Decomposing FoHF returns
Where and when funds of hedge funds add and lose value
Read More
11/08/2010
Comment: Christopher Miller
Our friends in Brussels have a new way of torturing hedge funds, hot on the heels of the AIFM Directive. The EU Capital Requirements Directive 3 comes into force in January, and the UK Financial Services Authority (FSA) will revise its Remuneration Code by then, subject to a consultation that is currently underway.
Most of the rules are not really new, but the changes will broaden the scope of coverage to probably over 2,500 firms, including hedge fund and Ucits managers.
One reason why Directive 3 is being applied not just to large systemic organisations, but also to smaller firms that arguably pose no systemic risk, is that otherwise large firms would be at considerable competitive disadvantage versus hedge funds.
The good news is something called the ‘proportionality’ rule, which means that national regulators have some discretion to apply the rules differently to different participants if the measures would not be proportionate. And the Committee of European Banking Supervisors will shortly publish guidelines for consultation on interpretation of the ‘proportionality’ rule. So this could mean that the FSA’s hands are partly tied when exercising discretion. No one knows yet, even though the rules come into force as soon as January.
Most people will be aware that the contentious parts of the Directive require remuneration above a certain level for certain types of employee to be deferred and partly paid in company shares.
In practical terms, what does it mean for remuneration and bonuses? Well, for a start, you can consider your contract to be voidable if it conflicts with the Code.
The Code stipulates that the most productive people, those earning a total of over £500,000 ($791,900), will have 60% of their bonuses deferred over three years, and that 50% of bonuses should be paid in the form of shares in the firm. There must also be the ability to claw back bonuses in the event of subsequent losses.
I simply fail to see how some of these measures, when related to most asset managers, contribute to financial stability and prudential soundness. Deferral and relating remuneration to longer periods is sensible, but the rules forcing firms to pay employees with shares in the management company are very questionable.
When applied to hedge fund managers, this is not just disproportionate, it is completely ridiculous, because it wouldn’t work, and even if it did it would not have any benefit.
To start with, many hedge fund profits are paid out as dividends or partnership profits anyway, and this potentially forces the owner to dilute shareholding.
The lack of benefit stems from the fact that traders’ interests are always aligned with shareholders interests anyway through sharing the performance fee, which is itself quite short-term; and of course, this has no effect on systemic risks.
If, because of the competition issues, the FSA is forced to put pressure on smaller firms, my view is that the remuneration should take dividend entitlement into account, but instead of forced deferral by investment in management company shares, the investment should be in client vehicles. This is not an unusual thing, and aligns managers well with both clients and the management company.
The big message is that to avoid excessive risk taking in hedge funds, investors have long since preferred manager co-investment, and this would formalise something which is quite common anyway in
the more reputable houses.
Interestingly, when the FSA applied its previous Remuneration Code to larger firms, it found that all of them already had similar deferral and shareholding rules in place, and some of them were
even stricter. Ironically, some firms actually relaxed their rules in response to the Code.
EU governments are not doing this exercise for their own benefit. In addition to deferral of fiscal revenues, the deferral of receipt of the bonus delays when it can be spent, which slows down the velocity of money in the system, impacting GDP and multiplier fiscal revenues. So this hurts pretty much everyone, except the inevitable cohorts of people employed to implement it. Let us trust that the FSA finds some other benefits in its cost/benefit analysis.
Christopher Miller is CEO of Investment Quotient, a financial research consultancy
- Share
-
Text Size
Decrease text size
Increase text size
What's in a name? Petra Capital Management
Formed in 2005, New York-based Petra Capital Management soon forged itself a reputation as one of the hedge fund industry’s best-known investors in the commercial mortgage-backed securities (CMBS) market.
Founder Andy Stone, an expert in real-estate debt from his time at Solomon Brothers and Credit Suisse First Boston, would even go on to be described as a ‘rock star’ in the field. His choice of moniker for his hedge fund project certainly lends itself to Stone’s background – and more than just in name and reputation.
Petra is, of course, a historically and archaeologically significant city in Jordan, renowned for its architecture cut into the rock face of its central valley. The rock-carved collection of tombs, temples and waterways is one of Jordan’s most famous symbols and tourist attractions, not to mention a regular in popular culture – featuring in films such as Indiana Jones and the Last Crusade. Unesco, which made the city a World Heritage Site in 1985, described it as “one of the most precious cultural properties of man’s cultural heritage”. Most pertinently though, Petra actually means ‘stone’ in Arabic.
Not quite the force he once was, Stone suffered a…
Former Harvard Management Company duo set up maiden hedge fund manager
Steve Alperin and Sara Fleiss, previously of Harvard Management Company, have set up their maiden hedge fund manager, HFMWeek has learned.
HFMWeek Daily Snapshot - 10 February
Today: Hedge fund outflows hit record low; Trafigura hedge fund targets $3bn by year-end; SEC to Consider Settlement With Ex-Bear Stearns’ Managers; Och-Ziff Net Income Drops 94% as Performance Fees Decline; and more...
EXCLUSIVE: Texas County commits $305m to fresh hedge fund hires
The Texas County & District Retirement System (TCDRS), which has $17.7bn in assets, has allocated $305m between two hedge funds, two months after making an extra $885m available to the space, HFMWeek can exclusively reveal.
Investor demand for CTAs is on the rise, says Agecroft Partners
Agecroft Partners is seeing widespread demand from institutional investors for Commodity Trading Advisors (CTAs), which is a dramatic change from the historical reluctance of many institutional investors and their consultants to allocate to this strategy.
Read More29/02/2012
UK: Open Protocol: The Challenge and Opportunities of Standardising Hedge Fund Risk Reporting
Join us and our panel of experts for HFMWeek's Subscribers' Club February's UK breakfast briefing…
29/02/2012
US: Endowments and Foundations in Hedge Funds
The next US HFMWeek Subscribers' Club breakfast, will take place on Wednesday February 29. Join…
02/02/2011
European Hedge Fund Services Awards 2012
HFMWeek's European Hedge Fund Services Awards are designed to recognise companies that have outperformed...
Be the first to comment on this article!