The guidelines, which apply from 1 January 2017, seek to clarify the concepts of disclosure, governance, and risk alignment in respect of remuneration; in advance of this date, non-EU investment managers of UCITS should prepare for discussions with UCITS managers.
On 31 March, the European Securities and Markets Authority (ESMA) published its report setting out the final guidelines (Guidelines) on sound remuneration policies under the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive.
The Guidelines clarify the remuneration policy requirements for self-managed UCITS and UCITS management companies (ManCos) to implement for staff whose professional activities have a material impact on the profile of the UCITS (Identified Staff).
Identified Staff includes senior management, risk takers, control functions and employees whose total remuneration falls within the bracket of senior management or risk takers.
The recitals of UCITS V provide that any remuneration policy should also apply, in a proportionate manner, to any third party making investment decisions that affect the risk profile of the UCITS. In a similar manner to the AIFMD1 Remuneration Guidelines2, ESMA has determined that management companies should not circumvent the remuneration requirements through delegation of activities to external providers, therefore, delegate investment managers will be impacted.
The Guidelines apply to the following staff unless it is confirmed that the relevant member of staff has no material impact on the risk profile of the UCITS:
• executive and non-executive directors;
• senior management;
• compliance, internal audit and risk management staff;
• staff engaged in portfolio management
• administration, marketing and human resources teams; and
• other risk takers whose decisions that materially affect the UCITS risk profile.
The functions and responsibilities performed by staff within the UCITS/ManCo should be assessed so that roles, which may materially affect the risk profile of the UCITS are identified. For instance, some staff not caught by one of categories above, but whose remuneration is equal or higher than senior executives and risk takers within a UCITS/ManCo, may be found to be exerting material influence on a UCITS’ risk profile. What is clear is that individual circumstances for each member of staff will need to be considered.
In summary, the Guidelines provide that remuneration comprises any benefit (direct or indirect, monetary or non-monetary) paid by a UCITS/ManCo to Identified Staff, including any fixed and variable aspects of salaries and discretionary pensions. The definition specifically includes performance fees and the transfer of units in the UCITS, and detailed rules apply concerning the pay-out process for variable remuneration (Pay-Out Process Rules). However, payments or benefits that are part of a general, non-discretionary policy of the UCITS and which pose no incentive effects in terms of risk taking can be excluded from the definition of remuneration.
When establishing and applying the remuneration policies, a UCITS/ManCo must comply with the remuneration requirements “in a way and to the extent that is appropriate to their size, internal organisation and the nature, scope, and complexity of their activities”. Therefore, proportionality may (subject to particular conditions) lead to the disapplication of aspects of the Guidelines if such approach can be reconciled with the risk profile, risk appetite, and strategy of the UCITS, the pay-out process rules, and the need to have a remuneration committee.
A UCITS’ prospectus must include either details of the remuneration policy itself, or a summary of the policy and a statement that the policy details are available on an identified website, with paper copies provided free of charge upon request. The Key Investor Information Document (KIID) must include a similar statement. The UCITS’ annual report must disclose the aggregate remuneration paid by the UCITS/ManCo to key staff, the number of beneficiaries, and any performance fees paid by the UCITS. The first disclosures need to be included in (i) the first annual report published on or after 18 March 2016 that relates to an accounting period endingafter this date; (ii) the prospectus by 30 September 2016; and (iii) the KIID at the time of the next update or otherwise by no later than 18 March 2017.
Customarily, a UCITS/ManCo delegates investment management functions to another entity, and the Guidelines will be applied on a “look-through” basis to such delegates. In these instances, the UCITS/ManCo must ensure that:
• the entities to which investment management activities have been delegated are subject to equivalent regulatory requirements on remuneration; or
• appropriate contractual arrangements are put in place to ensure that there is no circumvention of the remuneration requirements.
Any contractual arrangements should cover any payments made to a delegate’s Identified Staff in respect of compensation for the investment management activities on behalf of the UCITS/ManCo.
Investment management delegates to whom the Markets in Financial Instruments Directive (MiFID)3 and/or Capital Requirements Directive (CRD) IV4 apply are considered to be subject to equivalent remuneration rules to the Guidelines. Therefore, delegates within the European Union will satisfy the first condition described above.
Non-EU investment managers
Delegates of UCITS/ManCos based outside of the European Union will need, in lieu of an equivalent local regulatory regime on remuneration, to demonstrate contractual compliance with the Guidelines. However, thought should also be given to whether there is scope to dis-apply some of the requirements of the Guidelines based on the specific set of circumstances. For instance, do the activities performed by the non-EU delegate have little/no scope to affect the risk profile of UCITS or, based on the grounds of proportionality discussed above, is it appropriate to dis-apply aspects of the Guidelines such as the pay-out process rules.
Pay-Out Process Rules
Similar rules to those in the AIFMD Remuneration Guidelines are set out in the Guidelines, though there are some important differences. Where the Pay-out Process Rules apply for variable remuneration, the following are key factors to consider the proportion of the variable remuneration that should be deferred should range from 40-60% and depending on the impact the member of staff can have on the UCITS’ risk profile, the tasks performed and the amount of variable remuneration.
The AIFMD Remuneration Guidelines also state the deferral period must be at least three years though pro-rata vesting is permitted. Pro-rata vesting should not take place more frequently than annually and the first amount should not vest sooner than 12 months after the relevant accrual period. The deferral period should be calculated on the basis of the holding period recommended to the investors of the UCITS concerned, subject to a minimum three-year deferral period.
Provisions exist concerning paying variable remuneration in instruments provided this does not trigger interest misalignment or encourage risk taking which is inconsistent with the risk profiles, rules or constitutional documents of the UCITS. Variable remuneration paid in instruments should be subject to retention periods but these retention periods do not count towards the minimum deferral period of any award;
There is a requirement to pay at least 50% of variable remuneration in shares or units of a UCITS fund (or equivalent share-linked instruments etc) if the management of that UCITS fund accounts for at least 50% of the total portfolio managed by the management company under its authorisation under the UCITS Directive. Various claw-back provisions will need to apply in certain circumstances. In addition, for deferred remuneration an ex-post risk analysis should be undertaken which may reduce the amount of deferred remuneration payable.
1. Alternative Investment Fund Managers Directive.
3. Directive 2004/39/EC.
4. Directive 2013/36/EU.