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AIFMD lays down principles for firms to ensure that their remuneration policies and practices “are consistent with and promote sound and effective risk management and do not encourage risk-taking which is inconsistent with the risk profiles, rules or instruments of incorporation of the AIFs they manage.”
The remuneration provisions fall into three categories:
In addition to an authorised AIFM being subject to the remuneration rules, the rules also require an authorised AIFM to (i) ensure that a delegate is subject to regulatory remuneration requirements that are equally as effective as those under AIFMD; or (ii) put in place contractual arrangements with a delegate to ensure that there is no circumvention of AIFMD remuneration rules.
AIFMD contains an annex setting out the detailed principles to be adhered to when establishing and applying remuneration policies for staff whose professional activities have a material impact on the risk profiles of the AIFM and/or the AIF they manage. Click here for a link to the remuneration rules set out in Annex II of AIFMD. In addition to the rules set out in Annex II of AIFMD, the Level 2 Regulations contain remuneration provisions including relating to conflicts of interest and the disclosure of remuneration.
ESMA has issued guidelines (the “Guidelines”) on remuneration policies and practices to assist in the implementation of AIFMD. Click here for a link to the Guidelines (and here for an update to paragraph 33 of the Guidelines). The Guidelines do not have direct effect in EU Member States. However, Member States were required to implement AIFMD in accordance with the final Guidelines, and so firms should also refer to the relevant Member State’s own rules/ guidance on AIFMD remuneration. In Luxembourg, the Guidelines have been directly transposed.
In the UK, on the basis of this principle (called ‘proportionality’), the FCA generally does not require UK regulated AIFMs with assets under management of less than £1bn (or less than £5bn for AIFMs managing unleveraged AIFs with no redemption rights exercisable for 5 years following the initial investment in each AIF) to follow the rules on:
which are discussed below (the “Payout Process Rules”).
In Luxembourg, based on the Luxembourg AIFM Law, a similar derogation exists for Luxembourg regulated AIFMs with assets under management of less than €100,000,000 (or less than €500,000,000 for AIFMs managing unleveraged AIFs with no redemption rights exercisable for 5 years following the initial investment in each AIF).
AIFMs are required to have remuneration policies which:
The policy and its implementation should be maintained and reviewed periodically.
Firms which are ‘significant’ in terms of size, internal organisation etc. are also required to have a suitably independent remuneration committee which is responsible for the policy and key decisions made under it.
Pay that is linked to performance should be:
Performance assessment in respect of such pay should be set in a multi-year framework appropriate to the life cycle of the AIFs managed by the AIFM.
The balance of fixed and variable pay should be appropriate, and the proportion of fixed pay should be high enough to allow complete flexibility on variable pay (including flexibility to pay no variable pay where appropriate).
Variable pay and bonus pools should be risk-adjusted for current and future risks.
At least 40% of variable pay must be deferred for at least 3-5 years, unless the life cycle of the AIF is shorter. This is increased to (at least) 60% for staff receiving variable pay of a particularly high amount (and may include lower amounts, depending on the circumstances).
The actual period for deferral must be appropriate in view of the life cycle and redemption policy of the AIF and its risks.
This deferral requirement is usually met through some combination of:
Note that this requirement does not apply to all staff (see ‘Which Staff?’ below).
At least 50% of variable pay should be paid in units or shares of the relevant AIF or equivalent ownership interests or share-linked instruments or equivalent non-cash instruments (unless the AIF accounts for less than 50% of the total portfolio). But this is subject to the structure of the AIFM, the AIF etc. On this basis, the FCA gives firms some flexibility not to follow this rule where it would be impracticable to do so considering the objectives of the remuneration rules, e.g. where:
Where this is the case, firms often pay the relevant proportion of variable pay in the form of share incentives (or phantom arrangements) relating to the AIFM or its parent, or interests linked to the performance of AIFs or other portfolios managed by the AIFM or its affiliates, but there is no requirement to do that under the FCA guidance where the legal structure or instrument of the AIF makes the rule’s application impracticable considering the objectives of the AIFMD remuneration rules. In Luxembourg, the CSSF applies the Guidelines without applying the same flexibility as the FCA on this point.
Firms should be prepared to demonstrate that any instruments used to deliver pay align the risks taken by staff with those of the relevant AIFs, the investors in such AIFs and the AIFM itself, and do not represent a conflict of interest.
Where variable pay has to be paid in instruments or shares etc, they must be retained for a period aligned to the long-term interests of the AIFM and the AIFs it manages and their investors. Based on market practice, a retention period of 6 months is normally sufficient in both the UK and in Luxembourg, provided that other risk management techniques within the firm are operating to secure sound and effective risk management.
Note that this requirement does not apply to all staff (see ‘Which Staff?’ below).
An AIFM must not award, pay or provide guaranteed variable remuneration unless it:
This rule covers retention awards, buy-out awards, golden handshakes etc.
Payments to staff leaving the AIFM must reflect performance achieved over time and must not reward failure.
Variable pay, including any amounts deferred, should be paid out or vest only if:
Malus or clawback arrangements should be used to reduce variable pay where the financial performance of the AIFM or of the AIF is subdued or negative, (though this requirement does not have to apply to all staff - see ‘Which Staff?’ below).
Carried interest awarded to staff may be treated as an investment (and so not subject to the remuneration rules), as remuneration, or as some combination of the two.
The Payout Process Rules are generally considered not to apply to a carried interest arrangement which requires the AIFM to return all capital and profits at the agreed hurdle rate to the investors before staff are paid out.
The Payout Process Rules apply to staff (not just employees) “whose professional activities have a material impact on the risk profiles of the AIFM or of the AIFs the AIFM manages”. This includes:
The AIFM must ensure that staff of entities to which it has delegated portfolio or risk management and who fall into the categories above are subject to the same rules.
In the UK, the Payout Process Rules do not have to be applied in relation to staff:
Particular care is required in relation to control functions to ensure that their remuneration does not lead to conflicts of interest – e.g. bonuses should not be linked to the profits of the businesses which the control function is supposed to oversee. In general, their remuneration should be based on the achievement of objectives linked to their functions, independent of the performance of the business areas they control.
The only remuneration related change being made to AIFMD is set out in Recital 38 of the amending Directive, which instructs ESMA to update its Guidelines regarding aligning incentives with ESG risks in remuneration policies. There is no timing specified for this update.
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