ESMA updates UCITS & AIFMD Q&As in respect of performance fees

On 20 May 2022, ESMA published updated  

• Q&As on Application of the AIFMD and 

• Q&As on Application of the UCITS 

in light of the ESMA Guidelines on performance fees (the Guidelines).  

The issues (and responses) dealt with are the same in respect of both the AIFMD and UCITS but can be found in different sections of the relevant Q&A documents (Section XV in the AIFMD Q&As, Section XI for UCITS).

Performance reference period for the benchmark model

Based on the principles set out at paragraph 40 of its Guidelines, ESMA clarifies how the performance reference period for the benchmark model should be set. 

Paragraph 40 recommends that:  

• any underperformance of the fund compared to the benchmark index should be clawed back before any performance fee becomes payable; and  

• the length of the performance reference period, if shorter than the whole life of the fund, should be at least 5 years.  

To comply with the above, any underperformance must be brought forward at least 5 years before a performance fee becomes payable. This means that fund managers need to look back at the past 5 years when compensating underperformances. Where the fund has overperformed the benchmark index, the fund manager should be able to crystallise performance fees. 

The Q&As provide two examples to illustrate these principles, using the same information  - the first one sets this out illustrated as a graphical representation, the second one displays it in numerical terms. 

The Q&As also offer additional examples to further clarify how to compensate for underperformances:  

• where the fund's net performance of the fund in Y18 was 2% (instead of 0%), the underperformance carried forward to the Y19 would be -4%, since in Y18, the underperformance of -2% in Y14 should still be compensated and, in addition, the performance of -4% in Y17 should be brought forward to the following year  

• where the fund's net performance in Y18 was 5% (instead of 0%), the underperformance to be carried forward to Y19 would be -1%. The residual underperformance from Y17 that was not yet compensated (-1%)must be brought forward to Y19. 

• where the fund's net performance in Y18 was 7% (instead of 0%), this would compensate the underperformance of -6% in Y17 and the accrual of performance fees for the 1% difference would be crystallised in the payment of the performance fees to the management company. There would be no underperformance to be carried forward to Y19.  

This is in line with the principle in the guidelines that underperformance in a given year (e.g. Y14) should still be compensated during a period which includes the fifth year following that underperformance (Y18), while not be brought forward to the sixth year (Y19). 

Performance reference period for the hurdle rate model

ESMA clarifies that the requirement that the length of the performance reference period (if shorter than the whole life of the fund) should be at least 5 years applies to the hurdle rate model. Paragraph 42 of the Guidelines clarifies that the only exception is "the fulcrum fee model and other models which provide for a symmetrical fee structure".