BaFin changes its administrative practice on performance fee structures for UCITS

The BaFin has recently confirmed to other EU regulators that it will require UCITS registered for distribution in Germany to be compliant with BaFin’s principles on performance fees. BaFin argues that its principles reflect those of IOSCO as set out in its Good Practice for Fees and Expenses of CIS - Final Report (the IOSCO Principles) of August 2016. The BaFin principles are, however, more detailed than those of IOSCO.

This development was communicated on a regulator-to-regulator basis only - BaFin has not yet published an official statement, but it came to our attention that the German Investment Funds Association (Deutscher Fondsverband - BVI) had been informed by some individual managers about this development. At our request, the BaFin has informally confirmed the change to its practice. In absence of an official statement, it is not wholly clear at the moment how the BaFin justifies its practice.

The BaFin has published sample clauses on performance fees specifying the IOSCO principles.

Essential content of the BaFin performance fee clauses

The BaFin requires UCITS distributed in Germany to comply with the following:

• Calculation period: The calculation period for determination of a performance fee must be at least 12 months.
• Calculation method: The performance fee calculation method must provide a loss carry forward / high water mark, which covers at least the five previous years.
• Quantification of the performance fee: A percentage of the maximum amount of the total performance fee must be indicated.
• Cap on the performance fee: The amount must be limited in relation to the total assets of the fund.

These principles result from the BaFin’s interpretation of the IOSCO Principles and serve as a specification of the IOSCO Principles. Even if the BaFin deems its principles to be a specification of the IOSCO Principles, the latter do not contain the requirement for a loss carry forward covering at least the five previous years, nor do they require the cap related to the net asset value of the fund.

The BaFin’s change in a wider context

Other funds jurisdictions are also taking steps in this area and the BaFin’s position should be seen in this context.

For example, the Central Bank of Ireland recently required the ManCos of all Irish UCITS which charge a performance fee to review their practices. Read more on this.

In the UK, too, the FCA (in its April 2018 CP18/9) proposed to prevent Authorised Fund Managers (AFM) from charging performance fees on a gross basis, (i.e. before other charges such as the AFM’s fee have been reduced). In the FCA’s view a ‘fee on a fee’ of this type is not in the best interests of, and is unlikely to be understood, by investors. The FCA’s proposal is consistent with Good Practice 4 of the IOSCO Report, which states that performance fees should be taken on performance that is net of other fees.

Conclusion

BaFin will review performance fee provisions in all new applications for the distribution of UCITS in Germany as well as in amendment applications, and check whether they comply with the above principles.

For UCITS which are already registered for distribution in Germany, BaFin has informed the German Investment Funds Association that these UCITS need to comply with the principles by 31 December 2019. If UCITS do not meet these criteria, it is likely that BaFin will restrict such UCITS from distribution in Germany.

We are currently advising several clients on their performance fee structures in order to make them BaFin compliant. Although the BaFin has published examples of its preferred clauses for performance fee provisions, it will accept alternative wording so long as this adequately covers the principles set out above. However, where the BaFin sample clauses are not used, it will scrutinise the language in greater detail.