AIFMD Remuneration Rules to Hit Fund Managers Hard on Both Sides of Atlantic

Terry Flanagan

New guidelines around the remuneration of alternative investment fund managers in Europe are causing some degree of consternation on both sides of the Atlantic.

Earlier this month the European Securities and Markets Authority (Esma), the pan-European securities regulator, set out final guidelines for fund managers under the European Union’s Alternative Investment Fund Managers Directive (AIFMD), which is the EU’s first attempt at governing the hedge fund and private equity sectors. The new rules will take effect from July.

Non-EU alternative investment fund managers will also be subject in full to the guidelines—if they are using passport agreements—after a transitional period.

The remuneration principles, which will apply to a full range of financial and non-financial benefits given by the fund manager or the fund itself, will restrict the structure and form of remuneration that can be paid by EU alternative investment fund managers and evasion mechanisms will be strictly prohibited.

Law firm SJ Berwin, in a recent note to clients, called the Esma guidelines “fairly prescriptive” and said that Esma had “extended the AIFMD provisions significantly” in certain areas with its final guidelines. When the AIFMD was first mooted back in 2009, the directive was heavily criticized for its potential to stifle Europe’s fund management industry. But the industry now appears to have taken a stance of muted acceptance and a desire to work with authorities to make the best out of the situation.

“Compliance with the remuneration principles will present many challenges for AIFMs and some provisions are still difficult to square,” said SJ Berwin.

Esma’s guidelines also set out disclosure requirements applicable to both EU fund managers and those non-EU fund managers which market funds in the EU.

“Designed to protect firms from high-risk behavior that can increase short-term compensation—but which leaves behind long-term risks—advisers that fall within the scope of the AIFMD will be required to defer 40%-60% of variable-based compensation for three to five years for senior management, risk takers (including, in many cases, traders and sales staff), control functions (including risk management, compliance, and internal audit) and certain other highly-compensated employees,” said Deborah Prutzman, chief executive of the Regulatory Fundamentals Group, a New York-based firm that provides risk solutions for alternative asset managers and institutional investors, in a recent blog posting.

“Developing policies and procedures to comply with these requirements will not be easy.”

And it is not just the potential clutches of the AIFMD that alternative investment fund managers in the U.S. should be worried about.

“These rules may create complexities for U.S. advisers when an EU manager delegates investment or risk management responsibilities to a U.S. adviser,” said Prutzman.

“Regardless of the immediate impact of the EU rules on U.S. advisers, scrutiny of compensation arrangements is likely to increase. In the U.S., the Securities and Exchange Commission and other regulators have already taken small steps to regulate employee compensation with a view towards discouraging excess risk-taking.”

Prutzman added: “In short, expect demand for compensation-focused risk assessments to increase regardless of where the adviser is based.”

Esma, though, believes its guidelines will introduce sound and prudent remuneration policies and organizational structures which avoid conflicts of interest that may lead to excessive risk taking. The regulator says that stronger governance of how fund managers are paid will ultimately lead to improved investor protection.

“These guidelines will help promote prudent risk-taking by fund managers and help align the interests of both fund managers and investors,” said Steven Maijoor, chair of Esma.

“Making sure that these provisions on pay are applied in a common and consistent way is key to increasing investor protection and ensuring a level-playing-field in the alternative fund sector across the EU.”

Others are fearful of the extra costs that are likely to be imposed on fund managers once AIFMD kicks into gear later this year.

“Esma’s final guidelines are likely increase cost and complexity for fund managers,” said Neville Bramwell, a partner at Deloitte, a financial consultant.

“More firms will fall into the scope of the requirements than envisaged. The guidelines will now extend to include people performing risk or portfolio management functions on behalf of fund managers. That widens the scope of people who will have to comply with the new rules on remuneration.

“However, the provisions on proportionality—which govern how parts of the guidelines apply—mean certain measures will not affect some firms.”

A recent Deloitte survey indicated that smaller managers would be hardest hit by the AIFMD rules but the new Esma guidelines may, in fact, ease the burden on them somewhat.

“For example, smaller, less complex managers may not now need a remuneration committee to agree pay for fund managers,” said Bramwell.

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