The Alternative Investment Fund Managers Directive (“AIFMD”) contains provisions regulating the remuneration of individual fund managers where the fund/fund manager firm is caught by the directive. However, like so much of AIFMD, the impact of these provisions in practice will depend upon the way they are implemented/ interpreted by relevant regulatory authorities.

There has been significant movement here recently. The European Securities and Markets Authority (“ESMA”) has finally published its draft remuneration guidelines.  Not surprisingly, they draw extensively on the guidelines already in place on remuneration policies for banks and certain other investment firms which, have been implemented in the UK through the FSA’s Remuneration Code (the “Remuneration Code”).  However, there are still a number of issues on which ESMA is seeking responses. In addition, although the FSA will have fed into the ESMA paper, its own views have not yet been disclosed. These will be important as the actual implementing legislation in this area in the UK (ie the equivalent of the Remuneration Code) will be the FSA’s responsibility.

The ESMA consultation is open until 27 September 2012, although there is likely to be a further consultation on remuneration from an investor protection angle which will also influence ESMA. Final ESMA guidelines should be adopted later this year, hopefully in good time for the FSA to implement rules with effect from 22 July 2013, when the majority of the AIFMD provisions also come into force.

Basic Principle

The basic principle for remuneration is that fund managers caught by AIFMD (“AIFMs”) must establish and implement remuneration policies that 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 governing instruments of the funds (“AIFs”) they manage.  The remuneration policy adopted by the AIFM should be in line with the business strategy, objectives, values and interests of the AIFM, the AIFs which it manages or the investors in the AIFs.

Scope - AIFMs

The new rules will apply to all AIFMs within the scope of the AIFMD, as follows:

  • EU AIFMs that manage one or more AIFs, whether or not those AIFs are EU AIFs or non-EU AIFs;
  • Non-EU AIFMs that manage one or more EU AIF; and
  • Non-EU AIFMs that market one or more AIFs in the EU, whether or not those AIFs are EU or non-EU AIFs.

However, non-EU AIFMs which market units or shares of AIFs to professional investors in Member States without a passport will not be subject to the remuneration requirements – but will be subject to the rules on remuneration disclosure – until the “private placement” regime ends (probably in 2018/19). Whether a firm is within AIFMD is outside the scope of this Law-Now.

One question which has been raised for some time is the danger of overlap. If a firm is subject to both the AIFMD guidelines and the Remuneration Code, does it have to comply with both or does one take precedence? The ESMA guidelines suggest both, which could prove administratively complex, although in practice these AIFMs will already be familiar with the application of Remuneration Code and so the AIFMD is likely to have limited impact.  Difficulties could arise, however, if a firm is Tier 4 for Remuneration Code purposes (the maximum level of flexibility) but does not benefit from the same degree of flexibility under the AIFMD rules. Accordingly, it remains to be seen how the FSA will apply the AIFMD to those AIFMs already caught by the Remuneration Code, particularly on grounds of proportionality if AIFMD implementation differs from the Remuneration Code.

Scope – Remuneration

As with the Remuneration Code, the definition of remuneration is very broad. The remuneration to which the guidelines apply covers all forms of payment or benefits provided by an AIFM (salary or bonuses), or paid by the AIF itself, in return for the professional services of the AIFM staff.  It includes any transfer of units or shares of the AIF, eg options or special classes of management share.

ESMA’s pronouncements on carry were the most eagerly awaited provisions in the draft guidelines. Carried interest is defined as a share in the profits of the AIF accruing to the AIFM as compensation for the management of the AIF.  Here, however, ESMA distinguishes between what is the result of real investment by management and what is not. Returns pro-rata to the investment made are not treated as subject to the remuneration requirements of AIFMD. In the UK, HMRC expects very little to be paid up-front for carry for it to be acquired for market value and it might be hoped that the FSA would allow the same principle to apply to allow carry to be excluded, but this seems unlikely and outside the spirit of the legislation. Carry is therefore likely to be covered as remuneration. Co-investment clearly is outside the scope, though the FSA’s Remuneration Code has never said this expressly. Details need to be ironed out here: for example, ESMA would treat deferred payment arrangements as causing any investment to be caught by the remuneration requirements.

In practice, it might be thought the distinction may not matter greatly because if the remuneration is consistent with the ESMA remuneration principles anyway (and carry is expressly stated by the guidelines as likely to be), then it should not matter whether carry is in or outside the scope. However, a firm will need to know for reporting purposes whether it is, or is not, remuneration and so greater clarity will be needed than is currently given.

Standard employee benefits, such as mobile phones, are not considered risky and so fall outside the scope of the guidelines.

Scope – Staff

The basic principle on remuneration policy should be applied to all staff, as should the requirements regarding termination packages and personal hedging (see below).

However, the remaining principles are only required to be applied to “Identified Staff” – ie staff whose professional activities have a material impact either on the AIFM’s risk profile or the risk profiles of the AIF it manages – although AIFMs should consider whether they should be applied more widely.  “Identified Staff” is the analogous term to “Code Staff” under the Remuneration Code.  An AIFM must identify which members of staff should be Identified Staff and be able to demonstrate how they have assessed and selected the relevant individuals.  EMSA considers that individuals in the following categories must be Identified Staff, unless it can be shown that they have no material impact on the AIFM’s risk profile:

  • Members of the governing body of the AIFM – this includes directors, the CEO and partners;
  • Senior management;
  • Staff in control functions – ie staff responsible for risk management, compliance, internal audit and similar functions within the AIFM;
  • Staff responsible for heading the portfolio management, administration, marketing and human resources functions;
  • Other risk takers – ie staff whose professional activities (individually or collectively) can exert material influence on the AIFM’s risk profile or (and this is where AIFMD goes further than the existing Remuneration Code) on an AIF it manages.  This will include individuals capable of entering into contracts/positions and taking decisions which materially affect the risk positions of the AIFM or the AIF it manages, such as traders.  It will be for the AIFM to define what constitutes “material” in the context of their AIFM and the AIFs they manage, although they will need to be able to justify this to the FSA; and
  • Individuals who have a material impact on the risk profile of the AIFM, or the AIFs it manages, who do not fall within the above categories and whose total remuneration takes them into the same remuneration bracket as senior managers and risk takers.

Scope – Proportionality

Whilst the guidelines specify the categories of AIFMs and staff to be within the scope of the remuneration principles, it is recognised that the rules should be applied on a proportionate basis, in much the same way as the Remuneration Code for banks is applied proportionately.

Whilst some rules will apply to all AIFMs and their staff, or where appropriate their Identified Staff, other provisions can be applied proportionately, including the rules (explained further below – see General Remuneration Requirements) on:

  • Paying variable remuneration in the form of shares (or other non-cash instruments), retention of shares etc, deferral of receipt of remuneration and adjustment of deferred variable remuneration if clawback is required;
  • The remuneration of management and the annual review of the remuneration policy; and
  • The requirement to have a fully flexible policy on variable remuneration i.e. the ability not to pay anything more than just salary if circumstances so require.

As these are the very rules which can be onerous to comply with in structural terms, it is disappointing that little detail is given in the guidelines about how the proportionality principle should be applied. However, the European banking guidelines did not say very much either and reassuringly the Remuneration Code gave much more detail and leeway.  National supervisors will also have flexibility to determine how proportionality should apply in their own countries for AIFMD purposes.  The FSA’s views here will therefore be eagerly awaited and there will no doubt be much lobbying to reduce obligations as much as possible. The fact that only fund managers with €250 million or more under management have to have a remuneration committee may, for example, give grounds for hope that the threshold for firms having to implement these structural rules will be quite high.


The AIFM’s supervisory body (which will mean different things according to the legal structure of the AIFM) must take responsibility for overseeing the AIFM’s remuneration policy and should ensure that the remuneration policy is in line with the AIFM’s business strategy, objectives and values, aligns the interests of the AIFs and their investors with the Identified Staff managing the AIF and does not encourage excessive risk taking.

The supervisory function should ensure the remuneration policy is reviewed at least annually to ensure that the policy operates as intended and is compliant with national and international regulations, principles and standards, although this will be applied on a proportionate basis.

AIFMs which are significant in terms of their size or the size of the AIFs they manage should establish a remuneration committee to carry out the supervisory function.  AIFMs with a portfolio of less than €250 million in value, or which are subsidiaries of credit institutions that are required to have a remuneration committee and which performs its duties for the whole group, are not required to establish a remuneration committee.  However, establishing a remuneration committee is still seen as good practice.

Staff engaged in control functions should be compensated in accordance with the achievement of the objectives linked to their control functions, which should be independent of the performance of the business unit they control, in particular where they are eligible to receive variable remuneration.  The remuneration of senior control function staff should be determined by the remuneration committee.

General remuneration requirements

The draft guidelines establish a number of remuneration principles, which include:

Termination Payments:

Payments made to leavers must reflect performance over time – ie there should be no “reward for failure”. AIFMs must be able to explain the criteria used for determining a termination payment amount.  This principle applies to all staff.

Prohibition of personal hedging:

Personal hedging by staff is prohibited as it may undermine the risk alignment incorporated in their remuneration arrangements.  This principle also applies to all staff.

Variable remuneration:

The following principles are likely only to apply to the largest/riskiest firms on the basis of the proportionality principle and then only to Identified Staff.  The guidelines encourage wider application, but, if the experience of the Remuneration Code is anything to go by, few companies have voluntarily chosen to impose additional obligations on themselves if they were not already doing so.

Variable remuneration is anything other than salary. The AIFM must have a fully flexible policy on variable remuneration, which allows it to be reduced as a result of poor performance, possibly to zero.  Interestingly, the restriction on guaranteed bonuses which featured so strongly in the banking sector implementation of the Remuneration Code (and is also contained in AIFMD) does not surface in the ESMA guidelines in the same way, but that may be because it is now beyond discussion. Variable remuneration should be performance based and risk adjusted and this should be applied when determining:

  • Performance criteria – The amount of variable remuneration that an individual is eligible to receive should be determined by his own performance, that of the business unit to which he belongs or the AIF concerned, and the performance of the AIFM as a whole. The performance criteria should not encourage excessive risk taking;
  • Assessing performance – The amount actually paid should be adjusted for potential adverse developments in the future.  All risks should be taken into account, whether on or off balance sheet, and the AIFM should differentiate between risks affecting the AIFM, the AIFs it manages, the business units and individuals.  The AIFM must be able to demonstrate how this has been done;
  • The payout process – Payment of the variable remuneration should be aligned to the life-cycle and redemption policy of the AIFs managed by the AIFM, and:
    • at least 40% (rising to 60% for particularly high variable remuneration) should be deferred over a period which is appropriate given the life cycle and redemption policy of the AIF concerned.  In general, the deferral period will be three to five years unless the life-cycle of the AIF is shorter.  Deferred awards should vest no more quickly than on a pro-rata basis and no more frequently than annually;
    • at least 50% of upfront and deferred variable remuneration should be paid in the form of units or shares of the AIF (note not AIFM) concerned or equivalent instruments. This may cause many problems as carry or other similar arrangements do not directly use AIF instruments, and in other arrangements where AIFMs receive a management/performance fee in cash and more guidance will be needed here for those AIFMs for whom the proportionality principle does not disapply this principle;
    • AIFMs should also determine an appropriate retention policy; and
    • variable remuneration should be subject to clawback or malus (where unvested deferred remuneration is reduced where assumptions which led to earlier payments prove not to be true).

Helpfully, ESMA imply that standard carry arrangements should satisfy these rules (provided there is clawback until the fund is wound up). 

While the banking sector is facing caps on the ratio of variable remuneration vs fixed remuneration which are being proposed in the European Parliament, nothing yet has surfaced under AIFMD on this.


The AIFMD requires certain minimum levels of disclosure on remuneration in the AIF’s annual report.  This includes information about the total amount of fixed and variable remuneration paid by the AIFM, including where relevant carried interest is provided by the AIF.  It must also include information on the link between pay and performance, the performance criteria used and how this has been risk adjusted.  AIFMs must ensure that the remuneration policy is accessible to all members of staff, although confidential quantitative aspects do not need to be disclosed.

Concluding comments

With so much uncertainty on how the ESMA guidelines will emerge, and so much uncertainty on the FSA’s own position and the proportionality thresholds, it is difficult for firms to plan for what will be required. Also, nothing has yet been released on how existing arrangements will have to be changed to comply and any timescale for this, which was a key issue when the Remuneration Code was first introduced.

A copy of the draft guidelines is available here.  A link to the page for responding to the consultation is available here