneration with the risk profile of the firm and that they should allow the application of deferral and retention of the amounts of variable remuneration received. Our concern is that whilst carried interest arrangements in particular are invariably designed to, and do in practice, reflect those principles, the number and prescriptiveness of the provisions in the draft Article 6 could defeat their underlying object.
For this reason, we support a shorter, more principles-based, set of criteria. This is especially true as it is likely there will be a political willingness to align remuneration standards for investment firms and other types of financial entities, including asset managers, for which such arrangements are more common, putting them at risk and reducing their effectiveness in aligning long-term interest of the client and the firm.
As a reminder, carried interest arrangements exist in order to align variable remuneration of staff with the performance of the assets they manage or advise on. The intention is that if those assets perform poorly, and, broadly speaking, if the firm therefore performs poorly, variable remuneration should be reduced. They also have in-built deferral and retention mechanisms. While carried interest arrangements are agreed at the outset of the fund, cash is typically only paid by the fund to the carried interest participants once investors have had their drawn capital back plus an agreed preferred return. The period between the agreement of the carried interest arrangement and cash being paid out will typically materially exceed the minimum ‘deferral’ period of three years. There are however in that context mechanisms available (i.e. escrow and clawback) to ensure that if carried interest allocations are paid out early in the life of a fund (as might be the case if an early investment is realized for a very large return before all the capital has been drawn down from investors), then neither the manager nor its executives will have received any more than the agreed carried interest percentage on the profits of the fund by the end of the life of the fund.
We stand at the disposal of the EBA to give further information on the nature of the carried interest model and its specificities.
Question 3: Are the provisions in Article 6 appropriate and sufficiently clear? Where respondents are of the view that the draft RTS should define a set of specific arrangements rather than providing conditions that such arrangements should meet, comments are most helpful, when they clearly describe the alternative arrangements that investment firms desire to use to ensure that variable remuneration is aligned with the long-term interest of the investment firm and its risk profile.
Contrary to what the EBA has indicated in its slides, we are not convinced that the current conditions for alternative arrangements are sufficiently flexible, in particular for investment firms using specific remuneration arrangements fulfilling the same objectives as pay-out in shares or other prescribed instruments, such as carried interest.We welcome the principles underlying the provisions in the draft Article 6, in particular that alternative arrangements should contribute to the alignment of variable remuneration with the risk profile of the firm and that they should allow the application of deferral and retention of the amounts of variable remuneration received. Our concern is that whilst carried interest arrangements in particular are invariably designed to, and do in practice, reflect those principles, the number and prescriptiveness of the provisions in the draft Article 6 could defeat their underlying object.
For this reason, we support a shorter, more principles-based, set of criteria. This is especially true as it is likely there will be a political willingness to align remuneration standards for investment firms and other types of financial entities, including asset managers, for which such arrangements are more common, putting them at risk and reducing their effectiveness in aligning long-term interest of the client and the firm.
As a reminder, carried interest arrangements exist in order to align variable remuneration of staff with the performance of the assets they manage or advise on. The intention is that if those assets perform poorly, and, broadly speaking, if the firm therefore performs poorly, variable remuneration should be reduced. They also have in-built deferral and retention mechanisms. While carried interest arrangements are agreed at the outset of the fund, cash is typically only paid by the fund to the carried interest participants once investors have had their drawn capital back plus an agreed preferred return. The period between the agreement of the carried interest arrangement and cash being paid out will typically materially exceed the minimum ‘deferral’ period of three years. There are however in that context mechanisms available (i.e. escrow and clawback) to ensure that if carried interest allocations are paid out early in the life of a fund (as might be the case if an early investment is realized for a very large return before all the capital has been drawn down from investors), then neither the manager nor its executives will have received any more than the agreed carried interest percentage on the profits of the fund by the end of the life of the fund.
We stand at the disposal of the EBA to give further information on the nature of the carried interest model and its specificities.