Hedge Fund Vista Webinar - 27 May 2020

Return to workplace planning and how to optimise working in the new landscape

This is a very topical issue at the moment and clearly encompasses a broad range of challenges for employers in the UK and other jurisdictions.

As it stood at the date of the vista, the UK government guidance was that individuals should continue to work from home wherever possible. 

Firms are however planning for larger scale return in due course -- this requires companies to focus on  the necessary planning including ensuring they have undertaken compliant risk assessments and consulted with staff. This requires a focus on  the broader logistical challenges involved in getting the workforce back into the office under very different circumstances, and with very different risks and requirements, to the start of this year.

There is also a focus on the personal and emotional adjustments that will be needed across employee groups.

In the longer term, many companies may find themselves assessing whether a return to the old normal is, in fact, an optimal model for them, going forwards, as we emerge from lockdown.

Key UK legal considerations

UK employers need to consider a range of issues in return to office planning.

Some of these carry significant legal, operational, regulatory and reputational risk for firms and directors -- including potential uncapped claims, criminal liability and individual liability in some cases.

These risks include potential claims / enforcement action: 

• under health and safety legislation (and related claims in contract and tort);

• under discrimination legislation;

• for unfair dismissal;

• under whistleblowing legislation; and

• for data privacy breaches.

UK regulated firms also face regulatory scrutiny, with FCA expectations of senior managers in connection with aspects of return to office planning.

For a fuller account of some of the legal risks for UK employers, see our insight here.

For details of wider practical and planning points in connection with return to office planning -- including an international perspective -  see our insight here.

You can also read our Insight on the latest ICO guidance and data privacy considerations here.

Funds round up

COVID-19

Some key themes for funds at the moment include:

1. Virtual due diligence

Lots of clients are obviously working remotely and looking to continue to do this to some degree going forward. Allocaters and investors still want to invest money into hedge funds but there are still social distancing measures and travel restrictions in place that are likely to continue. In light of this, much more virtual due diligence is being undertaken, as operational due diligence teams aren't able to carry out on-site inspections. We have noticed that more established managers, with more of a brand and track record, tend to find this process easier, whereas it is proving harder for emerging and start up managers.

2. Updates to risk factors

We have received many queries regarding possible updates to risk factors within offering documents. At present, we are recommending the inclusion of a reference to pandemics within the market disruptions risk factor (which will be within the market disruptions risk factor if you are using the Simmons & Simmons standard set of risk factors) but we are not currently including a more bespoke COVID-19 related risk factor.

3. Use of electronic signatures on dealing documents

We have had a lot of enquiries regarding whether funds can accept the use of electronic signatures on their dealing documents. This is usually fine, as long as there are correct provisions within the document to protect the fund and manager, and also to ensure that the signature is legally effective from a Cayman perspective for Cayman funds.

There is a clear balance to be struck here between additional risks relating to electronic signatures and facilitating share dealing. The liability provisions within dealing documents should be checked, in order to ensure the fund and manager are protected and it should be ensured that the directors of the fund are comfortable in receiving electronic signatures. If the administrator is content with receiving electronic signatures, there is usually the requirement that the investor signs a written waiver so that they can accept electronic signatures from the client.

Electronic signatures are accepted from a Cayman law perspective, but Sections 8 and 19(3) of the Electronic Transactions Law (2203 Revision) of the Cayman Islands should be considered. These provide certain requirements for the delivery of documents in the form of an electronic record and certain requirements needed in order to rely on an electronic signature. These provisions can be expressly contracted out of and so we would suggest including a provision in the relevant dealing document stating that the relevant provisions of the Electronic Transactions Law shall not apply. These sections may already be disapplied in the articles of association of the fund, so technically the additional language within the share dealing document may not be strictly necessary but we would suggest that, at the next update of the share dealing documents, these documents are checked to ensure the provisions have been disapplied and also that the fund is willing to accept electronic signatures if that is the aim going forwards.

ESG

The EU Regulation on sustainability-related disclosures is coming into force on 10 March 2021. There was a joint consultation paper published by the European Supervisory Authorities on 23 April 2020, setting out the proposed Level 2 measures in connection with this regulation. These measures are quite detailed, so we have put together a top 10 note for things that asset managers need to know in light of this which can be accessed here.

US market discount bond rules

These rules are very relevant given the current situation, there is a lot of debt trading at a discount and these rules are often forgotten as they are somewhat counter-intuitive and are different from the normal US tax rule. The usual US tax rule is that you buy a security at cost, you sell it later for a gain and the difference between the two is capital gain which, if held for more than a year is long term capital gain to your investors (if they are US taxable investors), and if held for a year or less, is short term capital gain. The distinction here is important because long term capital gains are taxed at a 20% tax rate, whereas short term capital gains in ordinary income are taxed at a 35% maximum tax rate.

The market discount bond rules modify those normal US tax rules and apply to debt purchased in the secondary market at a discount. Under these rules, a portion of the gain on the sale or redemption of a market discount bond is treated as ordinary income (as opposed to capital gain) to the extent of the accrued market discount.

Accrued market discount

Accrued market discount is calculated by first taking the total market discount on a bond (this is the excess of face value over the purchase price). Market discount on the portion that is taxable as ordinary income then accrues on a rateable daily basis to maturity. Therefore when you sell the bond, the gain up to the accrued market discount is classed as ordinary income and any gain in excess of accrued market discount is capital gain.

An example of this is as follows: if you bought a bond at a discount in the market and you held it to maturity, then the difference between what you bought it for and what you redeemed it for would be ordinary income. However, if you sold it before maturity then the situation will be different. This is best illustrated by the following example:

• corporation X issues debt at par ($100) on 1/1/20 which matures on 31/12/24;

• due to the impact of COVID-19, the debt is trading at $80 on 31/5/20 when it is acquired by the Fund;

• on 31/12/21, the Fund sells the debt for $99;

• the debt, when acquired, had a total market discount of $20 (the difference between the $100 issue price, and the $80 paid for it). The market discount of $20 accrues rateably, on a daily basis. When it is sold, it has only been held for a portion of the period towards maturity with approximately $6.91 of accrued market interest; and

• on the sale of the bond for $99, $6.91 of the gain is ordinary income and the remaining $12.09 is long term capital gain (it is long term because the bond has been held for more than a year when it's been sold).

Exception for deeply distressed debt?

There is no statutory or regulatory exception for deeply distressed debt. Generally, some commentators and practitioners take the view that debt acquired at less than 40% of issue price is not subject to these rules. The theory behind that is that because it is so deeply distressed, it is no longer debt and there will be other factors to consider.

Bonus adjustments

As the financial markets slump, firms with annual bonus arrangements should be considering what bonus adjustments they should be making to mitigate against the economic downturn caused by COVID-19.

In addition to the commercial considerations, there are regulatory requirements and expectations that apply, such as all firms should be demonstrating how they are assessing risks and uncertainties on bonuses. The economic impact of COVID-19 has placed a fresh emphasis on this. The UK regulator has made a statement that it expects banks not to pay bonuses to senior staff and that it expects appropriate action is taken with respect to the accrual, paying and vesting of various forms of compensation over the coming months. Whilst these statements do not strictly apply to firms in the funds space and are certainly not mandatory requirements, they do give an indication of regulator expectations. On that basis all firms, including smaller firms and those who have traditionally applied proportionality to disapply the restrictive remuneration requirements such as deferral payments, should be reviewing their bonus arrangements to ensure they are sufficiently robust to meet the regulatory risk adjustments going forward.

Types of bonus adjustments

There are three particular types of bonus awards that are relevant, which firms need to be reviewing in terms of thinking about which adjustments may be required:

1. Pre-existing bonus awards which are already subject to deferral;

• The determination of which payments can be made under this will essentially depend on the contractual terms (ie the bonus letter, or bonus rules under which those were made).

2. Recent bonus awards granted but not yet paid;

• Most firms will have gone past year end and made bonus awards already, but any firm that is in the situation where bonuses are still due to be paid, will be slightly restricted in that if they have already granted this bonus and therefore payment of that bonus is outstanding, most firms will be obliged to pay out on those bonus awards.

3. Bonus awards in respect of the last performance year which have not yet been made (the most relevant)

• This will apply if, for example, a firm is coming to its year end towards the end of this calendar year. They will need to consider whether payment is justified in relation to that bonus. Whether or not payment is justified will depend on the regulatory requirements. There is a regulatory obligation to adjust bonus pools for all types of current and future risks, which would include the economic risks posed by COVID-19. The adjustments that are then applied, should be applied in a clear and transparent manner.

Risk adjustment housekeeping

Aside from this, there are key points for firms to consider in relation to remuneration policies, even before they come to year end, which include:

1. Methodology

• Are the risk adjustment criteria that have been used to set bonus pools for each firm relevant and weighted appropriately? Is the process clear, transparent and recorded so that even if no adjustments are deemed necessary (which may be the case depending on the firm's financial position), the process is clear enough so that if the regulator asks any questions about the process, the firm has a clear and justifiable position.

2. Governance

• What input and oversight does the firm's risk management head have and is this documented adequately? Are the remuneration committee chairs, to the extent that there is a remuneration committee, satisfied and able to confirm that adjustment levels are appropriate and justified in the circumstances?

3. Documentation

• Is the firm's remuneration policy accurate and compliant with the remuneration requirements? For example, does it have the adjustment metrics recorded in the policy which enable a firm to document and then make those adjustments to bonus pools? If there are any bonus plan rules and award documents, are those consistent with the firm's approach and policy? Do they contain the relevant provisions that allow adjustments to be made?

4. Discretion

• A lot of bonuses are discretionary arrangements. In those situations, firms should ensure that the discretion is appropriately exercised. Where awards are made, a check must be undertaken to ensure that the award documents contain the relevant provisions and sufficient flexibility which enables the firm to adjust variable remuneration outcomes where appropriate.