Episode 8: Your questions answered – management costs and fees under the new CPR
A discussion with Sara Dagostini, Policy officer, DG REGIO, European Commission and Oana Dordain, Deputy Head of Unit, hosted by Desmond Gardner from the fi-compass team at EIB.
Hello and welcome to a new episode of our popular ‘Calling the Tune Podcast’, which features content on the new Common Provisions Regulation 2021.
I am Desmond Gardner from the fi-compass team and I'm pleased to welcome Sara Dagostini and Oana Dordain , who are joining us today to discuss the hot topic of management costs and fees.
This topic was presented at our recent ERDF conference in Brussels, and we had a number of questions, which we didn't have time to cover. We will therefore discuss them today, and if any listeners have any further questions, please get in touch and we'll try and answer them in a future episode of this podcast.
Sara, Oana, welcome. Perhaps we should start today's discussion by explaining why we are recording this podcast, following the presentation you did on the topic at the recent ERDF conference in Brussels.
Sara: During the recent ERDF conferences, I have presented the novelties of the CPR with reference to the management costs and fees, highlighting especially this period of the CPR as flexibility and simplification. In this programming period, the management cost and fee rules and calculations have been simplified. One article, no methodology imposed, flexibility on criteria for managing authorities and bodies implementing, and the simple principle for the commission of the funds to be paid to the final recipient. However, despite all of these simplification exercises, at the end of the presentation, we still had several questions, and during the afternoon session, even more questions on this topic. That is why we thought that there was a need for this podcast.
Indeed, we had a large number of questions, which just shows the level of interest in this subject. So, let's try and cover them all today. I will use the wording of the questions that people asked, as far as I can. Let's start with some of the higher level questions that we were asked.
Somebody asked, “the programme contribution is defined by the CPR as the funds and private or public co-financing. Does it mean that both sources should be taken into account for the management fees calculation at holding fund and specific fund levels, and not only the ERDF component received from the managing authority?”
Oana: Yes, you are completely right. In the case of direct award, management costs and fees are calculated on the total amount of programme contribution paid to, or in the case of guarantees, set aside for guarantee contracts by the financial instrument within the eligibility period. As you rightly said, the programme contribution as per Article 2(19) of the CPR corresponds to ERDF funds and national co-financing. These two basis should be taken into account for the calculation of the management costs and fees. The national co-financing can be contributed at the level of the holding fund or at the level of the specific fund or at the level of final recipients. So, the national co-financing is used for the calculation of the management costs and fees, regardless of the level at which it is contributed. We also have the case of competitive tender, where the managing authorities and the bodies implementing the financial instruments may also agree to use the total amount of programme contributions as explained before.
Okay, so that's very clear. It's the ERDF programme contribution, that's the ERDF and national co-financing, that's used for calculating management costs and fees when it's a direct award. It is also interesting to hear you say that there's a lot more freedom when the funding agreement is arrived through a competitive selection process. There I guess the parties can set the parameters as they wish.
The meaning of performance based seems to be a key issue and we had a lot of questions on this. Let me put two of the questions to you now.
Somebody asked, “how do you interpret performance based? Can a structure with a base fee, which is market practice in private equity fund management, be considered performance based?”
A related question somebody else asked, “isn't the performance based only approach killing financial instruments in areas where few financial instruments have been used so far?”
Sara: To reply to this question, first of all, we would like to introduce a new idea. When speaking about management costs and fees, we refer to two different dimensions. The first one, is what is effectively paid based on the criteria agreed in the funding agreement. The second one, is what the Commission is reimbursing.
In the case of the first dimension, the managing authority has to agree with the bodies implementing the financial instrument, what are the performance criteria to be taken into account for the remuneration of the fund manager, depending, of course, on the scope of the financial instrument. For example, for some managing authorities, it may be relevant to have an important part of the funds returned, while for others it might be important to have supported SMEs more in certain sectors than in other sectors and so on. The managing authorities decide the performance based criteria depending on its objective. The performance of a bad implementing financial instrument should, however, always be tracked in relation to the target values agreed normally in the respective funding agreements. As an outcome of the negotiation, some indicators might be helpful, such as a number of eligible SMEs that receive the financing or geographical or sectoral coverage, jobs created, and so on. In the previous programming period, the fees were differentiated in base fee and performance fee, but this is not the case anymore for the 2021-2027 programming period, as we really wanted to leave flexibility for the managing authorities to decide. If needed, however, the performance criteria defined in the previous programming period can still be used.
Now, going back to the dimensions, when we talk about the second dimension, the CPR put in place a simple rule for the reimbursement of the management costs and fees by the Commission in case of direct award. This rule refers to one of the possible performance criteria, which is the level of the funds disbursed or set aside for guarantee contract. In case of competitive tender, the Commission is actually reimbursing the level of managing costs and fees agreed in the funding agreement, which is actually the result of the tender.
As you say, although the CPR does not refer to the base fee in the way it used to, it's not ruled out as a mechanism, if it is appropriate. I'm also interested in the second scenario where there's been this competitive selection. I wonder, Oana, do you want to comment about this as well, because this goes back to your previous answer. There's a lot more freedom in terms of structuring the management costs and fees when there has been a competitive selection process. Is that right?
Oana: This is correct. In case of a competitive process, the parties agree on what they will be remunerated, what the fund manager will be remunerated. This is the basis for the payment by the Commission of the management costs and fees, and this has to be translated in the respective funding agreement.
The next questions, I think we're starting to answer them already, but let's ask them because participants raised them at the time.
Somebody asked, “must management fees depend and be linked exclusively to the funds disbursed to final recipients? Is it also acceptable if management fees are charged upon certain non-disbursement milestones being fulfilled?”
We had a very similar question, “can you provide examples of performance milestones that trigger the payment of the management fee, considering that the set-up of financial instruments is particularly resource intensive at the early stage?”
Oana: As Sara explained about the second dimension of management costs and fees, the regulation refers to what the Commission is reimbursing for management costs and fees. The regulation does not specify that management costs and fees should be paid between the parties only based on disbursement to final recipients. The first phrase of paragraph Article 68(4) refers to the fact that, whatever kind of management fees system is agreed between the parties, this should be performance based. However, the regulation does not explain how this performance based should be settled because we wanted to give flexibility to the parties to define what is best for what they want to achieve. So, the definition of milestones related to performance is left to the discretion and negotiation of the managing authorities and bodies implementing the financial instruments. If we think of the experience in the 2014-2020 programming period, these performance elements could refer to the ability to disburse the funds, to the contribution of the financial instrument, to the objectives of the programme, to the quality of measures accompanying the investment, or to the resources paid back from the investments. We could also think of some examples, such as the number of SMEs that receive financing, ability to raise additional resources, jobs created, measurable social and/or environmental impact, always comparing values achieved to those initially agreed in the funding agreement. We also consider that for the need of liquidity during the intensive early stage, the advance of up to 30% of the total amount of proven contribution committed to the financial instrument can be used.
The Commission, as in several aspects of the CPR, you have simplified it by removing prescription. I think people now have to find the confidence to use the freedom that creates.
Looking at a similar topic: “is it allowed to charge fees on a different basis, such as signature of an agreement? For example, can management fees be charged just for the signature of an operational agreement? Is there any sufficiently performance based concept allowed?”
Another person asked, “is it possible to charge management fees for anything different than disbursements to final recipients, such as signature of an operational agreement between holding fund manager and an intermediary? The CPR does not seem to accept it.”
Sara: This is also linked to what Oana explained earlier. The answer is yes, the signature of the operational agreement can be considered within the meaning of performance based for the first dimension we talked about earlier. This implies that during the negotiation between managing authorities and bodies implementing the financial instrument, these criteria have been discussed, agreed and included especially in the funding agreement. While if we refer to the second dimension, this criteria is not linked as such to the eligibility of expenditure. For the Commission, only the disbursement of the funds to final recipient, this criteria is therefore not relevant for the Commission. The payment of management costs and fees between the fund manager and the managing authority is, however, left at the negotiation between managing authorities and bodies implementing the financial instrument, with a methodology agreed between them. Management costs and fees can also be a combination of fees and costs.
I have a couple more questions about base fees, which we've already talked about, but let's just deal with these questions so that we can put the subject beyond doubt. Somebody asked during the event, “management fees seem a challenge”, as a comment and, “as discussed today, it seems that only calculations based on disbursement to final recipients are aligned with the regulations. Any kind of base fee is not accepted.” Also, somebody asked, “the new CPR seems to avoid any kind of base fee which is not linked to disbursement to final recipients, as practice is well set now.”
Oana: The answer is no, it is not the case. Our purpose in the CPR was to simplify the management fees and to leave flexibility to the parties to agree on the best system of management fees. We didn't want to make it a challenge as was the case in 2014-2020. As we have explained, the Commission is paying to the Member States management fees based only on disbursements in case of direct award as we wanted to have a simple rule. However, as we have explained about the first dimension of management costs and fees, flexibility is left to the managing authorities to define how this performance is measured and details should be provided in the funding agreement.
I think your answers on this topic have been really clear and I'm sure our listeners will find this very useful as they structure their management costs and fees for their new financial instruments in the future.
Let's move on to a slightly different topic. We had a few questions about how management costs and fees relate to financial instruments that combine loan and grant in the same operation. This is, of course, a key new flexibility under the new CPR.
Somebody asked, “if combined with grant, what about management costs and fees for the grant part paid to final recipients?”, and more specifically, a further person asked, “if combined with grant on a capital rebate scheme, when we switch part of the debt into grant without a cash flow to final recipient, how do you calculate the management costs and fees then, as well as within the limits mentioned in the CPR?
Sara: In case of combination of financial instruments and grants in one single operation, as per Article 58(5), the rules of financial instruments are applicable. Therefore, the management costs and fees become eligible expenditure and can be claimed once the programme contribution is paid to final recipient or set aside for a guarantee contract. For instance, if we take the example of a loan combined with an interest rate subsidy, once the loan is disbursed to the final recipient and the grant is paid, for example, to the body implementing the financial instrument to reduce the interest rate, the management fees become eligible for the amount of the loan and the interest rate subsidy.
Another interesting example can be the loan combined with a capital rebate. In this case, the amount of programme contribution is the total of the loan, including the part that will possibly be written off and converted into a grant. As said earlier, combination as per Article 58(5) is considered in its entirety a financial instrument for its total amount and fully follows the rules of financial instruments.
That's a very good example of when the financial instrument rules apply to grant and loan in a combination in a single operation. That, of course, is the rules between the Commission and the managing authority. What about under the funding agreement? I think we've talked already that disbursement does not have to be the only criteria for management costs and fees. Is it possible to link it to payments of a capital rebate, for example?
Sara: As we explained earlier, the performance criteria, which is agreed through the negotiation of the party between the managing authorities and the bodies implementing, can be different and can indeed be linked to the trigger of the capital rebates because this is what we were mentioning earlier, referring to the first dimension. We wanted to highlight that this is part of the flexibility that the Commission wanted to leave to the managing authorities and bodies implementing, based on their specific needs.
A number of questions considered the different thresholds for maximum fee levels in the case of direct award. The thresholds are different for holding funds and specific funds, and two participants asked similar questions on this topic. Somebody asked, “what is the key difference between holding fund and specific fund structures?”
Somebody else asked, “what threshold applies if the same entity, such as a national promotional institution, is managing both holding funds and specific funds?”
Oana: There is a difference between the holding fund and the specific fund because they are fulfilling different tasks, and that is why the level of management cost and fees is different in the CPR. We have the definition of what a holding fund is in Article 2(20) of the CPR. The holding fund is set-up under the responsibility of a managing authority and implements one or more specific funds. The definition of the specific fund is provided in Paragraph 21 of the same Article 2 on definitions: where the specific fund provides financial products to final recipients, either under a managing authority or under a holding fund. Of course, if the same entity manages both the holding fund and the specific fund—and we saw this in many cases, mainly for holding funds that are also guarantors—the management costs and fees and the respective thresholds are applicable in case of direct award, as we explained before. So, one managing the holding fund, the corresponding threshold for the holding fund, depending on the underlying financial product, will be used. While, when managing a specific fund, we have to apply the respective thresholds of the specific fund depending on the financial product that will be implemented.
Let's take an example, in case of direct award, for a body implementing a financial instrument that manages a holding fund with an underlying loan fund, for example, the threshold of the holding fund manager will be 5% multiplied by the total amount of programme contribution allocated at the level of the holding fund for the loan fund, if disbursed to final recipients. So, this means that we apply the threshold on the programme contribution under management by the holding fund for the respective financial product. If at the same time, the entity is a manager of a specific fund equity, for example, the threshold to be applied will be 15% multiplied by the total amount of programme contribution allocated at the equity fund - if, of course, these are disbursed to final recipients. In case of competitive tender, as we said, there are no thresholds, but the results of the competitive tender, which will be paid as management costs and fees.
Another couple of questions about the thresholds, Oana, perhaps you could also answer. One participant asked, “how does the threshold of 15% correspond to the customary 20% for management costs and fees set aside for private venture capital funds, how was the 15% determined and was there any market research done?”
Somebody else commented and asked, “in order for the money to reach the final recipients, a lot of upfront costs have to be incurred, fund managers are forced to finance the management. It's a complete disincentive for private equity fund managers.” I think that is more of a comment, but it's a concern maybe amongst private equity fund managers.
Oana: As you know, to agree on the level of the management cost and fees was very difficult and it was the last point on which the co-legislators agreed. From the Commission’s perspective, the thresholds proposed were based on the actual average of management costs and fees paid in the previous programming period. We know that on average the cost for private equity is around 2% per year, but the implementation period for equity funds under one programming period is around seven years. So, with those we arrive to 15%. I would like to underline that the thresholds you can find in the regulation apply only in case of direct award and not when the private fund managers are selected with an open competition. In this case, the market rates for management fees will apply. So the remuneration from EU funds is capped only in the case of public bodies implementing equity funds as holding funds. With reference to previous replies, the managing authorities and equity fund managers can define, during the negotiations for the implementation of the financial instrument, the best criteria for payments, deciding that the upfront costs have to be paid on a specific criteria earlier in the process. This refers to the first dimension we explained earlier and has to be settled in the funding agreement. The purpose of this was to allow the fund managers to cover the costs that are incurred during the first years of implementation.
The last question today relates to the use of reflows. We were asked, “can we use reflows to pay management fees for the implementation of financial instruments after the contribution from the funds is totally dispersed?”
Sara: The reflows indeed should be reused, as per Article 62(1), also for management costs and fees, but only if these are related to new investments, which are done with the reflows. This is one of the changes in the rules compared to the previous programming period, in 2014-2020, as we want to incentivise the bodies implementing financial instruments to invest the reflows as quickly as possible. This was our intention.
So, the answer is a partial yes, but only to the extent that it relates to new investments.
Sara: Exactly, as an incentive to invest as quickly as possible.
That concludes the questions asked by participants during the event. Thank you, Sara and Oana, for dealing with the points in such detail. I'm absolutely sure that this will be of great interest and really useful for our listeners. Before we finish, let me give you both a last word. Is there any final message you would like to give about management costs and fees to our listeners?
Sara: Yes, to conclude, I would really like to stress that the main principle for management costs and fees are against simplification and flexibility, but linked to what we explain and define as first and second dimension. Really, we wanted to make life easier for the national authorities in deciding and negotiating their criteria. So, thank you very much all for your attention.
Oana: Yes, I would like to say that I really hope that the managing authorities and fund managers will take full advantage of these simplified rules to design the financial instruments, which are more suited to their needs. I also hope that they will avoid any kind of gold plating. If you have any further questions, let us know. We are here for you.
I would like to add my thanks to all the participants from the event, especially those who raised the questions that we've considered today. As I've said, I'm sure this podcast is going to be very helpful for many practitioners. I'm also sure that there will be more questions that people will want to ask. We encourage people to get in touch using our mailbox, which is firstname.lastname@example.org. We plan to do a further podcast in about two or three weeks where we would address any further questions that our listeners may have on this topic. So we look forward to hearing from you. That brings today's episode to a close. I'd like to thank again, Oana and Sara for joining me today.
Oana and Sara: Thank you very much, Desmond.
And a big thank you to you, our listeners, for tuning in to this episode of the fi-compass Calling the Tune podcast.
If you have any questions, please send us an email at email@example.com and don't forget to follow us on social media and look out for future editions of our fi-compass Jam Sessions podcast, where we will be considering the other topics featured at the ERDF Conference in October 2022. Have a great day, everybody.