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All in Proportion? UCITS Remuneration Guidelines and the Pay-out Process


As previously reported the European Securities Markets Authority (ESMA) has published its final Guidelines on sound remuneration policies under the UCITS Directive and AIFMD. The Guidelines clarify the obligations under the UCITS Directive for management companies regarding the establishment and application of remuneration policies for identified staff and will apply from 1 January 2017.  The final Guidelines (unlike the draft version) do not include guidance on the dis-application of certain requirements on the pay-out process.

ESMA did not include such guidance in the final report due to “recent work and legal analysis … which have called into question the existing understanding of the proportionality provisions” under the UCITS and AIFM Directives. As a result, ESMA has written to the European Commission and suggested that further clarity on the proportionality principle and cross-sectoral alignment is required. In this letter, ESMA explained that it had to balance the co-legislators’ steer to ensure alignment with the AIFMD Remuneration Guidelines and the obligation to closely cooperate with the EBA “in order to ensure consistency with requirements developed for other financial services sectors, in particular credit institutions and investment firms”.

However, ESMA also made it clear in its letter that it should be possible in certain situations to:

  1. dis-apply the requirements on the pay-out process (i.e. the requirements on variable remuneration in instruments, retention, deferral and ex post incorporation of risk for variable remuneration); or
  2. to apply lower thresholds whenever minimum quantitative thresholds are set for the pay-out requirements (e.g. the requirement to defer at least 40% of variable remuneration).

ESMA has concluded that it is appropriate to recognise the possibility to tailor the rules on the pay-out process of variable remuneration when these do not, in the specific circumstances, achieve the goal of aligning the interests of the fund manager’s staff with those of the investors. For example:

  • Application of pay-out process rules to delegates: the UCITS remuneration guidelines, as well as the AIFMD remuneration guidelines clarify that the remuneration requirements apply to delegates of the management company. This is the case even when the delegate’s contract with the management company sets out strict investment guidelines or it only covers a small portion of the UCITS portfolio. As a consequence, the delegate would have little or no discretion to affect the risk profile of the UCITS.

Consequently, there might be cases where the application of the pay-out process rules to the staff of the delegate would not be proportionate and would not achieve the outcome of aligning the delegate’s staff interests with those of the investors in the UCITS. There is also a risk that the unwillingness of delegates outside of the EEA to be subject to some requirements that they consider disproportionate, could prevent access of EU management companies to certain investment strategies.

  • Application of the deferral rules: Article 14b(1)(n) of the UCITS Directive requires a substantial portion, and in any case at least 40%, of the variable remuneration component to be deferred for a period. This deferral period should align with both the recommended holding period and the nature of the risks associated with the particular UCITS and should be a minimum of three years.

Certain types of funds may have a holding period that is significantly shorter than three years. Therefore, it may be argued that the application of the deferral rules in these instances is unlikely to align the interests of the management company’s staff with those of investors.

  • Application of the payments in instruments rules: Article 14b(1)(m) requires that a substantial portion of any variable remuneration component consists of units of the UCITS concerned, equivalent ownership interests, or share-linked instruments or equivalent non-cash instruments.

The payment of variable remuneration in shares or UCITS or equivalent non-cash instruments might not achieve an effective alignment of interests for certain staff of the management company who have no direct involvement in the management of UCITS, for example the head of the compliance or internal audit function. In such cases, it could be desirable to include other types of instruments in the remuneration packages of those staff such as, for example, shares in the management company.

  • Small and non-complex fund managers and small amounts of variable remuneration: small and non-complex fund managers have a relatively high number of identified staff, compared to larger fund managers, to whom the remuneration requirements could apply (even though this number is low in absolute terms). For these fund managers, the application of the pay-out process rules needs to be proportionate so as not to result in significant one-off and on-going administrative and systems costs that could put them at a competitive disadvantage against larger fund managers.

Similarly, certain staff only receive small amounts of variable remuneration. The pay-out process rules are only effective in aligning long-term interests when the amount of variable remuneration is meaningful enough to be spread over a multi-year horizon.

  • Application of pay-out process rules to portfolio managers who do not manage only portfolios of UCITS: certain portfolio managers employed by the management company do not manage the UCITS as a whole. For example, they may have responsibilities for managing an asset class/strategy in which they have a very specific expertise. These portfolio managers would apply this expertise across the various products managed by the management company, which could be UCITS, alternative investment funds or segregated mandates, but they might only affect the risk of a small proportion of the relevant portfolio.

In such instances, applying the pay-out rules, for example, the payment of a portion of variable remuneration in shares of the UCITS, could be disproportionate and may impose an excessive burden on certain portfolio managers. This could ultimately reduce the level of diversification and choice available to the funds’ investors.

ESMA is of the view that legislative changes in the relevant asset management legislation could be one way to further clarify the applicable regulatory framework and ensure consistent application of the remuneration requirements in the asset management sector.

Contributed by Niall Crowley