At least from July 2013, the whole European fund sector will be subject to new regulatory requirements concerning in particular the remuneration of fund managers and of staff with control functions. Therefore affected enterprises must adapt their existing remuneration schemes.

AIFM Directive

The reason for this is that the Directive on Alternative Investment Fund Managers (Alternative Investment Fund Managers – AIFMs, 2011/61/EC) must be transposed into national law until 22 July 2013. In December 2012, the German Federal Government adopted a bill on how to implement the AIFM Directive. It is expected that the Parliament of the Federal Republic of Germany will enact the statute in the next weeks so that it can come into force on 21 July 2013.

Significant Content of the German Capital Investment Code

The bill particularly contains the draft of a capital investment code (Kapitalanlagegesetzbuch, KAGB-E) which on the one hand transposes the European AIFM Directive, but on the other hand also the UCITS Directive (Undertakings for Collective Investment in Transferable Securities, 2009/65/EC) -while repealing the German Investment Act. This will entail substantial alterations for the management and the organisation of alternative investment funds. Some headwords in this context are for example:

  • regulation by the German Federal Financial Supervisory Authority (BaFin )
  • fit & proper test for the management
  • independent risk management
  • depository bank
  • EU passport

The scope of application of the act will encompass

  • closed-ended fund constructions,
  • hedge funds,
  • infrastructure and commodity funds
  • (open-ended and closed-ended) renewable energy and real property investment funds,
  • special funds as well as
  • funds investing in private equity.

The current bill is being criticised by a large number of business associations not only owing to this broad scope of application -partly exceeding the guidelines of the EU Directive. Therefore, it can well be imagined that the provisions of the current bill will be limited during the legislative procedure.

Focus: New Requirements for Remuneration Schemes

However, the national legislator has much less discretion with respect to the remuneration which will in future form a significant part of the risk management. This remuneration will have to be calculated in a sustainable and appropriate manner, without encouraging staff to take risks which are inconsistent with the risk profiles, contractual conditions or instruments of incorporation of the funds they manage.

  • Which staff will be affected by the new remuneration rules?

Comprised will be the management, risk takers and staff with control functions as well as all staff receiving a total remuneration that takes them into the same remuneration bracket as members of the management and risk takers whose professional activities have a material impact on the risk profiles of the AIFMs or of the AIFs they manage.

  • Which specific requirements will the remuneration have to comply with in future?

In addition to the general requirements of sustainability, consistency with business strategies, objectives, values and interests of the AIFM and the AIFs managed by it (or the investors in such AIFs) as well as of lacking encouragement to take risks and of measures for the avoidance of conflicts of interests, the act also contains specific stipulations (§ 37 (2) KAGB-E in conjunction with Annex II of 2011/61/EU). These include the following:

  • fixed and variable components of the total remuneration are appropriately balanced;
  • the fixed component represents a sufficiently high proportion of the total remuneration to allow the operation of a fully flexible policy on variable remuneration components, including the possibility to pay no variable remuneration component;
  • in case of performance-related remuneration: decisiveness not only of an assessment of the performance of the individual employee and his/her business unit and/or of the AIF concerned but also of the overall results of the AIFM (financial and non-financial criteria); assessment of performance is set in a multi-year framework appropriate to the life-cycle of the AIFs managed by the AIFM;
  • the measurement of performance used to calculate variable remuneration components or pools of variable remuneration components must include a comprehensive adjustment mechanism to integrate all relevant types of current and future risks;
  • as a rule, at least 50 % of the variable remuneration components must consist of units or shares in the AIF concerned or equivalent ownership interests;
  • a significant portion of the variable remuneration component (at least 40 %) is deferred over a period of time which is correctly aligned with the nature of the risks of the AIF in question and appropriate in view of the life cycle and redemption policy of this AIF (at least three to five years, unless the life cycle of the AIF concerned is shorter);
  • the variable remuneration, including the deferred portion, is paid or vests only if it is sustainable according to the financial situation of the AIFM as a whole, and justified according to the performance of the business unit, the AIF and the individual concerned. The total variable remuneration shall generally be considerably contracted where subdued or negative financial performance of the AIFM or of the AIFs concerned occurs;
  • staff are required to undertake not to use personal hedging strategies or remuneration and liability related insurance to undermine the risk alignment effects embedded in their remuneration arrangements;
  • guaranteed variable remuneration is exceptional and occurs only in the context of hiring new staff and is limited to the first year;
  • the pension policy is in line with the business strategy, objectives, values and long-term interests of the AIFM and the AIFs it manages;
  • payments related to the early termination of a contract reflect performance achieved over time and are designed in a way that does not reward failure;
  • AIFMs that are significant in terms of their size shall establish a remuneration committee.

The draft KAGB authorises the German Federal Ministry of Finance to issue regulations providing more details, in particular with regard to the actual terms and conditions of the remuneration schemes. Until now, no corresponding draft has been set up yet.

  • staff are required to undertake not to use personal hedging strategies or remuneration and liability related insurance to undermine the risk alignment effects embedded in their remuneration arrangements;
  • guaranteed variable remuneration is exceptional and occurs only in the context of hiring new staff and is limited to the first year;
  • the pension policy is in line with the business strategy, objectives, values and long-term interests of the AIFM and the AIFs it manages;
  • payments related to the early termination of a contract reflect performance achieved over time and are designed in a way that does not reward failure;
  • AIFMs that are significant in terms of their size shall establish a remuneration committee.

The draft KAGB authorises the German Federal Ministry of Finance to issue regulations providing more details, in particular with regard to the actual terms and conditions of the remuneration schemes. Until now, no corresponding draft has been set up yet.

  • What else must be considered when implementing the new requirements?

In addition to the issues mentioned above, the implementation raises questions in terms of labour and employment law:

  • For instance, it has to be examined whether existing works agreements can be replaced by new agreements with the works council. This would avoid that the enterprise must enter into a new bonus agreement with each individual employee concerned.
  • Even if no collective rules concerning variable remuneration exist up to date, the co-determination right of the works council will have to be considered. This does not apply to the overall volume of the bonus benefits, i.e. the "bonus pot", however to their distribution.
  • In particular, the enterprises concerned will have to cope with the challenge to word the new bonus scheme in a "transparent" manner in accordance with the strict requirements set in the rulings of the German Federal Employment Court. This seems to cause a problem not only in respect of the intended adjustment mechanisms for current and future risks, but also of the provision regarding clawback/non-payment in case of a weak financial situation of the AIFM.
  • Furthermore, also the most recent rulings of the German Federal Employment Court concerning cut-off date clauses (Stichtagsklauseln) have to be taken into account when it is intended to withhold a significant portion of the variable remuneration for a multi-year period. Thus, on the one hand the employee may not be granted any claim for the bonus during the withholding period and on the other hand he/she may not unjustly be deprived of remuneration components already earned (see German Federal Employment Court (BAG) of 18 January 2012, case nos. 10 AZR 667/10, 10 AZR 612/10 and 10 AZR 670/10).
  • Finally, alternative courses of action have to be considered in case the employees and/or the works council refuse to agree on new bonus regulations. One could consider withdrawing existing commitments, terminating works agreements, issuing (mass) notices of termination pending a change of contract (Massenänderungskündigung) or invoking the doctrine of change (Wegfall der Geschäftsgrundlage). However, case law imposes strict requirements on each of these options so that every individual case will have to be examined very carefully.