The impact of BaFin’s new performance fee clauses for German domestic UCITS

• Global

• Financial services and markets regulation
• Financial services

27-06-2019

Introduction

The German regulator BaFin updated the requirements for cost clauses of domestic UCITS funds in June 2018, including the requirements for performance fees. Since then, it has been reported in Luxembourg, UK and Ireland (most recently by Fitz Partners), that BaFin is going to introduce new performance fee requirements and will apply these requirements to non-domestic UCITS seeking to being marketed in Germany.

There has been no official statement by BaFin confirming the introduction of new rules and we believe it is very unlikely that BaFin will further update the current requirements from June 2018 that are already in place. However, given the EU-wide aspirations to agree on a common standard for performance fees in the retail fund sector – an ESMA consultation paper on this topic is due to be published this year - it is in our view advisable for UCITS seeking marketing approval in Germany to comply with the German requirements in order to ensure a smooth marketing registration process.

BaFin has published sample cost clauses for open-ended retail funds which include requirements for the calculation and presentation of performance fees (the “Sample Clauses”).

To read the Sample Clauses on the BaFin website (German language only), click here.

To read an English translation of the key clauses, click here.

Sample Clauses for performance fees of German UCITS

With regard to performance fees, the most important requirements for German UCITS according to the Sample Clauses are:

Bench Mark or High Water Mark

Performance fees to be calculated by comparing the performance of the UCITS to either an appropriate bench mark or a high water mark for each financial year accounting period. The high water mark is defined as highest share value during the five previous financial years.

Negative Amount Carried Forward

In case of an underperformance in relation to the benchmark, the negative benchmark difference must be carried forward. The UCITS Management Company will only receive a performance fee in the subsequent year if the outperformance exceeds the negative amount carried forward. For the annual calculation of the performance fee, any underperformance amounts during the previous five financial years must be taken into account. The negative amount carried forward may not be limited by a cap.

Fee Cap

Performance fees must be capped at a certain percentage of the average NAV of the UCITS during the financial year.

Impact on Ireland

The Irish supervisory authority, the Central Bank of Ireland (the “CBI”), has not issued a formal statement on this matter. However, on the 31st May 2019 the CBI published revised regulations applicable to UCITS, the Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1))(Undertakings for Collective Investment in Transferable Securities) Regulations 2019 (the “2019 Regulations”), which follow on from an earlier CBI consultation and replace the Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1))(Undertakings for Collective Investment in Transferable Securities) Regulations 2015, as amended (the “2015 Regulations”). For the most part, as the 2019 Regulations, codify existing requirements they are effective from May 2019, subject to certain exemptions and grandfathering provisions.

The 2019 Regulations introduce a number of new requirements that apply to UCITS, such as: in relation to share class provisions, codify the existing CBI guidance on performance fees and make a number of other changes to the 2015 Regulations. The changes in the 2019 Regulations follow on from a consultation in April 2018 and a thematic review of performance fees in the same year by the CBI to examine methodologies used to calculate performance fees to ascertain if they were in line with the CBI’s UCITS performance fee guidance. The CBI’s approach to performance fees was previously set out on its website and its fund application forms and is now detailed in the 2019 Regulations.

At present, it is estimated that 98% of Irish-domiciled UCITS meet the current CBI guidance.

The 2019 Regulations provide for the following (which codify the current performance fee guidance in place by the CBI in its funds application forms):

• performance fees must only be payable (or accrued) by the UCITS on achieving:

o a new high net asset value over the life of the UCITS; or

o the out-performance of an index (“Benchmark”)

It is anticipated that the CBI will clarify by way of guidance that this may be on either achieving:

• a new high NAV per share; or

• a new high NAV as adjusted for subscriptions and redemptions (“High Water Mark”)

Further

• the calculation of the performance fee must not crystallise more than once per year (in line with the IOSCO Good Practices)

o Similarly, it is anticipated that the CBI will clarify by way of guidance that performance fees may crystallise upon an investor redemption

• the performance fee must not be paid more than once per year

• the responsible person must ensure that the calculation of the performance fee is verified by the depositary

• where a UCITS has multiple managers or advisers, the responsible person must ensure that the performance fee is only payable on the performance of that part of the portfolio for which the investment manager or adviser is responsible

As the CBI mandates either the outperformance of a High Water Mark or Benchmark, the clawback mechanism is not used.

The CBI’s current guidance on performance fees also puts in place a cap and explicitly provides, “it is not the [CBI’s] practice to approve performance fees above 20% of the increase over the highest previous NAV or 20% of the amount the amount by which the UCITS outperforms the Index.”

In addition, the CBI guidance also currently provides that “any underperformance of an index in preceding periods is cleared before a performance fee becomes due in subsequent periods.” Which arguably addresses the issue of negative amounts being carried forward.

The CBI Regulations illustrate that the CBI’S thinking has independently been in line with BaFin’s requirements (and largely achieves the same effect as the BaFin requirements) and IOSCO Good Practices. However, it may be the case that terminology and how compliance is achieved will require further clarification to demonstrate that Irish UCITS Funds are in compliance with the BaFin Requirements to ensure Irish-domiciled funds are eligible for marketing within Germany from January 2020, and that the marketing registration process is as efficient as possible.

Impact on Luxembourg

The Luxembourg supervisory authority, the Commission de Surveillance du Secteur Financier (the “CSSF”), has not taken a formal written position on this matter. However, the CSSF has adopted a new market practice regarding the performance fee calculation in order to be aligned with the IOSCO guidelines on fees and expenses of collective investment schemes dated August 2016 (the “IOSCO Guidelines”).

In this context, the CSSF is requesting Luxembourg UCITS to have (i) a performance fee paid on an annual basis (ie a bi-annual performance fee calculation is no longer acceptable), and (ii) a five-year period in relation to the reset of such performance fee.

That being said, it would be prudent for a Luxembourg UCITS which intends to distribute in Germany to ensure their fund complies with the BAFIN requirements. We believe that the CSSF will welcome such steps given its willingness to fully comply with IOSCO Guidelines.

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