EUROPE: ESMA seeks consultation on draft guidelines on sound remuneration policies under the AIFMD

Thursday June 28 2012

Funds-Axis would like to highlight the recent publication of a consultation paper on ESMA outlining its draft guidelines for Alternative Investment Fund Managers under the AIFMD. A link to the full consultation paper can be found below;

 ESMA Draft Guidelines on Sound Remuneration Policy under the AIFMD

 This invitation to consultation on these draft guidelines by ESMA should be read by any asset manager or trade association that is deemed to fall under the scope of AIFMD as the final guidelines as issued by ESMA will have a regulatory impact. Also, in the opinion of Fund-Axis, many of these guidelines will impose stricter conditions on the remuneration policies of Alternative Investment Fund Managers than current regulation / codes require and as such Asset Managers should make any concerns they have in relation to these proposed guidelines heard now while they can still influence the outcome of the process. Please note a high level overview of the proposed guidelines is set out below in this article

Anyone wishing to enter a submission or opinion to ESMA must do so by the 27 September 2012. All submissions must be entered on to the following website, www.esma.europa.eu.

OVERVIEW

The aim of the guidelines is to create a uniform and practical approach to remuneration policies for Alternative Investment Fund Managers throughout the European Union and as a result increase protection for investors by reducing the remuneration incentives for Asset Managers to take undue risks with investor funds.

 If you wish to check if your AIFM falls within the scope of the remuneration guidelines, please note that ESMA has provided a list of categories of AIFM that will need to comply with these guidelines in relation to remuneration once finalised;

•  EU AIFM’s which manage one or more AIF’s irrespective of whether such AIFs are EU domiciled or otherwise;

• Non-EU AIFM’s which manage one or more EU Domiciled AIF’s;

• Non-EU AIFM’s which market one or more AIF’s in the EU irrespective of whether such AIF’s are EU Domiciled or otherwise; and

• Non-EU AIFM’s which market AIF’s to professional investors within the EU and which do not hold a European Passport will not be required to comply with the general AIFMD Remuneration Rules and only the rules on remuneration disclosure will apply until the private placement regime for non-EU AIFM’s/AIF’s is abolished.

N.B. Please note that currently no timeine has been established for the abolishment of the private placement regime and there is continued speculation that this regime may never be abolished.

 ESMA proposes the following guidelines in relation to;

•  What categories of Remuneration fall under the scope of the AIFMD;
• What categories of staff or types of staff are captured under the AIFMD;  
• How the Principle of Proportionality should be handled;
• Assets Managers Captured under AIFMD that form part of a Group;
  • The Overall Financial situation of the Asset Manager and what impact this should have on remuneration;
  • The oversight and governance of remuneration;
  • General & Specific requirements on risk alignment;
  • Time Horizons; and
  • Disclosure Requirements

 Categories of Remuneration Captured

For the purposes of the Guidelines, remuneration consists of the following;

• all forms of payment or benefit paid by the AIFM;
• any amount paid by the AIF itself, including carried interest;
• and of any transfer of units or shares of the AIF, in exchange for professional services rendered by the AIFM staff.

All remuneration can be divided into either fixed remuneration (payments or benefits without consideration of any performance criteria) or variable remuneration (additional payments or benefits depending on performance).

Benefits can come in the form of cash, shares, options, cancellation of loans to staff members at dismissal, pension contributions, discounts, fringe benefits or special allowances for car, mobile phone, remuneration by AIFs e.g. through carried interest models etc.

Any payments to staff that are not discretionary and are not linked to performance and therefore pose no incentive to the staff of the AIFM to take unnecessary risks can be excluded from the above definitions under AIFMD in terms of specific risk alignment remuneration practices.

Please refer to the full guidelines for further information.

Categories of Staff Captured by the AIFMD (“Identified Staff”)

A general list of the categories of staff caught by the guidelines is as set out below;

• Members of the governing body of the AIFM;
• Members of Staff deemed to be Senior management;
• Members of staff who operate control functions;
• Members of Staff who head up the following functions;
• Members of staff whose activities can exert material influence on the AIFM’s and  / or AIF including staff members with the capability to enter into contracts and / or positions and taking decisions that materially affect the risk positions of the AIFM/AIF

• portfolio management;
•  administration
• Marketing; and
•  human resources.

Please note that the above list is not the final and full list and Asset Managers should refer to the draft guidelines, links provided above, for further details.

Please also note, that AIFM’s will be required to be able to evidence to regulators how they assessed there various members of staff and allocated them into their categories and this evidence should be able to stand up to scrutiny.

Principle of Proportionality

The proportionality principle aims to consistently match the remuneration policies and practices with the individual risk profile, risk appetite and the strategy of the AIFM and of the AIFs it manages, so that the objectives of the principles are more effectively achieved. The proportionality principle applies to the general as well as to the specific remuneration requirements of the AIFMD. The effect of the proportionality principle is that not all AIFMs have to give substance to the remuneration requirements in the same way and to the same extent. Proportionality operates both ways: some AIFMs will need to apply more sophisticated policies or practices in fulfilling the requirements; other AIFMs can meet the requirements of the AIFMD in a simpler or less burdensome way.

Notwithstanding the fact that the remuneration principles in Annex II of the AIFMD are applicable to

all AIFMs, the proportionality principle permits AIFM’s to tailor the application of some requirements if this is reconcilable with the risk profile, risk appetite and the strategy of the AIFM and the AIFs it manages. The Guidelines set out the limits on which requirements can potentially be applied in a tailored manner insofar as such tailoring should not be understood as allowing an AIFM to disregard any of the requirements of Annex II of the AIFMD. If AIFMs deem a tailored application for these requirements appropriate for their type of AIFM or Identified Staff, they should be able to explain the rationale for every single requirement that is applied in a tailored manner.

The main categories of remuneration that may be subject to tailoring subject to the criteria contained in the guidelines are as follows;

• Variable Remuneration in Instruments;
• Retention;
• Deferral; and
• Ex-Post Incorporation of risk for variable remuneration.

Please note that the above list is not the final and full list and Asset Managers should refer to the draft guidelines, links provided above, for further details.

AIFMS as part of a Group

The application of these remuneration principles by AIFM’s which form part of a group apply at group level and not at the individual AIFM level.

ESMA has set out that it believes that there should be no exception to the application to any of the AIFM’s which are subsidiaries of a credit institution of the sector-specific remuneration principles set out in the AIFMD and in the guidelines.

Governance of Remuneration

The managing body is defined as being distinct form senior management whom it directs but whom senior management may form a part. In practice this is usually the board of directors or equivalent body. ESMA in these guidelines set out principles for the Governance of Remuneration within AIFM’s and the AIF’s that they manage and the managing body would have responsibility for these areas as set out below;

• Design, Approval and Oversight of the Remuneration Policy;
• Remuneration of members of the management and supervisory functions;
• Shareholders Involvement;
• Review of the Implementation of the Remuneration Policy;
• Establishment of Remuneration Committee;
• Process & Reporting Lines; and
• Remuneration of Control Functions.

General Requirements on Risk Alignment

The draft guidelines aim to align remuneration with prudent risk taking. The long term strategy of the AIFM should include the overall business strategy and quantified risk tolerance levels with a multi-year horizon, as well as other corporate values such as compliance culture, ethics, behaviour towards investors of the AIF’s it manages, measures to mitigate conflicts of interest etc. The design of the remuneration systems should also be consistent with the risk profiles, rules or instruments of incorporation of the AIF’s the AIFM manages and with the objectives set out in the strategies of the AIFM and the AIF’s it manages and changes that could be decided in the strategies must be taken into account. AIFM’s should, therefore, ensure that their remuneration systems are well designed and implemented. This includes, in particular, a proper balance of variable to fixed remuneration, the measurement of performance as well as the structure and, where appropriate, the risk-adjustment of the variable remuneration. Even a smaller or less sophisticated AIFM should ensure it makes the best possible attempt to align its remuneration policy with its interests and the interests of the AIF’s it manages and their investors. When developing their remuneration policy, AIFM’s should give due consideration to how remuneration contributes to the prevention of excessive risk-taking, the efficiency of the AIFM and the AIF’s it manages and the consistency of the remuneration policy with effective risk management.

Please refer to the draft guidelines for further details on both the General & Specific requirements on Risk Alignment for AIFM’S at the link provided above.

Time Horizon

AIFM’s, when assessing risk and performance for the purposes of remuneration setting should take into account both current and future risks that are taken by the staff member, the business unit, the AIF concerned or the AIFM as a whole. For this exercise, AIFM’s should examine what the impact of the staff member’s activities could be on the AIF’s they manage and AIFM’s short and long term success. To be able to do so, the AIFM should align the horizon of risk and performance measurement with the life-cycle and redemption policy of the AIF’s managed by the AIFM and their investment risks. The requirement of an AIFM to assess the performance of its staff in a multi-year framework appropriate to the life-cycle of the AIF’s managed by the AIFM implies the accrual period and the payout period for short-term and long-term remuneration covering an appropriate period in total. There is a link between these periods. The right balance between accrual and payout periods should depend on the type of AIFs managed by the AIFM and on the type of business and activity developed by the staff member. However, the use of multi-year accrual periods is more prudent since the assessment of the performance can take into account with certainty more risks that have materialized since the beginning of the accrual period.

Please refer to the draft guidelines, links provided above, for further details.

Disclosure
The disclosure requirements required that a specific statement be inserted into the annual report of each AIF and this statement should also give sufficient information on the link between pay and performance and the criteria used for performance measurements and risk adjustment by the AIF.

 Should you wish to contact the author of this article to discuss any queries that the above may have prompted, then please don’t hesitate to do so at info@funds-axis.com