At the end of last week, ESMA published its long overdue final guidelines on UCITS V remuneration. The key difference is on the application of proportionality on which ESMA has also written a letter to the European Commission, European Council and European Parliament.
The UCITS guidelines take effect for full performance years starting on or after 1 January 2017 and include an amendment to the AIFMD remuneration guidelines (which has the same effective date) in relation to the treatment of groups. The guidelines follow the publication of the draft UCITS remuneration guidelines in July 2015. Click here for a comparison of the final and draft UCITS remuneration guidelines.
Executive Summary
The four key points are as follows:
- Proportionality - Whilst ESMA thinks some firms should be able to disapply the UCITS and AIFMD payout process rules on deferral, payment in non cash and malus, it doesn’t think it can interpret the directives to allow this without legislative change. As a result, the UCITS guidelines do not include any wording on the possibility to disapply these pay out process rules. However, ESMA hopes that legislative changes will be proposed later this year so that clarity is obtained ahead of the 2017 performance year. Firms should also note that whilst ESMA has not yet amended the ESMA AIFMD guidelines to take the same approach (so the AIFMD guidelines still allow AIFMs to disapply the payout process rules) it envisages that they will be brought into line with the approach under UCITS once the proportionality principle is clarified. The key question is how national regulators will interpret the AIFMD and UCITS guidelines pending legislative change. It is possible that they could take the same approach as the UK regulators have with the EBA guidelines under CRD and decide to continue to allow rules to be disapplied pending legislative change.
- Delegation – It is unclear how the rules applicable to delegates will be applied to EU regulated entities which are not authorized under AIFMD or CRD IV (e.g. UK BIPRU firms). Also, given the discussions onproportionality under UCITS, it is unclear whether delegates will be required to apply the more onerous UCITS rules on deferral, payment in non cash, retention and malus. However, as the guidelines are otherwise drafted in a very similar manner to the AIFMD guidelines, they may be interpreted by national regulators in a comparable fashion.
- Overlap with CRD and AIFMD remuneration regimes – Where staff are subject to CRD, UCITS and AIFMD, ESMA states that either (i) their pay can be apportioned to satisfy the different requirements of the directives, or (ii) the requirements of the most appropriate directive can be applied. However for the latter approach, it is unclear whether parent company shares, instead of AIF/UCITS units, can be used to satisfy the payment in non cash rule because ESMA states that in such cases “variable remuneration should always be paid in the AIF instruments or UCITS instruments”.
- Payment in non-cash instruments – ESMA says that 50% of variable pay is required in non-cash units if the total of all the UCITS funds managed represent more than 50% of the total AuM. This differs from the draft UCITS guidelines where the proposal was to calculate the 50% threshold on an individual fund basis.
Proportionality
Whilst ESMA thinks some firms should be able to disapply the payout process rules on deferral, payment in non cash, retention, and malus under AIFMD and UCITS, it doesn’t think it can interpret the current wording of the respective directives to allow this (in light of the position taken by the EBA under CRD).
As a result, the UCITS guidelines do not include any wording on the possibility to disapply these pay out process rules. ESMA hopes that legislative changes will be proposed later this year so that there is clarity on this ahead of the effective date of 1 January 2017.
Firms should also note that whilst ESMA has not yet amended the ESMA AIFMD guidelines to take the same approach (so the AIFMD guidelines still allow AIFMs to disapply the payout process rules) it envisages that they will be brought into line with the approach under UCITS once the proportionality principle is clarified. ESMA states “The current AIFMD Guidelines will not be amended to bring them into line with the UCITS Guidelines pending clarification on the application of the proportionality principle”.
The key question is how national regulators will interpret the AIFMD and UCITS guidelines pending legislative change. It is possible that they could take the same approach as the UK regulators have with the EBA guidelines under CRD and decide to continue to allow rules to be disapplied pending legislative change.
Delegation
Whilst the provisions on delegates in the UCITS guidelines are similar to those under the AIFMD guidelines, the UCITS guidelines specifically refer to the CRDIV remuneration regime (as opposed to the CRD) and AIFMD remuneration regime as being equally as effective to that under UCITS. For the purpose of the AIFMD guidelines, the reference was to ‘CRD’ rather than ‘CRDIV’ and the UK FCA had taken the view that ‘CRD’ included both CRDIII and CRDIV, so delegates that complied with the CRDIII remuneration regime (e.g. UK BIPRU firms) were also considered subject to an equally effective remuneration regime as AIFMD. It remains to be seen if the FCA will/can take the same approach for UCITS purposes. However, as the guidelines are otherwise drafted in a very similar manner to the AIFMD guidelines, they may be interpreted by national regulators in a comparable fashion.
In addition, due to discussions on proportionality under UCITS, it is unclear whether a delegate’s staff would need to be subject to the payout process rules on deferral, payment in non-cash, retention and malus regardless of the delegate’s size and scope of activities. In the feedback section of the UCITS guidelines, ESMA states: “the rules applicable to delegates should mirror the ones applicable to management companies under the guidelines (i.e. the approach on proportionality should be the same).”
The guidelines also state that the delegation requirement applies when delegating risk management functions as well as investment management functions.
Overlap with CRD and AIFMD remuneration regimes
The UCITS guidelines clarify the treatment of staff who fall under more than one of UCITS V, CRD and AIFMD. They state that firms should either:
subject a pro rata amount of remuneration to the requirements of each applicable directive based on objective criteria such as time spent or assets under management; or
apply the rules of the directive which is considered most effective at discouraging inappropriate risk taking and aligning the interest of the relevant staff with those of the investors in the funds they manage.
On point 2, it is unclear whether UCITS or AIFM staff who are also subject to the CRDIV remuneration rules can be paid in parent company shares (rather than UCITS/AIF units) to satisfy the payment in non-cash requirement. The guidelines state: “However, where specific CRD requirements – such as those relating to the payment of variable remuneration in instruments – conflict with the requirements under the AIFMD or UCITS Directive, the remuneration of the individual concerned should in any event follow the relevant specific sectoral legislation conflicting with the CRD requirements. This means that, for instance, for individuals performing services subject to the AIFMD or UCITS Directive the variable remuneration should always be paid in the AIF instruments or UCITS instruments (Annex II (1) (m) of AIFMD and Article 14(b)(m) of UCITS V).” It remains to be seen how national regulators will apply this in practice (e.g. in the UK, FCA guidance on AIFMD currently allows AIFMs to use parent company shares in certain circumstances and it may be that they take the same approach for UCITS purposes).
Payment of variable remuneration in non-cash instruments
ESMA clarifies that the requirement to pay at least 50% of UCITS Identified Staff’s variable remuneration in non-cash instruments applies unless the total net asset value of all the UCITS managed accounts for less than 50% of the management company’s total portfolio. Under the draft UCITS guidelines, the 50% threshold was calculated on an individual UCITS fund basis, rather than total basis.
In feedback to the consultation, ESMA indicates that where the management of UCITS accounts for less than 50% of the total portfolio managed, the requirement to pay in non-cash instruments cannot be disapplied entirely; rather a percentage lower than 50% can be used.
ESMA states that dividends/interest cannot be paid on the non-cash instrument before vesting but does not clarify whether such dividends/interest can be accrued and paid on vesting.
ESMA Guidelines on AIFMD remuneration
ESMA proposes to make it clear that there should be no exception for an AIFM which is a bank subsidiary of the sector specific remuneration principles set out in the AIFMD. This suggests that such firms should pay AIFM Identified Staff in units or notional units in the AIFs (rather than parent company shares as is currently allowed by the FCA under certain circumstances). We will follow up with national regulators for clarity on this.
