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Adam Hewitson, legal counsel to Throgmorton

Opinion: The impact of the UK’s Remuneration Code on hedge fund managers


Adam Hewitson, legal counsel to outsourcing provider Throgmorton, argues that although hedge fund managers benefit from the principle of proportionality under the UK’s newly-revised Remuneration Code for the financial industry, they will still face pressure on management time and resources in ensuring compliance.

The revisions to the UK Remuneration Code that came into effect on January 1 have been well publicised and will not be new ground for most hedge fund managers. The consultation process, both at European and UK level, has offered plenty of scope for debate and conjecture about the impact of the revisions, including the impact on the hedge fund industry.

Whilst the full impact can only be assessed over time and the initial impact is less than first feared, the final form of the rules does require the immediate attention of hedge fund managers and will require that certain steps be taken. However, given the stated objectives of the code, the benefits of these actions remain to be seen.

The most immediate and obvious impact on hedge fund managers is that they need to invest some management time in reviewing and understanding the rules. While the principle of proportionality that pervades the code offers assistance to hedge fund managers trying to reduce its implications, any potential disapplication needs to be understood before it can be utilised.

Regardless of the application of proportionality, hedge fund managers or their compliance officers will find themselves burdened by reviewing current remuneration policies (or drafting one in the first place), setting criteria for the identification of ‘Code Staff’ – those covered by the code – and drawing up lists of these individuals, considering the requirement for a separate remuneration committee and understanding whether changes need to be made to existing employment contracts.

It is likely that any analysis of the last two points will conclude that no committee is needed and no changes to contracts are required, but consideration nevertheless has to be given to these matters.

Some leeway for compliance has been given to firms that fall within the provisions of the code for the first time as of January 1. These firms have until July 1 this year to implement the specific rules in principle 12 relating to remuneration structures, but the Financial Services Authority is still maintaining that all firms should have been substantially complaint with the rest of the code from the beginning of the year, with mitigation plans to deal with shortfalls.

Regardless of a firm’s approach to compliance, be it in-house review or with the assistance of external lawyers or compliance officers, the initial impact of the rules will inevitably put pressure on management time and resources.

In addition to the initial review of existing policies and procedures, hedge fund managers will need to prepare for the disclosure and reporting requirements that will be finalised over the next few months.

The FSA will be publishing guidance and templates for the provision of information to itself, although at its recent presentation on the code, the regulator would not be drawn on specific guidance in terms of the provision of information to the public.

The most likely outcome is that hedge fund managers should add the limited information that is required to their financial statements or include it as part of their existing pillar 3 disclosure processes. Either way, the information in respect of the 2010 financial year must be disclosed by December 31, 2011.

Ongoing requirements are not limited to the disclosure and reporting processes. Firms need to maintain an up-to-date list of Code Staff (which could be called for by the FSA at any time) and should review their remuneration policies annually.

As with all things, the devil is in the detail, and all financial sector participants covered by the code should pay attention to its potential impact in a number of areas of specific concern.

First, the code generally prohibits guaranteed bonuses, save for the initial year of employment. This has led to concern that the financial sector will turn into a poacher’s paradise as firms are restricted from matching bonus payments offered to their existing employees by competitors. It is worth noting that this provision applies to all staff, not just Code Staff.

Secondly, there is a grey area surrounding the application of the Code Staff definition to employees of an overseas parent that dedicate at least some of their time to an in-scope firm. It will be for individual firms to consider the influence that these individuals have on the in-scope firm and whether they should be considered Code Staff.

Thirdly, the disclosure requirements may lead to concern among smaller firms about breaches of the Data Protection Act if aggregate data can be easily linked to any individual. It will be for the individual firm to assess the likelihood of such a breach.

Finally, smaller firms may struggle to ensure that persons in control functions remain independent from the business units that they oversee.

The impact of these issues is yet to be seen and is likely to come out in the wash. This, of course, will be of little comfort to any firm subject to the code as it tries to establish the boundaries of what can and cannot be done.

The overall effect of the code on hedge fund managers is much less pervasive than was initialled feared. Through application of the principle of proportionality, the FSA has ensured that firms falling within the lowest of the four tiers are subject to materially reduced obligations, to the hedge fund industry’s benefit.

However, this begs the question of whether the hedge fund industry should have been caught up in this legislation in the first place. The answer to this almost certainly has to be no.

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