On 11 February the European Securities and Markets Authority (ESMA) published its guidelines on sound remuneration policies under the AIFMD.
The publication follows the consultation process launched last June, the summary and feedback of which accompanied the release. Subject to some limited exemptions, the guidelines set out the rules to which Alternative Investment Fund Managers (AIFMs) should comply with when establishing and applying the remuneration policies for certain categories of identified staff, and will apply to AIFMs from 22 July 2013.
The next stage will be for competent authorities to whom the guidelines apply to incorporate these into their supervisory practices. This includes where particular guidelines within the document are directed primarily at financial market participants. Both competent authorities and financial market participants must make every effort to comply with guidelines and recommendations. AIFMs will now have to wait for local authorities to release details as to precisely how they intend to implement these in each jurisdiction. These details are expected in the coming weeks and months.
The guidelines set out that remuneration includes of all forms of variable payments or benefits paid by the AIFM, any amount paid by the alternative investment fund (AIF) itself, including carried interest, and any transfer of units or shares of the AIF, in exchange for professional services rendered by the AIFM identified staff.
Unless it is demonstrated that they have no material impact on the AIFM’s risk profile or on an AIF it manages, identified staff include:
- Executive and non-executive members of the governing body of the AIFM including directors, the chief executive officer and executive and non-executive partners;
- Senior management;
- Individuals responsible for control function;
- Staff responsible for heading the portfolio management, administration, marketing, human resources; and
- Other risk takers such as staff members, whose professional activities can exert material influence on the AIFM’s risk profile, or on an AIF it manages.
A big positive for identified staff who are also shareholders or partners in AIFMs, is that returns on equity and similar interests will not be regarded as remuneration. However this does not apply where structures are used as a vehicle for circumvention of the guidelines. To assume that such persons, who in many cases represent the individuals who are the biggest risk takers in an AIFM, fall out of the regime altogether would perhaps be too optimistic a view, as this could render the guidelines potentially obsolete in many cases. A pragmatic view would be that between fixed remuneration and the return on equity, there will inevitably be an element of variable remuneration. However it is far from clear how this could be established in practice.
Subject to some practical restrictions and carve outs, the guidelines seek that the variable remuneration of identified staff have two key tenets:
- at least 50% of any variable remuneration consists of units or shares of the AIF concerned, or equivalent ownership interests, or share-linked instruments or equivalent non-cash instruments; and
- at least 40% (rising to at least 60% for particularly high amounts) of the variable remuneration component is deferred over a three to five year period.
Crucial to the final analysis and how AIFMs will be impacted, will be how competent authorities address the topics of delegation and proportionality. The guidelines seek that when delegating portfolio management or risk management activities, an AIFM should ensure that entities to which these functions are delegated are (a) subject to regulatory requirements on remuneration that are equally as effective as those applicable under these guidelines; or (b) appropriate contractual arrangements are put in place to ensure that there is no circumvention of the remuneration rules. Precisely what ‘equally effective’ amounts to in the first option is currently the subject of much debate. On the latter point, the interaction with existing local tax constraints, such as transfer pricing regulations and in the UK the investment manager exemption, will be very interesting and could potentially lead to unexpected consequences.
With regard proportionality, competent authorities should take account of an AIFM’s size, nature and the scope of financial activities undertaken, such that compliance with the guidelines is maintained to a level that is appropriate. It is hoped that this could lead to many of the smaller players in the industry avoiding the increased operational and compliance burden proposed.
All AIFMs are advised to monitor developments closely over the coming weeks and months to find out how the implementation of the guidelines will impact their business. The greatest challenge that AIFMs may face is finding a solution that balances the sometimes competing regulatory and tax regimes. The risk is that if forced to implement the guidelines as currently proposed, AIFMs will need to establish compliant policies that could lead to businesses or individuals suffering potentially penal rates of tax or a dry tax charge. At Kinetic Partners, we are currently
drawing on our extensive regulatory and tax expertise to tailor custom-made solutions for our clients that provide a concise and efficient answer for AIFMs
subject to the guidelines.
For further information please contact Michael Beart.
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