ESMA: UCITS Remuneration Guidelines

Extracts from final report of March 2016

EUROPEAN SECURITIES AND MARKETS AUTHORITY

These guidelines apply to management companies as defined under Article 2(1)(b) of the UCITS Directive and competent authorities. They also apply to investment companies that have not designated a management company authorised pursuant to the UCITS Directive.

UCITS having designated a management company authorised pursuant to the UCITS Directive are not subject to the remuneration principles established in the UCITS Directive, nor to these guidelines. However, the remuneration principles set out in the Recommendation are relevant to those UCITS.

These guidelines apply in relation to the remuneration policies and practices for management companies and their identified staff. These guidelines apply from 1 January 2017. Competent authorities to whom the guidelines apply should comply by incorporating them into their supervisory practices, including where particular guidelines within the document are directed primarily at financial market participants.

Which remuneration is covered by these guidelines?
Solely for the purposes of the guidelines and Article 14b of the UCITS Directive, remuneration consists of one or more of the following:

(i) all forms of payments or benefits paid by the management company,
(ii) any amount paid by the UCITS itself, including any portion of performance fees that are paid directly or indirectly for the benefit of identified staff, or
(iii) any transfer of units or shares of the UCITS, in exchange for professional services rendered by the management company’s identified staff.

All remuneration can be divided into either fixed remuneration (payments or benefits without consideration of any performance criteria) or variable remuneration (additional payments or benefits depending on performance or, in certain cases, other contractual criteria). Both components of remuneration (fixed and variable) may include monetary payments or benefits (such as cash, shares, options, cancellation of loans to staff members at dismissal, pension contributions) or non (directly) monetary benefits (such as, discounts, fringe benefits or special allowances for car, mobile phone, etc.).

Management companies should ensure that variable remuneration is not paid through vehicles or that methods are employed which aim at artificially evading the provisions of the UCITS Directive and these guidelines. The management body of each management company has the primary responsibility for ensuring that the ultimate goal of having sound and prudent remuneration policies and structuresis not improperly circumvented.

Consideration should also be given to the position of partnerships and similar structures. Dividends or similar distributions that partners receive as owners of a management company are not covered by these guidelines, unless the material outcome of the payment of such dividends results in a circumvention of the relevant remuneration rules, any intention to circumvent such rules being irrelevant for such purpose.

Identified staff
Management companies should identify the identified staff, according to these guidelines and any other guidance or criteria provided by competent authorities. Management companies should be able to demonstrate to competent authorities how they have assessed and selected identified staff.

The following categories of staff, unless it is demonstrated that they have no material impact on the management company’s risk profile or on a UCITS it manages, should be included as the identified staff:

  • Executive and non-executive members of the management body of the management company, depending on the local legal structure of the management company, such as: directors, the chief executive officer and executive and non-executive partners.
  • Senior management;
  • Control functions;
  • Staff responsible for heading the investment management, administration, marketing, human resources.
  • Other risk takers such as: staff members, whose professional activities – either individually or collectively, as members of a group (e.g. a unit or part of a department) – can exert material influence on the management company’s risk profile or on a UCITS it manages, including persons capable of entering into contracts/positions and taking decisions that materially affect the risk positions of the management company or of a UCITS it manages. Such staff can include, for instance, sales persons, individual traders and specific trading desks.

Additionally, if they have a material impact on the risk profile of the management company or of the UCITS it manages, other employees/persons, whose total remuneration falls into the remuneration bracket of senior managers and risk takers should be included as the identified staff, such as: high-earning staff members who are not already in the above categories and who have a material impact on the risk profile of the management company or of the UCITS it manages.

Proportionality
According to the Recommendation, when taking measures to implement remuneration principles Member States should take account of the size, nature and scope of financial undertakings’ activities. In taking measures to comply with the remuneration principles management companies should comply in a way and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities. In this way Article 14b of the UCITS Directive and the Recommendation envisage that provisions should operate in a way to enable a management company to take a proportionate approach to compliance with a remuneration principle.

The different risk profiles and characteristics among management companies justify a proportionate implementation of the remuneration principles. Criteria relevant to the application of proportionality are the size of the management company and of the UCITS it manages, its internal organization and the nature, scope and complexity of its activities.

Proportionality should also operate within a management company for some of the specific requirements. The categories of staff whose professional activities have a material impact on their risk profile should comply with specific requirements which aim to manage the risks their activities entail. The same criteria of size, internal organisation and the nature, scope and complexity of the activities should apply. In addition, the following non-exhaustive elements should be taken into account, where relevant:

  • The size of the obligations into which a risk taker may enter on behalf of the management company;
  • The size of the group of persons, who have only collectively a material impact on the risk profile of the management company;
  • The structure of the remuneration of the staff members (e.g. fixed salary with a variable remuneration vs. profit sharing arrangements), in particular, the following elements:
  • The amount of variable remuneration;
  • The percentage of variable remuneration over the fixed remuneration.

Financial situation
In order to guarantee ongoing compliance with the requirements of Article 7(1) of the UCITS Directive, management companies should ensure that they maintain a prudent balance between sound financial situation and the award, pay out or vesting of variable remuneration.

The fact that a management company is or risks becoming unable to maintain a sound financial situation, should be a trigger for, inter alia: a) reducing the variable remuneration pool for that year and b) the application of performance adjustment measures (i.e. malus or clawback) in that financial year. Instead of awarding, paying out the variable remuneration or allowing it to vest, the net profit of the management company for that year and potentially for subsequent years should be used to strengthen its financial situation.

Governance and remuneration
A management company’s remuneration policy should encourage the alignment of the risks taken by its staff with those of the UCITS it manages, the investors of such UCITS and the management company itself; in particular, the remuneration policy should duly take into consideration the need to align risks in terms of risk management and exposure to risk.

The supervisory function should be responsible for approving and maintaining the remuneration policy of the management company, and overseeing its implementation. The remuneration policy should not be controlled by any executive members of the supervisory function. The supervisory function should also approve any subsequent material exemptions or changes to the remuneration policy and carefully consider and monitor their effects. Procedures to determine remuneration should be clear, well documented and internally transparent.

In the design and oversight of the management company’s remuneration policies, the supervisory function should take into account the inputs provided by all competent corporate functions (i.e. risk management, compliance, human resources, strategic planning, etc.). As a result, those functions should be properly involved in the design of the remuneration policy of the management company.

The remuneration of the members of the management body should be consistent with their powers, tasks, expertise and responsibilities. Where appropriate considering the size of the management company, its internal organisation and the nature, scope and complexity of its activities, the management body should not determine its own remuneration. The supervisory function should determine and oversee the remuneration of the members of the management body.

For management companies which have a separate supervisory function, in order to properly address conflicts of interests, it may be more appropriate for members of the supervisory function to be compensated only with fixed remuneration. When incentive-based mechanisms are in place, they should be strictly tailored to the assigned monitoring and control tasks, reflecting the individual’s capabilities and the achieved results.

The supervisory function should ensure that the remuneration policy of the management company and its implementation will be reviewed on an annual basis at a minimum. Such central and independent reviews should assess whether the overall remuneration system:

  • Operates as intended (in particular, that all agreed plans/programs are being covered; that the remuneration pay-outs are appropriate, and that the risk profile, long-term objectives and goals of the management company are adequately reflected); and
  • Is compliant with national and international regulations, principles and standards.

Remuneration committee
The setting up of a remuneration committee should be considered, as a matter of good practice, even by those management companies that are not obliged to set up such a committee under Article 14b(4) of the UCITS Directive.

In order to operate independently from senior executives, the remuneration committee should comprise members of the supervisory function who do not perform executive functions, at least the majority of whom qualify as independent. The chairperson of the remuneration committee should be an independent, nonexecutive member. An appropriate number of the members of the remuneration committee should have sufficient expertise and professional experience concerning risk management and control activities, namely with regard to the mechanism for aligning the remuneration structure to management companies’ risk and capital profiles.

The remuneration committee should be encouraged to seek expert advice internally (e.g. from risk management) and externally. The chief executive officer should not take part in the remuneration committee meetings which discuss and decide on his/her remuneration.

The remuneration committee should:

Be responsible for the preparation of recommendations to the supervisory function, regarding the remuneration of the members of the management body as well as of the highest paid staff members in the management company;
Provide its support and advice to the supervisory function on the design of the management company’s overall remuneration policy;
Have access to advice, internal and external, that is independent of advice provided by or to senior management;
Review the appointment of external remuneration consultants that the supervisory function, may decide to engage for advice or support;
Support the supervisory function in overseeing the remuneration system’s design and operation on behalf of the supervisory function;
Devote specific attention to the assessment of the mechanisms adopted to ensure that:
The remuneration system properly takes into account all types of risks and liquidity and assets under management levels, and
The overall remuneration policy is consistent with the business strategy, objectives, values and interests of the management company and the UCITS it manages and the investors of such UCITS; and
Formally review a number of possible scenarios to test how the remuneration system will react to future external and internal events, and back test it as well.

Control functions
Management companies should ensure that control functions have an active role in the design, ongoing oversight and review of the remuneration policies for other business areas. Working closely with the remuneration committee and the supervisory function and management body, the control functions should assist in determining the overall remuneration strategy applicable to the management company, having regard to the promotion of effective risk management.

The remuneration structure of control functions personnel should not compromise their independence or create conflicts of interest in their advisory role to the remuneration committee, supervisory function and/or management body. If remuneration of the control functions includes a component based on management company-wide performance criteria, the risk of conflicts of interest increases and, therefore, should be properly addressed.

The long-term strategy of the management company should include the overall business strategy and quantified risk tolerance levels with a multi-year horizon, as well as other corporate values such as compliance culture, ethics, behaviour towards investors of the UCITS it manages, measures to mitigate conflicts of interest, etc. The design of the remuneration systems should be consistent with the risk profiles, rules or instruments of incorporation of the UCITS the management company manages and with the objectives set out in the strategies of the management company and the UCITS it manages and changes that could be decided in the strategies must be taken into account.

‘Golden parachute’ arrangements for staff members who are leaving the management company and which generate large pay-outs without any performance and risk adjustment should be considered inconsistent with the principle in Article 14b(1)(k) of the UCITS Directive. Any such payments should be related to performance achieved over time and designed in a way that does not reward failure. This should not preclude termination payments in situations such as early termination of the contract due to changes in the strategy of the management company or of the UCITS it manages, or in merger and/or takeover situations.

Risk alignment and disclosure
The specific requirements on risk alignment should be applied by management companies only to the individual remuneration packages of the identified staff, but management companies may always consider a management company-wide application (or, at least, a “broader than strictly necessary” application) of all or some of the specific requirements.

To limit excessive risk taking, variable remuneration should be performance-based and risk adjusted. To achieve this aim, a management company should ensure that incentives to take risks are constrained by incentives to manage risk. A remuneration system should be consistent with effective risk management and governances processes within the management company.

Management companies, when assessing risk and performance, should take into account both current and future risks that are taken by the staff member, the business unit, the UCITS concerned or the management company as a whole. For this exercise, management companies should examine what the impact of the staff member’s activities could be on the UCITS they manage and management company’s short and long term success. In addition to quantitative performance measures, variable remuneration awards should also be sensitive to the staff’s performance with respect to qualitative (nonfinancial) measures. Management companies should adopt a documented policy for the award process and ensure that records of the determination of the overall variable remuneration pool are maintained.

The remuneration policy of a management company should be accessible to all staff members of that management company. Management companies should ensure that the information regarding the remuneration policy disclosed internally reveals at least the details which are disclosed externally.