EU Member States are required to implement the Alternative Investment Fund Managers Directive (AIFMD) by 22 July 2013. Annex II of AIFMD contains a set of remuneration principles with which alternative investment fund managers (AIFMs) managing certain alternative investment funds (AIFs) within the scope of AIFMD must comply when establishing and applying remuneration policies for certain types of employees. These principles will apply to a wide range of AIFMs, including managers of hedge funds, private equity funds and real estate funds. The remuneration principles of AIFMD are similar to the remuneration principles established by the Capital Requirements Directive III (CRD III), but are focused upon the alternative investment fund management industry. The remuneration principles established under CRD III have been implemented in the UK through revisions to the FSA’s Remuneration Code (SYSC 19A of the FSA Handbook)

For the remuneration principles of CRD III, the Committee of European Banking Supervisors (CEBS) was required to develop guidelines on sound remuneration principles, and the FSA followed these guidelines when revising the Remuneration Code. For the remuneration principles of AIFMD, the European Securities and Markets Authority (ESMA) is required

to develop guidelines on sound remuneration policies. The FSA will follow these guidelines when deciding how to implement the remuneration principles of AIFMD.

On 28 June 2012, ESMA published a consultation paper outlining its draft guidelines (the Guidelines). This article provides a high-level summary of the key elements of the draft Guidelines and highlights some of the more significant deviations from CEBS’ approach in its guidelines relating to the remuneration principles established by CRD III.

Which Entities are Covered?

The remuneration principles of AIFMD will apply to all AIFMs that are within the scope of AIFMD, namely:

  • ƒƒ AIFMs that have their registered office in a Member State (so-called “EU AIFMs”), which manage one or more AIFs irrespective of whether such AIFs are EU AIFs1 or non-EU AIFs;
  • ƒƒ Non-EU AIFMs that manage one or more EU AIFs; and
  • ƒƒ Non-EU AIFMs that market one or more AIFs in the European Union irrespective of whether such AIFs are EU AIFs or non-EU AIFs.

Which Staff are Covered?

The remuneration principles will apply to staff whose professional activities have a material impact on an AIFM’s risk profile or the risk profiles of the AIFs that it manages (so-called “Identified Staff”). Identified Staff under the Guidelines are effectively the same as Code Staff under the Remuneration Code. Primarily, it will be the responsibility of the AIFM to determine who constitute Identified Staff. The AIFM should be able to show how it has carried out that identification exercise. This should involve an analysis of job functions and responsibilities.

According to the Guidelines, the following categories should be included as Identified Staff, unless the AIFM can establish that the activities of such individuals have no material impact on the AIFM’s risk profile:

  • ƒƒ Members of the AIFM’s governing body (i.e., the directors or management committee members);
  • ƒƒ Senior management;
  • ƒƒ Control functions (not to be confused with the concept of “Controlled Function” as defined by the FSA, which would include all FSA Approved Persons) — namely, staff responsible for risk, compliance, internal audit;
  • ƒƒ Heads of certain business lines — portfolio management, HR, marketing, administration; and
  • ƒƒ Other risk takers who individually or together can assert material influence on the AIFM or AIF’s risk profile (for example, individual traders or trading desks).

In addition, other employees should also be Identified Staff if they have a material impact on the risk profile of the AIFM or AIF, and their total remuneration takes them into the same bracket as senior managers.Currently, under the FSA’s guidance on the Remuneration Code, for asset management firms that ae not part of a group, there is no requirement that a fund manager be classified as Code Staff unless he or she is a senior manager or fills a control function. From the Guidelines as drawn, it seems unlikely that the FSA will apply a similar approach in relation to Identified Staff.

Types of Remuneration

Remuneration for the purpose of AIFMD is defined very broadly. Under the Guidelines, it includes any amounts paid by the AIFM (salary, bonus, profit share) and any amount paid directly by the AIF (including carried interest and transfer of units or shares in the AIF) to Identified Staff in exchange for professional services rendered by the AIFM staff.

Carried interest for this purpose includes any share of profit of the AIF paid to the AIFM (or staff directly) as compensation for managing the AIF, but does not include any pro rata return on a direct investment into the AIF made by the AIFM or any staff, provided that the investment is funded by the staff member. So, profit from investments in the AIF made by Identified Staff out of their personal pockets is not covered. In the same vein, remuneration will not include returns on co-investments made by staff alongside an AIF (a common form of incentive in the private equity sphere) unless that co-investment is funded by the AIFM (for example through loans that have not been repaid by a staff member by the time the return is paid).

AIFMs that are Part of a Group

There will be no exception to the application of the AIFMD’s remuneration principles for AIFMs that are part of a group of companies to which other remuneration principles, such as those under CRD III, already apply.

Remuneration Committee

AIFMs that are significant, in terms of their size or the size of the AIFs they manage, their internal organization and the nature, scope and complexity of their activities, must establish a remuneration committee that is responsible for, amongst other things, the preparation of decisions regarding remuneration. None of the members of the remuneration committee should perform executive functions, and the majority, including the chairman, should be independent.

The Guidelines suggest that although AIFMs that are not significant (in terms of size, internal organization and the nature, scope and complexity of their activities) will not be required to establish a remuneration committee, it would nonetheless be good practice for them to do so. The Guidelines suggest that the following AIFMs will not be considered significant and will not, therefore, be obliged to establish a remuneration committee:

  • ƒƒ AIFMs that manage portfolios of AIFs of 250 million Euros or less, in the aggregate; and
  • ƒƒ AIFMs that are subsidiaries of credit institutions which are obliged to establish a remuneration committee that performs its tasks and duties for the whole group.

Remuneration Principles

ESMA proposes a number of guidelines in relation to each of the remuneration principles of Annex II of AIFMD. The most pertinent are described in the following sections.

Ratio between Fixed and Variable Remuneration

AIFMs must ensure that fixed and variable remuneration elements are appropriately balanced and that the fixed proportion is sufficiently high to allow for a fully-flexible policy on variable remuneration. The Guidelines emphasise that this implies not only that variable remuneration should decrease as a result of negative performance, but also that it can fall to zero in certain cases.


AIFMs must ensure that payment of performancebased remuneration is spread over a period which takes account of the redemption policy of the AIFs they manage. It also requires AIFMs to ensure that a substantial portion, and in any event at least 40%, of variable remuneration is deferred over a period that is appropriate in view of the life cycle and redemption policy of the AIF concerned. Where variable remuneration is particularly high, at least 60% should be deferred. The minimum deferral period is three to five years, unless the AIFM can show that the life cycle of the AIF concerned is shorter. For example, if an AIF’s life cycle is one year, then the minimum deferral period must be at least one year.

As is the case under CRD III, deferred remuneration should not vest more quickly than on a pro-rata basis. For example, where there is a deferral period of three years, deferred compensation should not vest more quickly than at the rate of one third each year.

Performance Adjustment

Variable remuneration (including the deferred portion) must only be paid, or only vest, if it is both sustainable according to the AIFM’s financial situation and justified according to the performance of the business unit, the AIF and the relevant Identified Staff members concerned. The Guidelines make clear that AIFMs must be able to adjust variable remuneration as time goes by and as the outcome of Identified Staff members’ actions materialise. This may be through malus” arrangements (whereby the value of deferred remuneration may be reduced) or clawback provisions.

Non-Cash Instruments

AIFMs must ensure that a substantial portion, and in any event at least 50%, of any variable remuneration consists of units or shares of the AIF concerned (or equivalent ownership interests, share-linked instruments or non-cash instruments), unless the management of AIFs accounts for less than 50% of the total portfolio managed by the AIFM. The Guidelines also make clear that 50% of both deferred and non-deferred variable remuneration should consist of non-cash instruments.

The Guidelines provide that, in order properly to align their interests with those of the relevant AIFs, Identified Staff should only receive non-cash instruments related to the AIFs for which they perform activities. The Guidelines also note that share-linked instruments may not be available in relation to many AIFs, such as common funds, because of the AIF’s legal form or because it may be difficult to determine a share price that represents the AIF’s net asset value between annual net asset value calculations. In such situations, alternative instruments can be used, provided they reflect the AIF’s value and have the same intended effect as share-linked instruments.


Separate from the requirements regarding deferral, non-cash instruments must be subject to an appropriate retention policy designed to align incentives provided to Identified Staff with the interests of the AIFM and the AIFs it manages. The Guidelines emphasise that use of retention periods (such as, for example, a three-year retention period during which the recipient cannot sell the instruments) is the only mechanism available to emphasise the difference between cash paid up front and instruments awarded up front.

Payments Related to Early Termination/Severance

Payments made by AIFMs relating to the early termination of employment should reflect performance achieved over time, and not reward failure. The Guidelines explain that golden parachute payments that entitle employees leaving an AIFM to large payouts without any performance and risk adjustment would be inconsistent with this principle.


Guaranteed variable remuneration must be exceptional, only occur in the context of hiring new staff and be limited to the first year of employment.

The Proportionality Principle

As with CRD III, AIFMD has a proportionality principle that applies to the general and specific remuneration requirements set out in its Annex II. Accordingly, not all AIFMs will have to comply with the remuneration requirements in the same way, or to the same extent.

The CEBS guidelines for CRD III stated that the application of the proportionality principle could lead to certain specified requirements being “neutralized” for institutions with lesser risk profiles. These requirements included, by way of example, payment of 50% of variable remuneration in noncash instruments, deferral of 40% to 60% of variable remuneration for between three to five years, and the application of a maximum ratio between fixed and variable remuneration. From these guidelines, the FSA divided firms into four (now three) tiers and allowed certain firms falling into the third and fourth tiers to disapply (or neutralize) such requirements.

Unlike the CEBS guidelines, there is no mention of “neutralization” in the Guidelines. Instead, the Guidelines say that the proportionality principle may lead to a “tailored” approach, but specify that such tailoring “should not be understood as allowing any AIFM to disregard any of the requirements of Annex II of AIFMD”. There is no equivalent language to that in the CEBS guidelines regarding neutralization. With that said, the list of remuneration requirements to which tailoring may apply under the Guidelines is very similar to the set of requirements to which neutralization was allowed to apply in CEBS guidelines under CRD III.

The difference between the language around tailoring in the Guidelines and the language relating to neutralization in CEBS guidelines suggests that there should be no scope for any AIFM covered by the Guidelines to disapply requirements such as payment in shares and deferral. Nor is there anything in the Guidelines to suggest that there can be any alteration of the fixed numerical provisions of Annex II (such as, for example, the requirements that 50% of any variable remuneration consist of units or shares of the AIF and that 40% or, where relevant, 60% of variable remuneration be deferred for between three to five years).

This is likely to create potential issues for some AIFMs. For example, the Alternative Investment Management Association notes that the requirement for 50% of variable remuneration to consist of non-cash instruments will raise complex issues for the majority of hedge fund managers that do not issue publicly tradable equities or equity-like instruments for which there is a secondary market.

If the requirements cannot be disapplied and the numerical provisions cannot be altered, the question rather remains as to what ESMA is considering could be tailored, and how that tailoring might look in practice.


AIFMD imposes various internal and external disclosure obligations on AIFMs, including a requirement to make an annual report available each financial year for each of the AIFs it markets in the EU and each of the EU AIFs it manages. Such annual reports must contain, amongst other things, information on the total amount of remuneration, split into fixed and variable components, paid by the AIFM to its staff in the financial year.


The consultation on the Guidelines closed on 27 September 2012. ESMA will now consider the responses it received, with a view to finalising the Guidelines in the final quarter of 2012. In finalising the Guidelines, ESMA will also take into account its work on a separate set of guidelines, which will be complementary to the CEBS guidelines, focused on remuneration policies of investment firms from an investor protection perspective.