Directive 2011/61/EU on Alternative Investment Fund Managers (the ‘AIFMD’) effectively sets out the rules for authorization, ongoing operation and transparency for alternative investment fund managers (the ‘AIFM’) and the rules for managing and/or marketing alternative investment funds (the ‘AIF’) within the EU. The need for such rules was felt in order for new ‘competent authorities’ to be created in each member state which would be empowered by law and regulation to supervise AIFMs and consequently manage and monitor systemic risks. Ancillary to several key themes laid down in the AIFMD, Article 13 and Annex II describe remuneration policies which would apply to AIFMs within the European Union. It is also pertinent to note that specific remuneration Guidelines have been issued by the European Securities and Markets Authority (the ‘ESMA’) in order to give a smoother understanding of the AIFMD’s remuneration policy. The AIFMD’s remuneration policies are also reflected and significantly expounded in Appendix 12 of the Malta Financial Services Authority’s (MFSA) Investment Services Rules for Investment Services Providers (Part B: Standard Licence Conditions).
Applicability and Scope of the AIFMD
In line with Article 13 of the AIFMD, the MFSA is bound to apply its rules and policies, including remuneration policies and practices which shall apply at an AIFM level. – specifically to “those categories of staff, including senior management, risk takers, control functions, and any employees receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on the risk profiles of the AIFMs or of the AIFs they manage.” Thus, one can safely say that any rules adopted in the Directive are applicable under the Investment Services Rules of the MFSA.
Scope of the Directive
The scope of the Directive should be limited to entities managing AIFs as a regular business – regardless of whether the AIF is open or close ended, whatever the legal form of the AIF, and whether or not the AIF is listed – which raise capital from a number of investors with a view to investing that capital for the benefit of those investors in accordance with a defined investment policy.
The AIFMD seeks to address the potentially detrimental effects of poorly designed remuneration structures particularly on the sound management of risk and control of risk-taking behavior by individuals. This is why the AIFMD imposes on the AIFM the obligation to have remuneration policies in place to:
- Promote sound and effective risk management; and;
- Do not effectively encourage risk-taking which would be inconsistent with the risk profiles fund rules or instruments of incorporation of the AIF it manages.
General Principles Governing Remuneration Policies
The principles governing remuneration policies should recognize that AIFM’s are able to apply those policies in different ways according to their size and the size of the AIFs they manage, their internal organization together with the nature, scope and complexity of their respective activities. As a general rule, remuneration can be divided into two separate categories. These are:
- Fixed remuneration – these include payments or other benefits without any consideration for performance criteria; and
- Variable remuneration – these include other additional payments or benefits depending on performance, or in certain specific cases depending on other contractual criteria.
Both fixed and variable components may include monetary payments or other benefits which range from direct benefits such cash to non-direct monetary benefits such as discounts, fringe benefits or special allowances for car or mobile phones.
Annex II of the AIFMD and the Remuneration Policy
When developing its remuneration policy, the Licence Holder should give due consideration to how remuneration contributes to the prevention of excessive risk-taking, the efficiency of the Licence Holder and the AIFs it manages and the consistency of the remuneration policy with effective risk management.
Annex II sets, various rules and policies for senior management, risk takers, control functions and any equivalently paid employee whose professional activities have a material impact on their risk profile/the risk profile of the AIFs they manage. In complying with these policies consideration must be taken by the AIFM as to the size, internal organization, nature, scope and complexity of their respective activities. The remuneration policy must be in line with business and strategy, objectives, values and interests of the AIFM and the AIF it manages or of the investors of the AIF. Measures should also be adopted to avoid any conflict of interest.
Principles on Remuneration
- A remuneration policy must be set up and has to be reviewed at least annually. It shall follow prescribed principles as laid down both in the Annex and also in other national legislation and guidelines. Such principles include:
- A substantial portion (generally at least 50%) of any variable remuneration must consist of units of the AIF or related instruments (unless the management of AIFs accounts for less than 50% of the total portfolio managed by the AIFM).
- The relative units or instruments must be subject to an appropriate retention policy (this should align the interests of the AIFM with the AIF together with its investors).
- At least 40-60% of the variable remuneration (which depends on the level of such remuneration) must be deferred over a period which is appropriate to the life cycle, redemption policy and risk profile of other the AIF (at least 3-5 years unless the life cycle of the AIF is shorter).
- The variable element may only be paid or vested if it is sustainable as regards the financial situation of the AIFM as a whole, and justified by the performance of the business unit, the AIF and the individual concerned. Variable remuneration may be reduced by a variety of methods.
- Staff members are not to undertake personal hedging strategies or remuneration and liability related insurance to undermine the subsequent alignment effects of their remuneration arrangements.
The Pension Policy
The remuneration policy described in Annex II does also cater for rules which govern a pension policy. Apart from the fact that the pension policy must be in line with the strategy and long-term interests of the AIFM and the AIF it manages, it sets out other criteria applicable to employees. If an employee leaves before retirement, benefits deriving from the pension should be held by the AIFM for 5 years. If the employee reaches retirement, the relative benefits paid would be subject to a 5 year retention period.
Transparency is of paramount importance in remuneration policies. Indeed, for each of the EU-AIF’s it manages and for each of the AIF’s it markets in the EU, the AIFM shall draw up an annual report for each financial year by not later than 6 months following the end of the financial year. It shall include the total amount of remuneration for the financial year, which would be split into fixed and variable remuneration, paid by the AIFM to its staff, and number of beneficiaries, and, where relevant, carried interest paid by the AIF. It shall also include the aggregate amount of remuneration broken down by senior management and members of staff of the AIFM whose actions have a material impact on the risk profile of the AIF.
Significantly sized or complex AIFM’s (or AIFM’s which manage significantly sized AIF’s) must establish a remuneration committee. This committee is an integral part of the remuneration policy structure since it enables an independent competent judgment on remuneration policies and practices together with other incentives created for managing risk. Most importantly, the remuneration committee should be chaired by a non-executive director that exercises competent and independent judgment on remuneration policies and practices.
On the other hand, the ESMA guidelines on sound remuneration policies provide that the setting up of a remuneration committee should be considered, as a matter of good practice, even by those AIFMs that are not obliged to set up such a committee. In considering the size of the AIF’s the AIFM should consider the cumulative presence of all the three factors (i.e. its size or the size of the AIFs it manages, its internal organisation and the nature, scope and complexity of its activities). An AIFM which is significant only with respect to one or two of the three above factors should not be required to set up a remuneration committee.
The ESMA Guidelines specify that when delegating portfolio or risk management activities to third parties such as sub managers, the AIFM should ensure that:
- the delegated entities would be subject to regulatory requirements on remuneration which are equally effective as those applicable under the ESMA Guidelines or else; and
- that a contractual set up is put in place in order to ensure that there is no circumvention of the remuneration rules described in the Guidelines.
Essentially, the guidelines implicate that apart from the fact that an EU AIFM may only delegate risk management activities to other EU located managers which would thus be subject to the same remuneration rules, they can be also contractually required to adhere to such remuneration rules.
Despite that remuneration policies set out in the AIFMD are applicable to all License Holders as described, proportionality may lead to certain disapplication of some of the described requirements. License Holders may decide not to apply the requirements on:
- variable remuneration on instruments;
- retention and deferral;
- remuneration committee and;
- ex post incorporation of risk for variable remuneration.
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