Good luck to anyone trying to regulate hedge fund pay

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As we reported yesterday, the European Union has decided to expand the remit of the Alternative Investment Fund Managers Directive to include pay at hedge funds.

The Telegraph elaborated this morning. The EU wants to treat hedge funds like banks - namely to impose 40% deferrals over three years for most hedge fund employees, and 60% deferrals for the highest paid.

However, the Union is likely to find it distinctly less easy to impose its will on hedge funds, many of which are private partnerships, than on banks.

Firstly, hedge fund compensation tends to be a lot more idiosyncratic than banking pay.

"There's absolutely no standard formula," says one hedge fund headhunter. "Every fund is totally different and within a particular fund people will be on very different deals."

Secondly, although funds like Citadel defer pay, deferrals aren't really in the hedge fund vernacular.

"Top traders are typically on percentage deals which award anything from 8-70% of the profits they make, paid in cash," the headhunter points out.

Thirdly, even if hedge funds wanted to pay in deferred stock, most of them couldn't. With several notable exceptions (Man Group, Greenlight, Fortress, GLG) most hedge funds are limited partnerships, and partners won't be keen on diluting their stakes.

Fourthly, the highest earning hedge fund professionals are usually partners in the funds - not employees. As partners, they are also usually invested in the funds. As Paul Marshall pointed out in his recent article in the Financial Times, skin in the game is already as well-established hedge fund tradition that banks might think of emulating.

"The EU seems to be saying that employees in limited hedge fund companies will have their annual cash bonuses restricted," says John Godden at hedge fund consultancy IGS Group. "But very few people (away from the middle office and lower management are actually employees). The big boys are all partners."

And lastly, if the EU does attempt to crack down on hedge fund pay, funds are likely to prove evasive. Godden predicts that even more of them will go to Geneva. One hedge fund headhunter says they'll pay even more of their compensation through complex offshore arrangements to evade EU scrutiny. Another says they'll simply reclassify themselves as something else.

"If hedge fund pay is regulated and pay at prop trading companies isn't, people are simply going turn themselves into single investor prop trading houses where they can pay themselves as they feel fit," says Luke Williams at Kinsey Allen.

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