Guidelines on Charges for Fund Performance by ESMA in reference to UCITS and specific AIFs
ESMA Issues Guidelines on Performance Fees for Open-Ended AIFs
In a significant move, the European Securities and Markets Authority (ESMA) has released a Final Report and Guidelines on performance fees in certain types of Alternative Investment Funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS). The guidelines apply specifically to open-ended AIFs, including open-ended loan originating AIFs (LO AIFs) under the AIFMD framework.
The guidelines aim to ensure transparency, fairness, and alignment of interests in the performance fee models of these funds. Here's a breakdown of the key points:
- Performance Fee Calculation: Managers must ensure that any excess performance over a benchmark is calculated net of all costs and any changes in reference indicators should be reflected in performance calculations at the point at which those changes occur. The calculation of a performance fee should be verifiable and not open to manipulation, proportionate to the actual performance of the fund, and align the manager's interest with those of its investors.
- Performance Fee Models: Managers of funds in scope will need to carefully consider their performance fee models against the Guidelines and prepare to take any action necessary to address shortcomings in legacy approaches. Funds that operate a high watermark model should ensure that the mechanism allows for an upwards-only high watermark reset to be compliant with the guidelines.
- Disclosure Requirements: Annual and half-yearly reports should clearly show the actual amount of performance fees charged and the percentage of the fees based on the share class Net Asset Value (NAV). The prospectus and all pre-contractual information documents, as well as marketing material, should clearly set out all information necessary to enable investors to understand the performance fee model and the computation methodology. Examples of performance fee calculations should be included in the prospectus.
- Benchmark Selection: Managers are required to ensure that the benchmark used in the performance fee calculation is appropriate in the context of the fund's investment policy and strategy and adequately represents the fund's risk-reward profile.
- Reference Periods: The reference periods for assessing performance fees should be at least five years on a rolling basis, if shorter than the whole life of the fund.
- Investor Disclosure: Investors should be adequately informed about the existence of performance fees and their potential impact on the investment return. Where a performance fee uses a benchmark index and allows for a manager to receive a performance fee where there has been negative performance in absolute terms, there should be prominent warnings to investors in the Key Investor Information Document (KIID) and the prospectus.
- Crystallisation Frequency: The crystallisation frequency for the performance fee should not be more than annual, with exceptions, and the date should be 31 December of each year, or the fund's financial year-end.
- Performance Fee Model Consistency: Managers are required to implement and maintain a process to demonstrate and periodically review that the performance fee model is consistent with the fund's investment objectives, strategy, and policy.
- Timeline for Implementation: Existing funds will not be subject to the guidelines until the beginning of the financial year for those funds following six months from the application date of the guidelines. The guidelines apply to new funds or funds that introduce a performance fee for the first time two months after the date of publication on ESMA's website.
It's worth noting that the guidelines do not require an evergreen high watermark for all funds. Funds with a benchmark index may still allow for a performance fee to be paid where performance is negative if the fund has still outperformed its benchmark index.
Lastly, the guidelines do not apply to funds without a performance fee, but managers of such funds should be aware of them if they decide to adopt a performance fee model in the future.
[1] Source: ESMA's Final Report and Guidelines on Performance Fees in UCITS and AIFs, July 2021.
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