Following the consultation paper dated September 28, 2012, the European Securities and Market Authority ("ESMA") published on February 11, 2013 its final report on guidelines relating sound remuneration policies under the AIFMD ("Remuneration Guidelines" or "Guidelines"). Such Guidelines introduces details of prudent remuneration policies and organisational structures which shall avoid conflicts of interests that may lead to excessive risk taking.

As the next step the Remuneration Guidelines will be translated into the official languages of the EU. Within two months of the publication of the translations on ESMA's website, competent authorities should confirm to ESMA whether they intend to comply with the Guidelines by incorporating them into their supervisory practise.

The Remuneration Guidelines will apply from July 22, 2013, subject to the transitional provisions of the AIFMD (i.e. one year following July 22, 2013). In the following, significant selected issues of the Guidelines will be summerized, followed by a more detailed overview.

I. Summary

The main points of relevance are:

  • Fund-as-a-whole carried interest models are recognized as compliant with the requirements of variable remuneration where claw backs are in place and provided that no variable compensation is paid to the Identified Staff before carry is due. ESMA only mentions this one model but in our reading other carried interest models should also be coherent to the extent they provide the same risk alignment and protection for investors.
  • Slight improvement regarding disclosure requirements which no longer seem to have to be publicly made.
  • Not only identified staff of the AIFM but also staff of delegates to which portfolio management or risk management have been delegated must be subject to the Guidelines provided that their professional activities have a material impact on the risk profile of the AIF. Advisors are not delegates and hence their staff should not be covered.
  • ESMA recognizes the principle of proportionality which - in certain exceptional cases - may even lead to the disapplication of the requirements regarding variable remuneration
  • ESMA introduces anti-circumvention-obligation: The governing body of the AIFM has the responsibility to avoid circumventions (e.g. the outsourcing of professional services to firms that fall outside the scope of AIFM; the use of tied agents etc.)

According to ESMA, there should be no exception to the application to any of the AIFMs which are subsidiaries of a credit institution of the sector-specific remuneration principles set out in the AIFMD or in the Guidelines. However, in this case a simplified application of the Guidelines might be possible in single respects.

II. Content of the Remuneration Guidelines

1. Staff subject to the Remuneration Guidelines

The Guidelines shall be applicable to staff members of the AIFM and its delegates whose professional activities have a material impact on the AIFM's risk profile or the risk profiles of the AIF that it manages. It is up to the AIFM to identify the relevant categories of staff being subject to the provisions of the Remuneration Guidelines.

Such "Identified Staff" is being defined as any categories of staff, including senior management, risk takers, control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takes, whose professional activities have a material impact on the AIFM's risk profiles or of the AIFs it manages.

In particular, the following categories of staff should be considered as Identified Staff (unless it is demonstrated that they have no material impact on the AIFM's risk profile or on an AIF it manages):

  • Executive and non-executive members of the governing body of the AIFM,
  • Senior management,
  • Control functions (being defined as staff other than senior management responsible for risk management, compliance, internal audit or similar functions within an AIFM),
  • Staff responsible for heading the portfolio management, administration, marketing, human resources, and
  • Other risk takers (such as staff members, whose professional activities can exert material influence on the AIFM's risk profile or on an AIF it manages, including persons capable of entering into contracts/positions and taking decisions that materially affect the risk positions of the AIFM or of an AIF it manages; such staff can include, for instance, sales persons, individual traders and specific trading desks).

EMSA clarifies that the examples listed above are not definitive. External service providers which do not have the power to take any decisions are not covered. However, categories of staff of entities to which portfolio or risk management activities have been delegated shall also be subject to the Guidelines provided that their professional activities have a material impact on the risk profiles of the AIF. As advisors, per definition, only render advisory services and therefore by nature cannot have a material impact on the AIFM's risk profile or on an AIF it manages (such impact can only have the respective deciders), they should not be qualified as Identified Staff.

2. Covered types of Remuneration

ESMA stipulates a broad scope of types of remuneration being subject to the Guidelines and states that for the purposes of the Remuneration Guidelines, remuneration consists of

  • all forms of payments or benefits paid by the AIFM,
  • any amount paid by the AIFM itself, including carried interest (which ESMA clarifies is only remuneration for services rendered for purposes of the Guidelines), and
  • any transfer of units or shares of the AIF

in exchange for professional services rendered by the AIFM Identified staff. As a result, all types of remuneration and payments are subject to the Guidelines, irrespective whether (i) the remuneration is fixed or variable or whether (ii) it includes monetary payments or benefits (such as cash, shares, options, etc) or non monetary benefits (such as discounts, fringe benefits or special allowances e.g. for car, mobile phone, etc.).

AIFMs must ensure that, in order to prevent anti-circumvention, variable remuneration is not paid through vehicles and that no methods are employed which aim at artificially evading the provisions of the AIFMD and the Remuneration Guidelines. For example, the use of tied agents or the outsourcing of professional services to firms that fall outside the scope of the AIFM-D could bear a risk of anti-avoidance. ESMA makes clear that payments made by the AIF to the relevant staff members through carried interest vehicles are permitted but should also be subject to the remuneration provisions of the Guidelines.

ESMA further stipulates that when delegating portfolio management or risk management activities, AIFM should ensure (i) that such entities to which portfolio management or risk management activities have been delegated are subject to regulatory requirements on remuneration that are equally as effective as those applicable under the Guidelines and (ii) that appropriate contractual arrangements are in place in order to ensure there is no circumvention of the remuneration rules. As stated above, advisors do not assume any delegated functions and hence would not be covered.

Dividends or distributions that parties receive as owners of an AIFM are not covered by the Guidelines, unless the payment of such dividends results in a circumvention of the relevant remuneration rules.

III. Principle of Proportionality

In taking measures to comply with the Remuneration Guidelines, AIFMs should comply in a way and to the extent that is appropriate to their seize, internal organization and the nature, scope and complexity of their activities.

As a consequence, not all AIFMs should have to give substance to the remuneration requirements in the same way and to the same extent. In this context ESMA states, that proportionality should operate in both ways, pursuant to which some AIFMs will need to apply more sophisticated policies or practices in fulfilling the requirements and other AIFMs can meet the requirements in a simpler or less burdensome way. Proportionality may lead, on an exceptional basis, to the disapplication of certain remuneration requirements within the limits set by the Guidelines.

The following requirements may be disapplied if its proportionate to do so:

  • variable remuneration in instruments (i.e. units or shares of the AIFs managed by the AIFM or equivalent ownership interests),
  • retention,
  • deferral,
  • ex post incorporation of risk for variable remuneration,
  • the requirement to establish a remuneration committee.

Disapplication should never be automatically triggered. The AIFMD should always make a careful assessment. If AIFMs deem a disapplication for requirements set out in the Guidelines appropriate for their type of AIFM or Identified staff, they must, however, be able to explain to competent authorities, if requested, the rational for every single requirement that is disapplied.

IV. Governance of Remuneration

1. Overall Principle

As the overall principle, ESMA stipulates that the AIFM's remuneration policy should encourage the alignment of the risks taken by its staff with those of the AIFs it manages, the investors of such AIFs and the AIFM itself; in particular, the remuneration policy should duly take into consideration the need to align risks in terms of risk management and exposure to risk.

2. Remuneration of the Management Body and Supervisory Function

The remuneration of the members of the management body should be consistent with their powers, tasks, expertise and responsibilities. Where appropriate considering the size of the AIFM, its internal organization and the nature, scope and complexity of its activities, the management body should not determine its own remuneration, but a supervisory function ("Supervisory Function"), which should also oversee the remuneration of the management body.

As regards the Supervisory Function's remuneration ESMA states that it may be more appropriate for its members being compensated only with fixed remuneration.

For those AIFMs that given their size, internal organization and the nature, scope and complexity of their activities do not have a separate supervisory function, the principle according to which members of the supervisory function may more appropriately be compensated only with fixed remuneration should apply only to the non-executive members of the management body that perform the tasks of the supervisory function.

The approval of an AIFM's remuneration policy and decisions relating to the remuneration of members of the management body may be assigned to the meeting of the shareholders of the AIFM, depending on the AIFM's characteristics or on the national rules in the jurisdiction in which the AIFM is established. Even in that case, however, the supervisory function remains responsible for the proposals submitted to the meeting of the shareholders of the AIFM.

V. Remuneration Committee

1. Role of the Remuneration Committee

According to the Guidelines, the remuneration committee should:

  • be responsible for the preparation of recommendations to the supervisory function, regarding the remuneration of the members of the management body as well as of the highest paid staff members in the AIFM,
  • provide its support and advice to the supervisory function on the design of the AIFM's overall remuneration policy,
  • have access to advice, internal and external, that is independent of advice provided by or to senior management,
  • review the appointment of external remuneration consultants that the supervisory function, may decide to engage for advice or support,
  • support the supervisory function in overseeing the remuneration system's design and operation on behalf of the supervisory function,
  • devote specific attention to the assessment of the mechanisms adopted to ensure that:
  • the remuneration system properly takes into account all types of risks and liquidity and assets under management levels, and
  • the overall remuneration policy is consistent with the business strategy, objectives, values and interests of the AIFM and the AIFs it manages and the investors of such AIFs; and
  • formally review a number of possible scenarios to test how the remuneration system will react to future external and internal events, and back test it as well.

2. Setting up a Remuneration Committee

A remuneration committee is not always necessary. ESMA clarifies that in order to identify whether a remuneration committee is expected to be set up as a matter of good practice, the principle of proportionality is to be considered. The following (non-exhaustive) elements are to be taken into account when determining whether or not to establish a remuneration committee:

  • whether the AIFM is listed or not,
  • the legal structure of the AIFM,
  • the number of employees of the AIFM,
  • the AIFM's assets under management,
  • whether the AIFM is also a UCITS management company,
  • the provision of the services mentioned under Art. 6(4) AIFMD, (such as management of portfolio investments on a discretionary, client-by-client basis, investment advice, etc.)

Taking into account the above principles and having regard to all circumstances, ESMA provides the following examples pursuant to which AIFMs may not need to establish a remuneration committee:

  • AIFMs for which the value of the portfolios of AIFs that they manage does not exceed EUR 1.25 billion and not having more than 50 employees, including those dedicated to the management of UCITS and the provision of the services mentioned under Article 6(4) of the AIFMD;
  • AIFMs which are part of banking, insurance, investment groups or financial conglomerates within which an entity is obliged to set up a remuneration committee which performs its tasks and duties for the whole group, provided that the rules governing such remuneration committee's composition, role and competences are equivalent to the ones set out in these guidelines and the existing remuneration committee takes responsibility for checking the compliance of the AIFM with the rules set out in these guidelines.


The remuneration committee should comprise members of the supervisory function who do not perform executive functions, and at least the majority of whom qualify as independent. The chairperson must be and independent non-executive member. Unfortunately, it still remains unclear what ESMA understands by "independent".

VI. Control Functions and Remuneration

AIFMs should ensure that control functions have an active role in the design, ongoing oversight and review of the remuneration policies and business areas.

The remuneration at the level of staff in control functions should allow the AIFM to employ qualified and experienced personnel in these functions. If they receive variable remuneration, it should be based in function-specific objectives and should not be deter-mined "solely" by the AIFM-wide performance criteria. This wording is encouraging as it indicates that the remuneration can at least partly be influenced by the individual financial performance of the business area they monitor.

VII. Guidelines on the General Requirements of Risk Alignment

1. General

The general requirements on risk alignment should be applied by AIFMs only to the individual remuneration packages of the Identified Staff. But AIFMs should make an assessment on whether these requirements should be applied to the AIFM as a whole and if required, be able to demonstrate why they have applied these requirements to the Identified Staff only.

The design of the remuneration systems should be consistent with the risk profiles, rules or instruments of incorporation of the AIFs the AIFM manages and with the objectives set out in the strategies of the AIFM and the AIFs it manages and changes that could be decided in the strategies must be taken into account. AIFMs 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.

2. Discretionary pension benefits

In case of discretionary pension benefits, as part of the variable remuneration, a staff member should not retire or leave the AIFM with such benefits vested, with no consideration of the economic situation of the AIFs that the AIFM manages or risks that have been taken by the staff member in the long term.

In order to align this specific kind of pension benefits with the economic situation of the AIFs that the AIFM manages, ESMA stipulates that discretionary pension benefits, where legally possible according to the relevant pension legislation, should be paid in the form of instruments (i.e. units or shares of the AIFs managed by the AIFM or equivalent ownership interests).

3. Severance Payments

AIFMD provides that payments related to the early termination of a contract must reflect performance achieved over time and may not reward failure. The Guidelines further clarify that AIFMs should set up a framework in which severance pay is determined and approved, in line with the AIFM's general governance structures for employment. Such framework should ensure that there is no reward for failure. In this context, "golden parachute" agreements should be considered as inconsistent.

AIFMs should be able to explain to competent authorities the criteria they use to determine the amount of severance pay. It is good practice to defer any outstanding variable payments or long-term incentive plans and for these to mirror the original deferral schemes.

4. Prohibition of Personal Hedging

ESMA takes the view that an appropriate remuneration policy which is aligned with risks will, if sufficiently effective, occasionally result in a downward adjustment to the amount of variable remuneration awarded to staff. The effectiveness of risk alignment will be significantly weakened if staff members are able to transfer the downside risks to another party through hedging or certain types of insurance.

VIII. Guidelines on the Specific Requirements of Risk Alignment

1. General

Also the specific requirements on risk adjustment should be applied by AIFMs only to the individual remuneration packages of the Identified Staff, but AIFMs may always consider an AIFM-wide application.

2. Fixed Remuneration

AIFMD foresees the requirement of a fully flexible policy on variable remuneration which implies that variable remuneration should decrease as a result of negative performance and that it can go down to zero in some cases. According to ESMA this requires, however, that the fixed remuneration should be "sufficiently high" to remunerate the professional services rendered.

3. Variable Remuneration

The rules on variable remuneration have remained unchanged compared to the discussion paper. Hence, to limit excessive risk taking, variable remuneration should be performance-based and risk adjusted. ESMA still differentiates between three steps for such purposes: (i) the performance and risk measurement process, (ii) the award process and (iii) the payout process:

  1. The performance assessment should link the remuneration with the achievement of the investment strategy of the AIFs concerned and the business plan, if any, or the objectives of the AIFM. When assessing performance, only the effective results should be taken into account.
  2. After the period during which the performance of the staff member is assessed and measured for the purposes of determining its remuneration ("accrual period"), the AIFM should use a specified award process in order to translate performance assessment into the variable remuneration component for each staff member.
  3. In order to align the actual payment of remuneration to the life-cycle of the AIF managed by the AIFM and the investment risks, the variable remuneration should partly be paid upfront (short-term) and partly deferred (long-term). The short-term component should be paid directly after the award to the staff for performance delivered in the accrual period, subject to ex post risk adjustment. The long-term component should be awarded to staff during and after the deferral period (3 to 5 years at minimum). ESMA foresees strict deferred pay out mechanism of at least 40 to 60%. AIFMD provides that subject to the legal structure of the AIF, a substantial portion, and in any event at least 50% of any variable remuneration must consist of units/shares in the AIF or equivalent ownership interests. ESMA acknowledges that for many AIFs this requirement of a share-linked instruments may be problematic and suggests that alternative methods may be used in such cases (although little guidance is given in that respect).

Each of such steps is subject to a complex quantitative and qualitative risk measurement. Whereas the above principles regarding variable remuneration will be relevant to bonus payments to staff within the AIFM, it should still not be relevant for carried interest payments in our view.

4. Assumption for Carried Interest Schemes

ESMA recognizes that the objectives of the requirements on risk alignment of variable remuneration (see above 2.(i) through (iii)) may be more naturally met by certain remuneration structures which are structured in a very specific way with the aim of ensuring the alignment of the interests of the respective staff with those of the investors of the AIFs the AIFM manages. Therefore, ESMA states that "while it is necessary to have regard to all the relevant circumstances case-by-case, the guidelines on "Risk Alignment and Variable Remuneration", "Award Process" and "Pay-out Process" may be met where:

  1. An AIFM first returns all capital contributed by the investors of the AIF it manages and an amount of profits at a previously agreed hurdle rate (if any) to the investors of the AIF, before the relevant staff may receive any compensation for the management of the relevant AIF; and
  2. The compensation received by the relevant staff is subject to clawback arrangements until the liquidation of the relevant AIF".

ESMA only describes a fund as a whole concept subject to clawback mechanism and foreseeing that no variable compensation (hence no boni payment) may be made before investors receive back contributed capital plus hurdle. It is too restrictive to prohibit any variable compensation to any Identified Staff; for the rest we believe this should generally reflect many carried interest models. We understand this to be an example of one carry model which complies with the Guidelines, but carried interest models vary in practice and we understand that other classical private equity models should also be deemed to comply.

IX. Disclosure

AIFMs should disclose detailed information regarding their remuneration policies and practices on an annual basis and as soon as practicable after the information becomes available. It is still unclear to whom such disclosure must be made. We assume it is to disclose to the competent authorities and in the annual report. Further, AIFMs shall provide general information about the basic characteristics of their AIFM-wide remuneration policies and practices. The disclosure should be produced and owed by the management body that has the ultimate sign-off on remuneration decisions and be clear and easily understandable and accessible.

In accordance with the Recommendation of the Commission, the following information should be disclosed:

  • Information concerning the decision-making process used to determine the remuneration policy, including information about the governance procedure and the significant bodies (e.g. remuneration committee, external consultants) relating to the development of the remuneration policy, and information about the role of all relevant stakeholders involved in the determination of the remuneration policy; additionally, the disclosure should include a description of the regional scope of the AIFM's remuneration policy, the type of staff considered as material risk takers and the criteria used to determine such staff;
  • Information on linkage between pay and performance, including information about the main performance metrics, the design and structure of the remuneration process, the different forms of variable remuneration used and the rationale for using them and for allocating them to different categories of staff; additionally, the disclosure should include a discussion of the parameters used to allocate deferred and non-deferred remuneration for different staff categories;
  • Information on the criteria used for risk determination, risk measurement and risk adjustment;
  • Information on the quantitative (financial) and qualitative (non-financial) parameters for assessing individual performances relevant for determining the remuneration policies and practices.

However, the Recommendation's remuneration dis-closures may be made on a proportionate basis under consideration of the proportionality principle. ESMA states that small or non-complex AIFMs/AIFs will only be expected to provide some qualitative information and very basic quantitative information where appropriate. In practice, they are not expected to provide all the information pursuant to the Recommendation. We would not read ESMA's Guidelines such that individual amounts paid to specific team members must be disclosed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.