A number of new European legislative efforts regulate pay in the financial services and asset management sectors.

New rules regulating how and how much staff are paid will be introduced in Europe under three separate European directives, CRD IV, AIFMD and UCITS V. European member states will need to implement these new rules, which will also impact non-European headquartered firms (including certain US firms) carrying out relevant activities in Europe. This Client Alert outlines each of the three European directives and how affected businesses should prepare for their introduction.

EU Cap on Bankers’ Bonuses: Goodbye to the Bonus Culture?

In an effort to end what a leading European legislator has described as the “gambler mentality in the investment fund sector”, the European Parliament has recently approved the implementation of Capital Requirements Directive IV (CRD IV) which amends the EU’s rules on capital requirements for banks and investment firms. This proposal — which, subject to certain nuances, could see bonuses for certain employees capped at 100 per cent of fixed salary — is arguably designed to assuage public dissatisfaction regarding the bonus culture, and ensure the re-election of certain eminent European leaders this year.


The new rules are anticipated to be in force from 1 January 2014. Assuming implementation in January 2014, the rules will initially impact those bonuses paid in 2015 concerning performance in 2014.

What do the new rules say?

CRD IV introduces additional transparency and disclosure requirements for individuals earning over €1 million per year. However, the most controversial aspect of CRD IV hinges on the expected impact on bonuses — under CRD IV they will be capped at 100 per cent of base salary.

This cap can be increased to 200 per cent with the approval of a simple majority of the shareholders (unless fewer than half of the shares are voted, in which case a 75 per cent shareholder approval would be required). Shareholders must be able to justify the reasons for and the scope of approval sought, including the number of staff affected, their functions and the expected impact on the requirement to maintain a sound capital base.

Even with shareholder approval to increase the maximum bonus above 100 per cent of base salary, these new rules will also require that 25 per cent of any bonus above this initial 100 per cent cap must be deferred for at least five years in the form of long-term deferred instruments, such as shares and contingent convertible debt instruments. This deferred remuneration can benefit from a discounted valuation for the purposes of the cap provided the deferred portion is subject to clawback and is delivered in shares or bail-in bonds (a form of convertible debt).

The European Banking Authority (EBA) is expected to publish guidelines on the applicable discount rate by March 2014, taking into consideration inflation rate, risk and appropriate incentive structures. Firms will be able to set specific criteria for the application of these malus and clawback arrangements, including, for example, where an employee participated in or was responsible for conduct which resulted in significant losses to the institution, or failed to meet appropriate standards of fitness and propriety.

CRD IV continues to apply the existing restrictions that at least 50 per cent of total variable remuneration should consist of equity-linked interests and at least 40 per cent of the variable component must be deferred over a period of three to five years.

As a concession to certain objections to the impact of CRD IV, the European Commission has agreed to conduct a review of the impact of the Directive on competitiveness and financial stability by June 2016.

Whose bonuses are at risk?

As with the existing Capital Requirements Directive, CRD IV will apply to credit institutions and investment firms that fall within the scope of the Markets in Financial Instruments Directive. At this stage it is not clear whether the rules will be applied “proportionately” so that smaller institutions (currently classified as “Tier 3” under the CRD III remuneration rules) can exempt themselves from the bonus cap. Earlier in the year, it seemed likely that this bonus cap would be included in the Undertakings for Collective Investments in Transferable Securities (UCITS) Directive (which is currently being drafted — see below). However, on 3 July 2013 the European Parliament voted against the inclusion of the bonus cap in the UCITS V Directive. The Alternative Investment Fund Managers Directive (which is due to be implemented by all European member states by 22 July 2013 — see below)) does not include a bonus cap.

Not all staff will be within the scope of CRD IV. Broadly, the rules only apply to:

  • Members of senior management
  • Risk-takers
  • Staff who perform control functions
  • Any other employee whose total remuneration brings them into the same pay bracket as those employees listed above

On 21 May 2013 the EBA launched a consultation paper on the qualitative and appropriate quantitative criteria to identify these staff categories. According to the consultation paper, these criteria would be:

  • Standard qualitative criteria — Related to the role and decision-making power of staff members (i.e. if an employee is a member of a management body, is a senior manager, has the authority to commit significantly to credit risk exposures, etc.)
  • Standard quantitative criteria — Related to the level of variable or total gross remuneration. Employees should be identified as material risk-takers if any of the following apply:
    • Their total remuneration exceeds, in absolute terms, €500,000 per year
    • They are within 0.3 per cent of staff with the highest remuneration in the institution
    • Their remuneration is equal to or greater than the lowest total remuneration of senior management and other risk-takers
    • Their variable remuneration exceeds €75,000 and 75 per cent of the fixed component of remuneration
  • Internal criteria — Based on internal risk assessment processes and should reflect the specific institution’s risk profile

The introduction of a specific remuneration level as a criteria for defining who is within the scope of the cap would significantly fetter firms’ discretion in determining who they consider to be material risk-takers. This proposal would increase the number of affected employees by an estimate of up to ten times at some organisations. Currently several groups are lobbying for this broad brush approach to be revised — in particular to remove from scope anyone whose variable remuneration exceeds €75,000 which will bring so many more employees into scope in the financial services industry.

CRD IV has a wide reach both within and outside Europe (in respect of EU-headquartered firms). For example, employees of organisations headquartered in the EU will be within scope, even if they live and work outside the EU. This has spurred concern that EU-headquartered institutions will struggle to compete for top talent in US and Asian markets. At present, the Commission’s only concession to this concern is the assurance to assess the Directive’s extra-territorial impact as part of the June 2016 review. Unfortunately, an assessment assurance does not provide firms with much comfort prior to that date. Organisations which are headquartered outside the EU, but which have operations within the EU, will be within the remit of CRD IV with regards to EU-based employees.

How can the impact of CRD IV be minimised?

  • Increase fixed pay. Increasing base salaries may appear an obvious solution, however this is not necessarily an attractive option to employers as they enjoy the flexibility offered by the fact that a large portion of bonuses are currently subject to specific deferral and clawback restrictions. If the balance of remuneration is adjusted so the proportion which accounts for fixed base salary is significantly increased, this makes clawback of these amounts, if performance is poorer than expected, almost impossible. In addition, a significantly increased base salary means employees will have less to lose, which would arguably adversely affect the risk-taking culture these measures are purported to address.
  • Place a portion of fixed pay on escrow. Paying a portion of fixed pay into escrow and/or subjecting it to claw-back provisions would afford employers more control and flexibility than simply increasing base salaries. However, this approach risks that any remuneration which is subject to certain conditions, or claw-back provisions, would be deemed to be variable, and therefore subject to the cap.
  • Re-categorise a portion of remuneration as housing or other allowances. Arguably this would have the same effect as increasing base salary, although increasing and/or decreasing these allowances may be possible. One approach could be to pay employees an allowance in respect of their “code staff” responsibilities — i.e. those responsibilities which bring them within the scope of the bonus cap. However, there is a risk that these allowances would simply be considered part of the variable remuneration and would therefore fall within the remit of variable remuneration subject to the cap.
  • Offer employees equity or similar units. This strategy would allow employers to compensate employees in their separate capacity as shareholders or similar owners. However, such compensation may require introducing a new class of shares or other complicated arrangements, which employers may be reluctant to do — particularly in relation to less senior employees who may nevertheless fall within the scope of CRD IV, as new shareholder classes would require shareholder approval and may even pose a risk of diluting existing shareholders’ rights.
  • Bifurcate employees’ income. Requiring employees to enter into dual employment relationships with two separate group entities pursuant to which they perform risk-taking or similar activities for one entity which would be within the scope of CRD IV, and other out-of-scope activities for the second entity (e.g. business development or overall group strategy). Bifurcation may permit organisations to offer employees large bonuses under their second employment relationship which would not be subject to this cap. However, (i) this may not be feasible for employees whose total activities fall within the scope of CRD IV and (ii) there is a risk that the UK Financial Conduct Authority (FCA) or other applicable regulatory authority would deem this remuneration structure a sham and still apply the cap to these bonuses.

In the absence of a simple solution to the problems posed by the cap on bonuses, banks and investment firms likely will focus heavily on ever more creative remuneration structures to minimise as much as possible the impact CRD IV may have on employee satisfaction, recruitment and retention.

AIFMD: The Net Tightens Over Private Equity and Asset Management Firms

By 22 July 2013, each European Member State must implement the European Alternative Investment Fund Managers Directive (AIFMD) which will impose a raft of new regulations on alternative investment funds (AIFs) and alternative investment fund managers (AIFMs), including how (and how much) they pay their staff. These rules will be familiar to FCA-regulated firms who have been subject to similar (although not identical) rules since 2011. However, for a number of firms — in particular private equity funds, hedge funds and real estate funds — the AIFMD will introduce rules on remuneration for the first time. The new rules will also apply to firms based outside the EU (including in the United States) if they are marketing or managing AIFs within the EU.


The AIFMD came into force in July 2011 and European member states have until July this year to implement its provisions. The AIFMD is intended to establish an EU-wide harmonized framework for monitoring and supervising risks posed by AIFMs and the AIFs they manage. Annex II of the AIFMD sets out a number of remuneration principles which AIFMs are expected to apply to certain staff involved in AIF management.

Latest developments

On 3 July 2013 the European Securities and Markets Authority (ESMA) published its final guidelines on the remuneration rules contained in Annex II of the AIFMD, although some uncertainty persists as to how the rules will work in practice. Each member state’s relevant financial services governing body is expected to implement the rules for its jurisdiction. For example, on 28 June 2013 the FCA published a policy statement explaining how it will implement the new rules under a new AIFM remuneration code. This code will operate alongside the existing remuneration code which applies to FCA-regulated banks, building societies as well as certain investment firms (the Remuneration Code). The FCA have stated that compliance with the new AIFM remuneration code will be deemed to be compliance with the previous code for those firms that are subject to both codes from 22 July 2013. In France these new rules likely will be implemented by way of ordinance and amendments to the French financial market authority (the Authorité des Marchés Financiers) regulations.

However, these new rules may have a limited impact in France in light of the fact that several provisions set out in the AIFMD have already been implemented into French legislation pursuant to an agreement between the Authorité des Marchés Financiers and the main French associations representing alternative investment fund managers regarding remuneration policy. This agreement, which was entered into in November 2010, already provides for deferral of remuneration and the linking of performance related remuneration based on the performance of the investment fund.

Which firms will the AIFMD remuneration rules affect?

Broadly, an AIF is a “collective investment undertaking” which is not subject to the UCITS regime, and includes hedge funds, private equity funds, venture capital funds, retail investment funds, investment companies and real estate funds, among others. Broadly, AIFMD will capture the following firms:

  • EU AIFMs — including managers of AIFs which have their registered office in an EU member state and manage one or more AIF, regardless of whether the AIF being managed is an EU or non-EU AIF
  • Non-EU based AIFMs which manage one or more EU based AIF
  • Non-EU based AIFMs, if marketing AIFs within the EU, regardless of whether the AIF being marketed is an EU or non-EU AIF
  • Certain firms used as authorised depositaries

Clearly, therefore, fund managers based in the US or elsewhere outside the EU can be captured by the AIFMD rules. The FCA has confirmed that it will not apply the remuneration provisions to those AIFMs managing funds worth less than €100 million.

Managers of UCITS are not covered by the AIFMD although managers of FCA-authorised non-UCITS funds will be covered including non-UCITS retail schemes, funds of alternative investment funds and qualified investor schemes. See below for more information on the proposed new European regulations applicable to UCITS managers’ remuneration.

Which employees will the rules affect?

The AIFMD rules will take a similar approach to the Remuneration Code applicable to FCA-regulated firms in targeting staff whose professional activities have a material impact on the risk profile of the AIFM or the AIF being managed. These “identified staff” are likely to include:-

  • Senior managers — including executive and non-executive members of the AIFM’s governing body
  • Risk-takers — likely those taking investment decisions and therefore potentially having a material impact on the AIFM’s risk profile
  • Employees whose remuneration puts them into the same pay bracket as senior managers and risk-takers — if their activities have a material impact on the risk profile of the AIFM (or the AIF being managed)
  • Employees carrying out control functions such as legal, compliance, risk management and human resources

The AIFMs are responsible for determining which staff fall into these categories and should be able to demonstrate to their regulator how they categorised their “identified staff”.

In addition, the new rules will apply to external organisations’ staff to whom the AIFM has delegated risk or portfolio management. The AIFM will be responsible to ensure that any such delegates are either subject to the AIFMD rules (or equivalent rules) themselves, or impose contractual obligations on the delegate to comply with the rules when compensating its staff for the performance of activities on behalf of the AIFM. At this stage whether any other rules will be deemed “equivalent” to the AIFMD rules remains ambiguous, which likely means that AIFMs will have to impose prescriptive contractual obligations on their delegates.

What type of payments will be regulated?

The new rules will apply to:

  • All payments and benefits paid by the AIFM
  • Any amount paid directly by the AIF, including carried interest
  • Any transfer of AIF shares or units (or similar instruments),

in each case in return for professional services rendered by the AIFM’s “identified staff”.

The express inclusion of carried interest is perhaps the most controversial aspect for many private equity firms — given that most carried interest arrangements already inherently incorporate the sound risk management principles pursued by the AIFMD (e.g. alignment of employee/stakeholder interests, performance linked remuneration and deferral of payment). The inclusion of carried interest is also controversial since the AIFMD appears to treat carried interest as income, whereas in many jurisdictions in Europe and in particular the UK, carried interest is generally treated and taxed as a capital payment.

The AIFMD defines “carried interest” as “A share in the profits of the AIF accrued to the AIFM as compensation for the management of the AIF and excluding any share in profits of the AIF accrued to the AIFM as a return on investment by the AIFM to the AIF.”

The distinction between a “share in profits” accrued as compensation for the manager (which will be subject to the new rules) and a “pro-rata return on investment” made by the manager (which will not be subject to the new rules) is therefore key.

The ESMA guidance also confirms that, to the extent an individual is granted a loan in order to invest in the AIF, if that loan has not been repaid in full by the time the return on investment is paid, the loan will not be classified as an “investment” and will not be exempt from the new rules. The reasoning for this treatment is there must be an “actual disbursement” by the individual for a co-investment to be exempt from the new rules. This approach could cause problems where an individual receives some return on investment (with more to follow) at a stage when they have not yet repaid any loans taken to co-invest.

Dividends or similar distributions to employee shareholders or partners of AIFMs are not caught by the new regulations unless the material outcome of the payment of the dividends results in circumventing the remuneration rules (whether intentionally or not). Again the guidance is intended to allow genuine “co-investment” (as opposed to remuneration) to escape regulation.

What are the new rules?

In summary, AIFMs captured by the new rules will have to comply with the following:

  • Remuneration policy — The AIFM should design and implement a remuneration policy which is consistent with and promotes sound and effective risk management. The policy should not encourage risk-taking which is inconsistent with the risk profiles, rules or instruments of the AIFs being managed. The policy (and its implementation) should be regularly reviewed by the AIFM’s management body.
  • Disclosure — AIFMs will be required to make annual disclosures which should include disclosure of aggregate amounts paid by the AIFM to its staff, including details of how this amount is split between variable/non-variable pay, the number of recipients, any carried interest arrangements, and the amount paid to “risk-takers” and senior management. Some disclosures are also required by reference to the relevant AIF under management. Crucially, the ESMA guidelines have clarified that these disclosures should be made to the relevant regulator and will not be public disclosures.
  • Control function staff — Staff in control functions should be remunerated by reference to objectives linked to their functions (and not solely by AIFM-wide performance criteria). For example, risk management staff should not be incentivised by reference to the AIFM’s financial performance. The remuneration committee should oversee the remuneration of senior officers in the risk management functions.
  • Remuneration committee —- Certain AIFMs, depending on their size and the size of the AIFs that they manage, will be required to introduce a remuneration committee. The remuneration committee members should be non-executive directors.
  • Performance related remuneration — Where pay is performance linked, assessment of performance must: (i) include risk adjustment mechanisms; (ii) take into account non-financial and financial criteria; (iii) be set in a multi-year framework appropriate to the life-cycle of the AIF; and (iv) be based on a combination of individual performance, performance of the relevant business unit and performance of the AIFM as a whole.
  • Guaranteed bonuses — Guaranteed bonuses should only be agreed on in exceptional circumstances, in the context of recruitment, and must be limited to the first year of the new recruit’s employment.
  • Fixed/variable ratio — The proportion of fixed to variable remuneration must be appropriately balanced and the fixed portion should be sufficient to allow for the proper operation of variable remuneration (including allowing for no variable remuneration to be paid at all).
  • Severance payments — Severance payments must reflect the employee’s performance over time and must not reward failure.
  • Proportion to be paid in shares/units — 50 per cent of variable remuneration should be paid in units or shares “mainly” of the relevant AIF being managed. An appropriate retention policy should also apply to these instruments.1 There appears to be some flexibility in terms of allowing staff to hold instruments in AIFs which they do not directly manage.
  • Deferral — At least 40 per cent (and in some cases 60 per cent) of variable remuneration must be deferred over at least three years (and in some cases five years).
  • Payment/vesting of deferred amounts — Deferred amounts must be subject to payment and vesting provisions, depending on the financial situation and performance of the relevant individual, business unit and AIF.
  • Reduction/clawback rules — Variable remuneration should be reduced or clawed back where the AIFM or AIF performs badly.
  • Pensions — An AIFM’s pension policy should be in line with the business strategy and long term interests of the AIFM and the managed AIFs. Certain discretionary pension benefits should be held by the AIFM in non-cash instruments for a five year period in certain circumstances where an identified staff member retires early.
  • Personal hedging strategies — AIFM identified staff must not use personal hedging strategies or remuneration to undermine the risk alignment effects of their remuneration arrangements.


The AIFMD allows the AIFM to take a proportionate approach to complying with the new remuneration principles in a way, and to the extent, appropriate to the AIFM’s size, internal organisation, and the nature, scope and complexity of its activities. The ESMA guidelines slightly clarify this fairly opaque language. In particular, the guidelines explain that the following rules can be disapplied in “exceptional circumstances” if reconcilable with the risk profile, risk appetite, and strategy of the AIFM and the managed AIF:

  • The requirement to defer between 40 per cent and 60 per cent of variable remuneration for three to five years
  • The requirement that 50 per cent of variable remuneration should be paid in instruments other than cash
  • The requirement that non-cash instruments be retained for a period to allow for retrospective risk adjustment
  • The requirement to establish a remuneration committee

This “proportionate” approach which allows certain rules to be “neutralised” will be familiar to anyone who has spent time deciphering the FCA Remuneration Code and should allow some flexibility for affected firms. The ESMA guidance clarifies that disapplication of these rules must be on an all or nothing basis (i.e. employers cannot simply adjust the percentage of variable remuneration paid in non-cash instruments). The 50 per cent rule is either applied or disapplied.

Unhelpfully, the ESMA guidance deliberately does not establish proportionality levels linked to the AIFM’s size which would allow an AIFM more comfort that it can disapply particular rules. ESMA expressly states that size of the AIFMD should not determine the correct proportionate approach, although it does concede that an AIFM with assets under management of less than €1.25 billion and fewer than 50 employees may not be required to establish a remuneration committee. Even then, the disapplication of a rule should never be automatic and AIFMs will be expected to collate evidence as to why the disapplication was deemed proportionate.

Hopefully, the FCA will provide more clarity in due course on exactly how proportionality will work in practice. In particular, we anticipate that AIFMs will be keen to disapply the rules proscribing that a particular percentage of remuneration should be deferred and paid in shares or units. Compliance with these rules will require certainty as to the value of each individual’s variable remuneration at any given time (which will be difficult when factoring in carried interest whose value is difficult to ascertain until paid).


All European member states have until 22 July 2013 to implement the AIFMD remuneration rules. Under the transitional provisions, AIFMs which have been managing funds before that date have a one year grace period in which to comply with the new rules. However, initially non-EU AIFMs which market non-EU AIFs without a passport to professional investors will not be required to comply with the remuneration rules, except insofar as they relate to disclosure in the AIF annual report.

UCITS V: Further Regulation on the Horizon

The AIFMD does not capture UCITS. Anticipated new European legislation known as EU Directive UCITS V, however, would introduce similar but potentially more onerous remuneration restrictions on UCITS managers.

The draft UCITS V directive published in July 2011 initially proposed an approach similar to the AIFMD in that:

  • Affected firms would be expected to introduce remuneration policies which promote sound and effective risk management and discourage risk-taking which is inconsistent with the UCITS risk profile.
  • New remuneration rules would apply to “identified staff” who, broadly speaking, would be those risk-takers and senior managers whose activities could affect the risk profile of the firm.
  • The rules would cover requirements to balance the proportion between fixed and variable remuneration, defer at least a proportion of variable remuneration over an appropriate period, and pay at least 50 per cent of variable remuneration in units of the UCITS being managed or equivalent ownership/non-cash instruments.

So far, fairly familiar. However, in March 2013, the European Parliament’s Economic and Monetary Affairs Committee (ECON) voted in favour of certain additional proposals that UCITS V should incorporate, including the introduction of a cap on staff bonuses on a 1:1 ratio with their annual salary. This proposal was designed to align UCITS V with the recently approved limitations on banker bonuses under CRD IV (see above).

Fortunately on 3 July 2013 the European Parliament voted against this amendment to UCITS V and the expectation is now that UCITS V will not contain a 1:1 bonus cap.

The next stage is for negotiations between the European Parliament, Commission and Council to finalise the terms of UCITS V with a view to implementing the directive in the latter half of 2015 or early 2016.

It remains to be seen whether certain other amendments to UCITS V which ECON approved will be included in the final version of the directive. If they are included, they would mean a departure from the approach taken under AIFMD. In particular, these amendments entail:

  • Explicitly including “identified staff,” defined as temporary or contractual staff and also staff members at fund or sub-fund level who are decision takers, fund managers, and people who take real investment decisions or “persons who have the power to exercise influence on such employees” including investment policy advisors and analysts as well as senior management.
  • Expressly prohibiting the CEO and other members of the senior management team controlling the firm’s remuneration system. Remuneration policy should instead be designed and implemented by independent individuals with expertise in risk management and remuneration.
  • An additional disclosure obligation that “comprehensive, accurate and timely information about remuneration practices” is disclosed to all stakeholders. This suggests a level of public disclosure not anticipated in AIFMD.
  • A reduction in the amount of variable remuneration which should be deferred from 40 per cent to 25 per cent.
  • A requirement that where a remuneration committee is required (which will be a question of proportionality as under AIFMD), the committee should include employee representatives and should expressly take into account the long term interests of stakeholders, investors and the public interest.

Once the UCITS V directive is finalised, we anticipate further guidance from both ESMA and the respective member states’ relevant financial services governing bodies as to how the rules will be implemented in each member state.