The final text of the AIFM Directive was published in July 2011. It must be implemented in the UK by 22 July 2013. The task of transposing the Directive into practical regulations lies primarily with the newly formed European Securities Market Association, which is currently consulting with regulators in member states. The task of transposing the Directive into workable rules at national level by 2013 is ambitious.
In addition, the EU is conducting a consultation exercise on whether a separate regulatory structure should be established for the venture capital industry (loosely defined as the provision of capital to start-ups, early stage companies and SMEs), either within AIFMD or separately. Whether the consultation process results in concrete proposals may be known by the end of 2011 or early in 2012.
In the meantime, this briefing looks at the impact of AIFMD in the area of remuneration.
The Directive requires AIFMs to:
- Have remuneration policies and practices for relevant staff that avoid conflicts of interest, that are consistent with and promote sound and effective risk management and that do not encourage risk-taking that is inconsistent with the risk profiles, rules or instruments of incorporation of the AIFs it manages
- Disclose to investors certain remuneration information in relation to AIFs managed or marketed within the EU.
The staff to which the remuneration policy must be applied are the same categories that are “code staff” under the FSA Remuneration Code: those engaged in senior management, risk taking functions, control functions and any other employee receiving total remuneration that puts them in the same bracket as those categories.
The detailed principles on which remuneration policy and practice must be based are set out in Annex II to the Directive – see link [here]. The main principles are that:
- Fixed and variable components should be appropriately balanced
- At least 50% of variable remuneration should consist of units or shares of the AIF 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)
- At least 40% of variable remuneration should be deferred over an appropriate period (vesting on a pro rata basis) reflecting the lifecycle and redemption policy of the AIF which the Directive suggests should be 3 to 5 years unless the lifecycle is in fact shorter
- Payment and vesting of variable remuneration should be subject to the overall financial performance and downward adjustment or malus
- Guaranteed variable remuneration should be exceptional and limited to new hires in their first year
- Payment on termination of employment should reflect performance and not reward failure
- AIFMs that are “significant” in size or in terms of the size of the funds they manage should establish a remuneration committee to oversee remuneration policy.
Sanctions for non-compliance are a matter for each member state to determine.
Remuneration disclosure obligations
The AIFM must produce an annual report for investors of each fund that it manages or markets in the EU. The report must contain the following remuneration information:
- The total amount of remuneration for the financial year, split into fixed and variable remuneration, paid by the AIFM to its staff and, in relation to carried interest, the number of beneficiaries and the carried interest paid by the AIF
- The aggregate amount of remuneration broken down by senior management and members of staff of the AIFM whose actions have a material impact on the risk profile of the AIF.
In general terms, compliance with the principles in Annex 2 of the Directive is on the basis of proportionality: the AIFM must comply in a way and to an extent that is appropriate to its size and internal organisation and the nature, scope and complexity of its activities. Therefore the proper approach to compliance may vary between AIFMs.
There are a number of problematic areas in relation to remuneration, for example:
- Although the Directive expressly refers to carried interest as being an element of remuneration (in contrast to the FSA Remuneration Code), the definition used in the Directive does not fit with typical carried interest structures in funds managed in the UK
- The requirement to award variable remuneration in the form of fund interests or other non-cash form has the potential to dilute investors but is subject to the legal structure and incorporation documents of the fund and may therefore be trumped by existing anti-dilution provisions or structures in which such interests cannot easily be granted
- The Directive is silent on whether profits payable to LLP members in an LLP ownership structure are to be counted as remuneration, although arguably the spirit of the Directive suggests that they should be.