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The Financial Markets Authority (FMA) has issued draft
guidelines to give KiwiSaver managers and trustees a basis for
determining that performance fees meet the "not
unreasonable" requirement under the KiwiSaver Scheme
Rules.
The FMA is seeking comments before finalising and formally
publishing the
Guidance Note.
The consultation window is tight, with submissions due by
Friday 2 December 2011.
General principles
The Guidance Note (the Note) proposes two
principles:
that it is reasonable to offer fair reward for the application
of investment manager skill, and
that performance fees should adequately reflect the risks taken
by both the investment manager and the investor.
The FMA further elaborates on these general principles by noting
that:
performance fees should reward only truly exceptional skill and
performance in comparison to the "market" (which will be
given a case-by-case meaning depending on a fund's
characteristics)
investors should not pay twice for the same return
performance fees should ensure alignment of the
manager's interests with the investors' interests,
and
fee structures should share the downside (as well as the
upside) of performance between the manager and the investor, and
should not have the potential to encourage inappropriate or undue
risk taking by the manager.
Proposed specific requirements
In applying the principles, the FMA indicates it will expect
that performance fees will contain the following elements:
performance fees expressed as a percentage of assets under
management and based on returns (after deduction of all fixed base
investment management fees) in excess of a hurdle rate of
return
a hurdle rate of return reflecting the risk characteristics of
the fund and an appropriate return benchmark (based on a suitable
market-related index) with an allowance where there are active
management fees already implicit in any fixed base fee
a high water mark so that past under-performance is recovered
before any subsequent over-performance is rewarded
assessment periods extending beyond one year - the FMA
envisages that this would include deferred payment or claw-back
provisions (with corresponding adjustments to the high water mark)
to capture the unders and overs of an uneven performance within an
assessment period, and
the performance fee being subject to an annual cap.
These elements will have to be justified in the scheme's
offering documents and the documents will need to explain any
inconsistencies with the FMA's criteria. The FMA
expects that if any element is not present "this will be
reflected in other terms or in any fixed fee payable".
"Reset" provisions (which allow the manager to adjust
either the hurdle rate of return or the high water mark) will be
regarded with scepticism by the FMA, particularly where the
adjustments can be made without seeking the approval of either the
investors or the trustee. The FMA indicates that resets would
require its approval.
Our take on the proposals
We think, for the most part, the proposed framework is a helpful
guide and that, in principle, prescribing minimum standards for
performance fees will make it easier for potential investors to
make like-for-like comparisons between schemes.
The Note seems to us to set out an overall "counsel of
perfection" though, rather than just essential minimum
standards. We think the Note should clarify what the FMA will
consider to be unacceptable and then separately describe what are
desirable best practice standards.
In particular, we think that the FMA is seeking to prescribe
best practice standards when:
proposing to prescribe a multi-year assessment with deferred
payments and claw-backs and an annual cap as standard
resisting resets (which may be appropriate in some contexts) to
ensure the performance fee continues to motivate out-performance,
and
seeking to apply the guidelines as a disclosure benchmark for
fees paid on an arms-length basis to third party product
managers.
The "not unreasonable" test in the Act does not
expressly apply to the fees charged by the managers of underlying
products into which a scheme invests, so the FMA may be
over-reaching in requiring managers to disclose the key elements of
such performance fee structures. Despite this disclosure
requirement, it appears that the FMA does not intend requiring
third party sub-managers' performance fee structures to be
approved against the criteria in the guidelines. This point
needs to be clarified.
The information in this article is for informative purposes
only and should not be relied on as legal advice. Please contact
Chapman Tripp for advice tailored to your situation.
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