This February, the European Securities and Markets Authority (Esma) published its final report setting out guidelines for the remuneration of alternative investment fund managers (AIFMs) under the Alternative Investment Fund Managers Directive (AIFMD).
These guidelines could have a significant impact on managers of alternative investment funds, including hedge funds, which are managed or marketed in the EU. These rules could require material changes to the remuneration of staff and the associated governance. These changes will directly impact staff working in risk management and compliance functions.
A high level summary of the key requirements is as follows: investment fund managers will need to implement a remuneration policy that ensures the AIFMs’ interests are aligned with those of the alternative investment funds they manage.
For staff who have (or could have) a material impact on the AIFM’s risk profile:
• at least 40% to 60% of variable remuneration should be deferred generally for a minimum of three to five years.
• at least 50% of variable remuneration should be paid in shares or units in the fund.
The AIFM should be able to reduce variable remuneration by malus (pre-vesting) or clawback (post-vesting).
More complex AIFMs will be required to set up a remuneration committee, comprising a majority of independent non-executives with expertise in risk management and controls.
Details of the remuneration policy, including aggregate amount of remuneration paid to staff (split into fixed and variable) will need to be disclosed annually.
These requirements are likely to add to the workload of staff in AIFM risk management, internal audit and compliance functions (“control functions”). For example, additional processes will be needed to identify the staff affected by the remuneration rules. Also, the implementation of the firm-wide remuneration policy will need to be reviewed at least annually and be compliant with regulations.
Control functions need to have an active role in the design and oversight of the remuneration policy for other business areas, analyse how this remuneration structure affects the relevant risk profile, and periodically carry out an internal audit of the implementation of the policy.
The remuneration of control function staff may also be affected by the AIFMD requirements. The Esma guidelines require AIFMs to ensure that the remuneration of staff in control functions does not result in any conflict of interest. This includes minimising the link between remuneration of control function staff and the performance of any business unit they are overseeing.
To achieve this, where variable remuneration is paid to control staff, performance will need to be based on achievement against objectives specific to that function, and not solely on the overall performance of the AIFM. However, the rules specifically state that the remuneration level for staff in control functions must be sufficient to attract qualified and experienced personnel. This may lead to a change in the balance of fixed/ variable pay for control staff with an increase in fixed salary counterbalanced by a decrease in variable pay.
Existing AIFMs will have until July 22, 2014 to comply with these requirements unless they seek earlier authorisation. However, given the significant changes that may be required, affected firms should be considering their existing arrangements and the extent to which changes will need to be implemented. Control functions will have a significant part in this process.
Brian Forrester is an investment partner at Deloitte
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