The European Securities and Markets Authority has published final guidelines on remuneration of alternative investment fund managers, designed to prevent conflicts of interest arising that could lead to managers taking on excessive risk to the detriment of their investors.
The guidelines have been finalised following the publication of a consultation paper in June 2012 and ESMA’s receipt of feedback from industry members, a summary of which is included in the document, along with the opinion of the Securities and Markets Stakeholder Group.
The rules will apply to European Union-based managers of alternative investment funds including hedge funds, private equity funds and real estate funds, and also to non-EU-based managers that market funds to EU investors under passporting arrangements, which will be subject to the guidelines in full after a transitional period. Non-EU managers will become eligible for an AIFM Directive passport following a delegated act by the European Commission in or after July 2015.
The guidelines, which have been drawn up in co-operation with the European Banking Authority in order to ensure alignment of remuneration policy rules across different sectors of the financial industry, will require managers to introduce sound and prudent remuneration policies and organisational structures. According to ESMA, stronger constraints on how fund managers are paid will ultimately lead to improved investor protection.
The authority argues that the remuneration rules will prompt prudence in risk-taking by fund managers and help align their interests with those of investors. It sees the application of the provisions universally and consistently as essential to the establishment of a level playing field in the alternative fund sector throughout the EU.
The rules managers must comply with when establishing and applying a remuneration policy for certain categories of staff are set out in the Alternative Investment Fund Managers Directive, which is scheduled to take effect on July 22, 2013, and ESMA’s guidelines are designed to provide clarification on how the provisions should apply.
ESMA says the governing body of each manager must ensure that sound and prudent remuneration policies and/or structures are in place and are not circumvented. Managers should determine which staff should be covered by the policies and be able to demonstrate the criteria used in making the decision.
The guidelines should apply to staff identified as having professional duties that might have a material impact on the fund’s risk profile, including senior management, “risk takers” and those responsible for control functions, as well as any employee whose total remuneration puts them in the same pay bracket as these categories of staff.
The types of remuneration covered include all forms of payment or benefit paid for professional services or duties by the management company or by the fund itself, including carried interest, as well as any fund units or shares they receive.
The guidelines say all remuneration should be divided into fixed remuneration (payments or benefits not affected by performance criteria) and variable remuneration (additional payments or benefits depending on performance or, in certain cases, other contractual criteria).
Both types of remuneration may include monetary payments or benefits including cash, shares, options or remuneration by funds through carried interest models, as well as non-monetary benefits such as discounts or car allowances.
The guidelines also include the application of the principle proportionality to the remuneration provisions, the structure, role and functioning of an alternative management firm’s remuneration committee, the role of compliance and control functions within the organisation, and the role of pensions and other deferred remuneration.
The guidelines will be next be translated into all the EU’s official languages. Within two months of the publication of the translations on ESMA’s web site, national regulators should confirm to the authority whether they comply or intend to comply with the guidelines by incorporating them into their supervisory practices. They will apply from July 22, subject to the adoption by member states of the AIFM Directive’s transitional provisions.