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Industry Response to the CEBS Consultation on Remuneration Policies and Practices

Core Content

The European private equity and venture capital industry has responded to the CEBS consultation on remuneration policies and practices, emphasizing the importance of proportionality and the unique nature of its business model. The industry supports the general goals of sound remuneration policies, such as aligning investor and manager interests, reducing systemic risk, and promoting long-term investment. However, it argues that these guidelines should not be applied uniformly across all financial sectors, as private equity and venture capital operate under different conditions and do not pose the same level of systemic risk as traditional banking institutions.

Main Points

• Support for Alignment of Interests: The industry agrees that aligning the interests of investors and managers is crucial. Private equity and venture capital remuneration structures inherently support this by requiring fund managers to invest their own money into the fund (co-investment), which creates a strong incentive for long-term success.

• Carried Interest and Co-Investment: Carried interest is a standard and integral part of private equity and venture capital compensation. It is not a means of evading responsibilities but rather a mechanism that aligns manager and investor interests. Fund managers only receive carried interest when the fund generates returns above a specified hurdle rate, and they share in the profits of successful investments.

• Liquidity and Risk Characteristics: Private equity investments are typically illiquid, with no redemption rights for investors during the fund's life. This structure is designed to ensure that fund managers are focused on long-term value creation rather than short-term gains. Additionally, the lack of leverage and the long-term nature of investments reduce the likelihood of systemic risk.

• Deferral and Retention Periods: The industry argues that the deferral period for variable remuneration should begin when the manager first receives a contingent right to receive such compensation, not when it is paid out. In the case of carried interest, which is inherently deferred, a retention period is unnecessary and could be counterproductive.

• Proportionality and Contextual Application: The guidelines should be applied proportionally, considering the specific characteristics of the private equity and venture capital industry. The 50% share-like variable remuneration requirement should not apply to carried interest, which is entirely deferred.

• Discretionary Risk Adjustments: The industry believes that carried interest, combined with clawback mechanisms, already reflects the risk and return profile of the investments. Therefore, a discretionary ex post risk adjustment is not required and could distort the intended alignment of interests.

Key Information

• Industry Structure: The European private equity and venture capital industry is represented by the Public Affairs Executive (PAE), which includes representatives from various segments of the industry and national associations.

• EVCA: The European Private Equity and Venture Capital Association (EVCA) is the main representative body of the industry, with over 1,300 members. It promotes the industry, develops standards, and organizes professional events.

• AIFM Directive: The AIFM Directive is expected to address the specificities of private equity and venture capital, including the alignment of investor and manager interests. However, it will not be directly applicable for about two years.

• Current Applicability of CEBS Guidelines: During the interim period before the AIFM Directive is implemented, some private equity firms may have to comply with parts of the CEBS guidelines. The industry has specific concerns about certain provisions, particularly those related to deferral and retention periods, and the application of the 50% share-like variable remuneration requirement to carried interest.

Conclusion

The European private equity and venture capital industry advocates for a tailored approach to remuneration policies that reflect its unique characteristics and risk management practices. It emphasizes that its compensation structures are aligned with long-term investor interests and are not inherently flawed or risky. The industry calls for the removal or clarification of certain references to carried interest in the CEBS guidelines, as they are not applicable in the same way as in traditional banking. It remains committed to engaging with policymakers to ensure that regulations are both effective and proportionate.