Alternative Investment Management Association

Transcription

1 Alternative Investment Management Association EUROPEAN SECURITIES AND MARKETS AUTHORITY 103 Rue de Grenelle Paris France Submitted via the ESMA website 27 September 2012 Dear Sirs, AIMA s response to ESMA s Consultation Paper - Guidelines on sound remuneration policies under the Alternative Investment Fund Managers Directive (the AIFMD ) The Alternative Investment Management Association Limited 1 ( AIMA ) is grateful to ESMA for the opportunity to comment on its consultation paper (the Consultation Paper ) (ESMA/2012/406) regarding ESMA s Draft Guidelines on sound remuneration policies under the AIFMD (the Draft Guidelines ). The Consultation Paper mentions that in finalising the Draft Guidelines, ESMA will also take into account the development of its work on the separate set of guidelines, which will be complementary to the CEBS Guidelines, focused on remuneration policies of investment firms from an investor protection point of view, for which a separate consultation paper will be published at the end of Q AIMA would welcome some clarification on how these guidelines will feed into the Draft Guidelines. AIMA s key concerns Although, in general terms, we accept much of the content of the Draft Guidelines which ESMA puts forward, we would highlight, in particular, the following areas where we have concerns: Bank-style regulation of asset managers: The Draft Guidelines appear to be heavily based on the CEBS Guidelines on Remuneration Policies and Practices, which were designed primarily for banks. Although we recognise that ESMA had to look at CEBS when developing its Draft Guidelines, we respectfully urge ESMA to focus less on imposing bank-style regulation for alternative investment fund managers ( AIFMs ) and focus more on the specifics of the asset management sector. Specifically, we urge ESMA to consider the fact that most AIFMs will be medium or small companies run by their owners which do not have complex governance structures and that hedge fund investors expressly understand the risk levels associated with alternative investment funds ( AIFs ) (which are disclosed to them in the relevant offering document) in a way that banking clients and customers would not. Proportionality: Article 13(2) of the AIFMD specifically requires that ESMA takes into account the principle of proportionality when formulating the guidelines on remuneration under the AIFMD. The AIFMD also specifically states that the remuneration principles set out in Annex II of the AIFMD shall apply to AIFMs in a way and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities. It is important that this principle is not lost in the drafting. Many smaller, owner-run AIFMs will therefore find it extremely cumbersome, if not impossible, to comply with the Draft Guidelines in practice. 1 AIMA is the trade body for the hedge fund industry globally; our membership represents all constituencies within the sector including hedge fund managers, fund of hedge funds managers, prime brokers, fund administrators, accountants and lawyers. Our membership comprises over 1,300 corporate bodies in over 40 countries. The Alternative Investment Management Association Limited 167 Fleet Street, London, EC4A 2EA Tel: +44 (0) Fax: +44 (0) info@aima.org Internet: Registered in England as a Company Limited by Guarantee, No VAT registration no: Registered Office as above

2 Tailoring: We accept that an AIFM should not be able to disregard any of the requirements of Annex II of the AIFMD and that an AIFM should be able to explain the rationale for every single requirement that is applied in a tailored manner. 2 However, we consider that the tailoring approach suggested by ESMA should mean that in some circumstances AIFMs may have regard for each of the guidelines and decide that, subject to the requirements of their home Member State regulator, certain guidelines should apply to a minimal extent. The Level 1 text clearly permits such an approach, which is also permitted under CRD3, and so it would be inconsistent not to allow this. Without this sort of a proportional approach, certain guidelines will be very difficult for smaller AIFMs to comply with in practice. Scope: We strongly disagree that the guidelines on remuneration under the AIFMD should be applicable to delegate entities or any staff of the AIFM who are not Identified Staff. The AIFMD states in Article 13(1) and Annex II that AIFMs are required to have policies on remuneration which cover their Identified Staff. The required remuneration policies and practices of the AIFM apply only to Identified Staff of the AIFM. Nowhere in the Level 1 text is there any mention of certain requirements applying on a firm wide basis nor to entities who are not the AIFM. We agree with ESMA that inevitably certain requirements will apply to the AIFM as a whole. It should not therefore be necessary to set this out in the guidelines. Suggesting that certain requirements should apply to all staff at an AIFM defeats the purpose of the Level 1 provisions applying only to Identified Staff and this should therefore be removed. Unintended Tax and Regulatory Impacts: Many firms that will be AIFMs are established as limited liability partnerships ( LLPs ) or limited partnerships. AIMA considers that dividends paid to an AIFM s shareholders (and profit allocations to partners or members of AIFMs structured as LLPs or limited partnerships) who are otherwise Identified Staff as well are not remuneration and are therefore not subject to AIFMD remuneration regulation. However, in the event that such payments are considered remuneration, AIMA asks ESMA to consider the fact that the profits of such entities are required for tax purposes to be allocated to the members or partners each year, whether or not the profits are distributed, thus a requirement to defer payment of any such amount will result in an unfunded tax obligation for the relevant member or partner. This unintended result will disproportionately affect the members and partners of LLPs and limited partnerships. See Appendix A for a discussion of the key tax and regulatory issues. Conclusion We consider that, in general, the Draft Guidelines provide a good basis for the AIFMD remuneration guidelines. We believe, though, that these would be improved should ESMA take into account the matters which we raise above and in the detailed responses set out at Annex 1 below when producing its final guidelines. We also urge ESMA to seek to take a consistent approach where appropriate to remuneration guidelines in the context of UCITS and MiFID and to consider any potential challenges that may arise from taking an inconsistent approach when finalising the AIFMD remuneration guidelines. We would be happy to engage with ESMA in any way felt to be appropriate and useful following the formal close of the consultation period and to discuss the contents of our response with ESMA at any stage. Yours faithfully, Jiří Król Director of Government & Regulatory Affairs 2 See paragraph 36 of the Consultation Paper. 2

3 Annex 1 AIMA s responses to the questions posed in ESMA s Consultation Paper II. Background Q1: Do you agree with the approach suggested above for developing the present Guidelines? If not, please state the reasons for your answer and also suggest an alternative approach. As noted in the Consultation Paper in paragraph 12, there are numerous differences between the asset management sector and the banking universe. It is of the utmost importance that the specificities of the industry are taken into account in developing the guidelines and basing the guidelines on the CEBS Guidelines is therefore not an obvious approach. There are well-established differences between hedge fund managers or asset managers in general and banks which warrant a differentiated regulatory approach: Investors in funds seek particular risk exposures: bank depositors or money market fund investors generally do not seek exposures to bank loans, trading portfolios or other risk portfolios; Hedge funds can control, manage and change their liquidity profiles ex-ante by aligning their redemption policies with the liquidity profiles of the funds and ex-post by potentially limiting or even suspending redemptions (and therefore lengthening their liability profile) depending on the market liquidity situation; Hedge funds create bespoke liquidity conditions for particular funds or even groups of investors which then match the liquidity profiles of the invested instruments (managed accounts, single investor funds); Hedge funds are high risk financial products that do not offer any kind of guarantee or give an impression to guarantee the redemption of the original investment at par or at a pre-specified time; and Hedge fund investors fully understand the risks involved in making hedge fund investments (which have been disclosed to them in the relevant offering document) and have the ability and resources to anticipate and manage the risks associated with those investments. This suggests that developing the Draft Guidelines on the basis of the structure used for the CEBS Guidelines will require great care to ensure that the structures imposed are actually appropriate to AIFM remuneration. If AIF investors have chosen to pay an AIFM a performance fee, this is strong evidence that AIFM should be able to pay employees on same basis. A discussion of the typical hedge fund remuneration structure is included for reference in Appendix B. In light of the fact that the AIFMD was designed to address systemic risk, we would urge ESMA to keep that principle in mind when finalizing the Guidelines and applying the proportionality principles. Other G20 nations regulating compensation for systemically important financial services firms are setting the thresholds at substantially higher levels than those currently envisaged by the Guidelines. Accordingly, the Guidelines are relatively expansive in scope and coverage and may ultimately set the European Union at a competitive disadvantage in seeking to attract and retain top individual investment management talent and investment management firms as a whole within the European Union. 3

4 IV. Scope of the Guidelines Q2: Do you agree with the above considerations on the scope of the Guidelines? In particular, do you agree with the clarifications on what should be considered as a remuneration falling into scope and what should be considered an ancillary payment or benefit falling outside the scope of the Guidelines? If not, please state the reasons for your answer and also suggest an alternative approach. AIMA does not agree with the conclusion reached in paragraphs 14 to 17 and Annex II of the Consultation Paper. The Level 1 text explicitly states in Article 13 and Annex II that the remuneration policies and practices of the AIFM apply only to Identified Staff. Nowhere in the Level 1 text is there any mention of certain requirements applying on a firm wide basis. We agree with ESMA that inevitably certain requirements will apply to the AIFM as a whole. It should not therefore be necessary to set this out in the Draft Guidelines. Suggesting that certain specified requirements should in all events apply to all staff at an AIFM defeats the purpose of the Level 1 provisions applying only to Identified Staff and this should therefore be removed. Regarding types of remuneration in scope, it should be made clear in the ESMA Guidelines that dividends paid to an AIFM s shareholders (and profit allocations to partners or members of AIFMs structured as LLPs or limited partnerships) who are otherwise Identified Staff as well are not considered remuneration and are therefore not subject to AIFMD remuneration regulation. Employees who either bought or who were granted common shares in the AIFM as part of variable remuneration in the past have a stake in the AIFM which ensures alignment between shareholder/employee, AIFM, AIF and AIF investor. Holding AIFM shares should not be considered a structure or method to evade the requirements of the AIFMD. See also our response to Question 7 below. Please note that the CEBS Guidelines on Remuneration Policies and Practices of 10 December 2010 explicitly states in paragraph 17 that Dividends that partners receive as owners of an institution are not covered by these guidelines (unless they represent a vehicle or method for circumvention); however, any imprudent extraction of capital out of the institution through pay outs of dividends would be covered by normal capital adequacy rules under Pillars 1 and 2. In our opinion the same or substantially similar wording should be included in the ESMA guidelines where partners should be substituted by (i) partners in an AIFM that is organised as a limited liability partnership or a limited partnership and (ii) employees who are shareholders of an AIFM that is organised as a limited liability company or simply by partners or shareholders. Q4: Do you agree that the AIFMD remuneration principles should not apply to fees and commissions received by intermediaries and external service providers in case of outsourced activities? We agree that the AIFMD remuneration principles should not apply to fees and commissions received by intermediaries and external service providers in case of outsourced activities. This is not within the scope of the Level 1 text of the AIFMD in any event (see Scope in our opening remarks). Q5: Notwithstanding the fact that the provisions of the AIFMD seem to limit the scope of the principles of remuneration to those payments made by the AIFM or the AIF to the benefit of certain categories of staff of the AIFM, do you consider that the AIFMD remuneration principles (and, therefore, these Guidelines) should also apply to any payment made by the AIFM or the AIF to any entity to whom an activity has been delegated by the AIFM (e.g. to the remuneration of a delegated investment manager)? We do not consider that it would be appropriate for the Draft Guidelines to apply to any payment made by the AIFM or the AIF to any entity to whom an activity has been delegated by the AIFM. The Level 1 text only requires AIFMs to have remuneration policies and practices in place which cover Identified Staff of the AIFM. The AIFMD therefore does not require AIFMs to have remuneration policies and practices that cover staff of any entity to which the AIFM has delegated activities. We would therefore urge ESMA not to widen the scope of Identified Staff to cover such persons where they are outside the control of the AIFM in its performance of its portfolio management and/or risk management functions. 4

5 In addition, extending the remuneration requirements to delegated investment managers domiciled outside the EU would have the effect of extending the extraterritorial reach of these requirements to the United States, Asia and elsewhere. The result could be that such non-eu investment managers would choose not to accept mandates from EU AIFs, thus limiting the access of EU investors to talented and specialist managers based outside the EU. Q6: Do you consider that payments made directly by the AIF to the AIFM as a whole (e.g. payment of a performance fee or carried interest) shall be considered as payments made to the benefit of the relevant categories of staff of the AIFM and, therefore, fall under the scope of the AIFMD remuneration rules (and, therefore, of these Guidelines)? The AIFMD text does not provide scope for performance or management fees payable by the AIF to the AIFM as a whole (rather than directly to individual AIFM staff) to be brought within the Draft Guidelines. Paragraph 2 of Annex II of the AIFMD on remuneration states that the remuneration provisions of the AIFMD apply to all remuneration paid by the AIFM or directly by the AIF itself made to the benefits of those categories of staff... Since performance fees or management fees are paid by the AIF to the AIFM as a whole, they are not paid either by the AIFM or by the AIF to Identified Staff. (See Appendix B). Even if this were permitted by the Level 1 text of the AIFMD, such an approach would in any event be inappropriate as the AIFMD seeks to achieve investor protection. The rate of performance fees payable to the AIFM are the point on which investors will have made a commercial, informed decision, as opposed to the remuneration of individual staff members which they will often not have visibility of. The Guidelines also do not take into account the fact that the AIFM may be required to pay some amount to one or more sub-advisers, nor do they take into account the fact that other costs and expenses beyond remuneration of AIFM staff must come out of amounts received by the AIFM from the AIF. Moreover, for newer managers, part or all of the performance fee is likely to be used for reinvestment in helping grow the business and infrastructure. As a result, a direct attribution of amounts paid by the AIF to the AIFM staff is likely to be over-inclusive. Q7: Do you agree with the categories of staff identified above which should be subject to the remuneration principles set out in the Guidelines? If not, please state the reasons for your answer and also suggest an alternative approach. The categories of Identified Staff set out in paragraph 26 of the Draft Guidelines are extremely broad and go beyond the categories of staff envisaged by either Annex II to the AIFMD or CRD3. We would urge ESMA to consider revising the Draft Guidelines to make them more consistent with CRD3 and to ease the administrative burden on regulators and regulated firms. Separately, many of an AIFM s senior staff (for example, portfolio managers, senior analysts and traders) are typically not employees, do not have employment contracts and are not remunerated by way of salary plus bonus. Instead, they are members or partners in the organisation, their remuneration is governed by a partnership or LLP agreement and they are entitled to a share of the AIFM's profits in the relevant financial year. If variable remuneration is clawed back, or reduced under malus arrangements, this would (in an LLP-type structure) result in a build up of funds within the AIFM which, as mentioned above, ultimately belong to those partners/owners of the business who are entitled to share in its profits. In many cases, these are likely to be the same individuals as are covered by the Draft Guidelines. If the effect of the performance adjustment provisions is to prevent distribution of the retained funds to those individuals, we note that they must nonetheless be allocated for tax purposes (although tax treatment is dependent on the jurisdiction) and that this would leave the relevant individuals with an unfunded tax liability under the tax regulations in some jurisdictions. For this reason, the owners of owner-managed AIFMs should be excluded from the scope of Identified Staff to the extent they are not otherwise persons with a senior management role or Identified Staff; being a partner by itself should not make someone Identified Staff. More generally speaking, given the level of alignment between a partner or shareholder who is an employee and the AIFM, the AIF and AIF investors, both (i) partners or members in an AIFM that is organised as a limited liability partnership or limited partnership and (ii) employees who own common 5

6 equity of an AIFM where the AIFM is organised as a limited liability company, should be excluded from the scope of Identified Staff. This should be independent of their share in either the partnership or the common equity. V. Proportionality principle Q9: Do you agree with the clarifications proposed above for the application of the proportionality principle in relation to the different criteria (i.e. size, internal organisation and nature, scope and complexity of activities)? If not, please state the reasons for your answer and also suggest an alternative approach. We would welcome further clarification on the guidelines which may be applied in a tailored manner. We disagree with the concept that size is a relevant factor for alignment of interests. More relevant considerations might be whether an AIFM is a public company (and therefore potentially subject to higher risk since Identified Staff will be less aligned in interest with the shareholders) or an owner managed business (where the principal risk takers are the owners) and whether the AIFM is engaged in proprietary dealing (which involves more risk than dealing as agent which is what most AIFMs will do). Hedge funds investor base is composed primarily of sophisticated investors, mainly investment professionals, who are entirely aware of the risk profile they wish to adopt and who explicitly incentivise managers to follow their wishes. The performance fee paid by the AIF to the AIFM is an explicit incentive for AIFMs to fulfil their role as risk takers. This transparent risk-taking structure and explicit high risk profile is fundamentally different from that of banks and other financial institutions, in which risks are intended to be significantly lower. It is important that proportionality continues to recognize the important role of incentive payments and bonuses in aligning the interests of AIF clients, the AIFM and AIFM staff. Since the criteria set out in paragraph 26 of the Draft Guidelines are not the sole drivers of risk the Draft Guidelines should not be prescriptive and should leave some discretion in the hands of national regulators to apply the principle of proportionality on the basis of additional or other factors. VI. AIFMs being part of a group Q12: Do you agree that there is a need for consistency in the potential application of different requirements for AIFMs which belong to a group subject to other principles? We agree that there is a need for consistency among AIFMD, UCITS, CRD, MiFID, etc.. As a matter of drafting, it would be an improvement if ESMA were to refer in paragraph 29 of the Draft Guidelines to "banking, insurance or investment groups" as opposed to "banking (or insurance or financial) groups". It is just as likely that an AIFM might be grouped with a MiFID investment firm subject to CRD as with a credit institution. We would also encourage a disapplication of the rules to foreign subsidiaries until there is consistency in global law. Q13: Do you agree that the proposed alignment of the CRD and AIFMD remuneration provisions will reduce the existence of any conflicting remuneration requirements at group level for AIFMs whose parent companies are credit institutions subject to the CRD? If not, please state the reasons for your answer and provide quantitative details on any additional costs implied by the proposed approach. We would welcome clarification of how the differing provisions of the CRD and the AIFMD will be applied in practice, especially in situations where an AIFM is subject to both AIFMD at a firm level and CRD at a group level. In that regard, we have two concerns about overlapping and potentially conflicting requirements concerning remuneration deriving from the AIFMD and the CRD. 6

7 First, we are concerned that, on one reading of the AIFMD, a particular AIFM could be at the same time subject to the AIFM remuneration principles (and the draft ESMA guidelines) and the CRD remuneration principles (and the EBA/CEBS guidelines) on a solo basis. This is because an AIFM may carry on the discretionary portfolio management service referred to in point (a) of Article 6(4) of AIFMD. ESMA recognises this possibility in paragraph 29 of the Consultation Paper. We agree with ESMA's analysis in paragraph 29 so far as it goes. However, it omits to address the implication of Article 11(1)(d) AIFMD. Article 11(1)(d) provides that the competent authorities of a Member State may withdraw the authorisation of an AIFM where the AIFM "no longer complies with Directive 2006/49/EC [i.e. the Capital Adequacy Directive] if its authorisation also covers the discretionary portfolio management service referred to in point (a) of Article 6(4)". We interpret this to mean that the AIFM must comply with the CRD, including its pay regulation provisions as well as its minimum regulatory capital requirements (in addition to the relevant provisions of the AIFMD). If this is correct, it would be helpful if ESMA could make clear in the final guidelines that AIFMs providing Article 6(4) services which comply with the ESMA guidelines under the AIFMD will be deemed to satisfy the CRD remuneration requirements. On the other hand, if ESMA interprets Article 11(1)(d) differently, we would be grateful if ESMA would make that clear to ensure consistent interpretation across the EU. Second, there are likely to be circumstances in which a member of the Identified Staff of a credit institution or CAD investment firm (under CRD) is also a member of the Identified Staff of an AIFM affiliate (under the AIFMD). Example 1: a senior manager may be a director of a bank and a director of its AIFM sister company. Example 2: an AIFM is a subsidiary of a credit institution; the professional activities of a director of the AIFM pose sufficient risk to the consolidation group that he is deemed to be Identified Staff of the banking group, even though he is not an officer of the bank. In these cases, only one set of rules should apply in respect of the relevant individual, and the group parent institution should be able to determine which set of rules is most appropriate. The draft ESMA guidelines do not address this point in respect of individuals "wearing two hats" (dealing only with the separate point that one set of sectoral rules should not apply to an affiliate subject to a different set of rules). It is not clear that the paragraph of the CEBS Guidelines quoted in paragraph 47 of the draft ESMA guidelines deals with the point either. We suggest a further paragraph for the final guidelines as follows: "If an individual is Identified Staff in respect of two or more entities affiliated with each other, the parent institution may decide to apply only one set of sectoral rules to the remuneration of that member of Identified Staff, taking into account the risks his activities pose to the entities separately and together." Where an AIFM is part of a larger group that is subject to CRD3, the AIFM should be allowed to take into account the broader context but should not be required to apply all of CRD3. If a group has adopted a remuneration policy under CEBS, the group remuneration policy should be deemed compliant under AIFMD subject to taking into account the scope of Identified Staff. VII. Financial situation of the AIFM (Annex II, paragraph 1(o) of the AIFMD) Q15: Do you agree with the above principle aimed at preserving the soundness of the AIFM s financial situation? If not, please state the reasons for your answer and also suggest an alternative approach. Clawbacks are not appropriate in an owner managed business, where money clawed back would generally be returned to the profit pool and then be redistributed to the same members (see Appendix A). Such concerns can be addressed through the rules applied at the time of any award and the mechanism of deferral. Ironically, the required deferral of variable remuneration could lead firms to increase the fixed portion of the compensation paid to many types of staff. As fixed compensation increases overheads, if an AIFM finds itself in a perilous financial situation, as many firms did in 2008, the increased overheads would likely put them out of business whereas the ability not to have to pay the variable portion of compensation in down years (like 2008) allowed firms to depress costs and weather the crisis, thus avoiding the need to make staff redundant or keeping them from going out of business entirely. The importance of talent to the hedge fund industry cannot be overstated. The services provided by AIFMs to the funds they manage are based almost entirely on the knowledge, skill, and experience of 7

8 highly trained and specialised staff, who are highly mobile between firms and countries. Constraints on the ability of AIFMs to reward staff appropriately through bonuses would impact on the firm s ability to attract and retain talent and would substantially and adversely affect the industry and would be against the interests of AIF clients. If an AIFM loses its highly skilled staff, the AIFM may not remain viable or be able to meet the performance/control criteria expected by AIF investors. The Draft Guidelines should also make clear that there is no possibility to apply clawbacks on paid dividends under the AIFMD remuneration rules since (1) dividends are not (to be) considered remuneration and (2) dividend payments are already governed by, amongst others, Basel II capital adequacy rules. (See also our response to Question 2.) VIII. Governance of remuneration Q17: Do you agree with the proposed split of competences between the members of the management function and those of the supervisory function? If not, please provide explanations. We consider that governance of the remuneration policy and practices is one of the clearest examples of where a proportionate application of the guidelines is necessary. In an owner managed business the supervisory function is unnecessary and the management function can appropriately be responsible for these matters since the senior managers are the owners of the business. Owner managed businesses should not have to hire non-executive directors simply to fill this type of function. Some firms will not have the same range of bodies that can be found in other types of corporate structures and may not have a distinct supervisory and a management function or non-executive directors and in a partnership structure this is simply not possible. We therefore suggest that the public or nonpublic ownership of the AIFM and, where relevant, the size of the AIFM is taken into account when considering the appropriate governance structure of the AIFM. We would suggest that the most appropriate way to structure the guidelines would be to set out the minimum requirements that should apply to all AIFMs and then set out the additional requirements that will be applicable to publicly-traded AIFMs. Q18: Do you agree with the guidelines above on the shareholders involvement in the remuneration of the AIFM? In an owner managed business this requirement is unnecessary as the shareholders are the owners of the business making the decisions. The provision is also not really compatible with limited liability companies. Guidelines on this are properly part of company law or corporate governance best practice guidelines and not financial regulation. In this respect AIFMs are no different from other companies. Q19: Do you agree with the criteria above for determining whether or not a RemCo has to be set up? If not, please provide explanations and alternative criteria. A decision as to whether or not a RemCo should be established should be taken on the basis of the guidelines and application of the proportionality principles, subject to sensible application by the relevant home Member State regulator, and the result does not need to be prescribed. If a result is to be prescribed, the guidelines should set out the minimum requirements that should apply to all AIFMs and then to set out the additional requirements that will be applicable to larger, publicly-traded AIFMs. We believe the examples should be removed. Specifically, we would suggest that the EUR 250 million threshold for establishing a RemCo is arbitrary and should be removed. We note that the inclusion of the threshold is inconsistent with ESMA s general approach to the application of the proportionality principle as set out in paragraph 24 of the cost benefit analysis. That paragraph states that any quantitative approach would limit the extent to which flexibility could be used and a case by case approach taken in determining how the proportionality principle should be applied. Since ESMA considers that flexibility is the key element when dealing with the proportionality principle, it decided to prefer the qualitative to 8

9 the quantitative approach. Removal of the threshold would therefore seem consistent with ESMA s general approach to the Draft Guidelines. Q21: Please provide quantitative data on the costs and benefits that the proposed criteria to determine whether a RemCo has to be set up would imply. We estimate the annual costs of a RemCo to be between 99,600 and 204,600. We also estimate that there will be a one-off fee in year one of between 22,200 and 44,400 in order to establish the RemCo. In addition to these costs, we note that where a committee is formed that is independent of management it is often the case that there will be additional costs for external advisers and consultants. These costs would be in addition to the costs specified above. The breakdown of these costs is provided in a table in Appendix C. Q23: Do you agree with the principles relating to the composition of the RemCo? Please provide quantitative data on the costs and benefits that the proposed principles on the composition of the RemCo would imply. The requirements on the composition of the RemCo need to be able to be applied in a proportionate manner in the same way the decision whether to have a RemCo at all can be applied proportionately. In addition, executive members should be permitted to serve on the RemCo, subject to the management of any conflicts of interest. Q26: Do you agree with the principles above on the process and reporting lines to be followed by the RemCo? If not, please provide explanations. These principles can only be applied subject to applicable data protection and privacy regulations and should be applied in a way designed to manage conflicts of interest and maintain confidentiality. Q27: Do you consider that the AIFM s RemCo should provide adequate information about the activities performed not only to the AIFM s shareholders meeting, but also to the AIFs shareholders meetings? When providing your answer, please also provide quantitative details on the additional costs involved by such requirement. We do not agree that the information should be provided to the AIFs shareholder meetings. When an investor is considering an investment in an AIF, the investor considers the fully disclosed amount of the management and performance fee payable by the AIF. If the investor is not happy with that fee rate, the investor will not invest. If investors are subsequently unhappy of with the level of fees or performance, they will redeem. The basis of the contract is a fee at the disclosed rate to be paid to the AIFM for the AIFM (and not individual members of the AIFM staff) to provide services. Under Article 22(2)(e) and (f), investors will receive information about the overall amounts of compensation the AIFM pays to its staff. This will allow investors to gauge whether they believe the AIFM is devoting sufficient resources to the retention of staff in light of the performance being attained. Prescribing the provision of further detail would have no identifiable benefits and will introduce additional administrative costs, since one person will need to be allocated to be the sole person making these disclosures to manage conflicts of interest and confidentiality matters. As stated above, these also seem to be matters of company law or corporate governance, not financial regulation. Q28: Do you agree with the above criteria on the remuneration of the control functions? If not, please provide explanations. While we agree with many of the criteria on the remuneration of the control function, we disagree with the concept that the individual financial performance of the business area that staff in control functions monitor should not be considered in connection with the award of variable remuneration. Paragraph 91 states that remuneration of those staff members in compliance and risk management functions must be designed in a way that avoids conflict of interests [sic] related to the business unit they are overseeing and, therefore, should be appraised and determined independently. Staff in control functions should be 9

10 treated the same way and profitability of the business area they oversee should be permitted as a factor to be considered in connection with variable remuneration decisions. This requirement should be replaced with one to design remuneration in a way that manages any conflicts of interest. IX. General requirements on risk alignment Q30: Do you agree with the principles related to the treatment of discretionary pension benefits? If not, please provide explanations. Although not responsive to Question 30, we do have a comment on paragraph 98 of the Consultation Paper (see below) and Question 30 is the only one posed in relation to that subset of Guidelines. The Consultation Paper notes in paragraph 98 that [r]emuneration has a direct or indirect influence on people s behaviour. Paragraph 98 goes on to posit that variable remuneration may encourage staff to take undesirable or irresponsible risks in the hope of generating more turnover or making more profit and thus increasing his/her variable remuneration. This paragraph does not, however, take into account that the converse may also be true where AIF investors have chosen to incentivise the AIFM by paying a performance fee then failing to pay bonuses to staff may encourage insufficient risk-taking. Where AIF investors have chosen to invest in an AIF bearing a performance fee, there should be a presumption that risk taking within the limitations disclosed to investors is desired by those AIF investors. The application of the risk management elements of the remuneration policy will need to be applied according to each AIFMs (and each AIF s) particular facts and circumstances and proportionality will need to be considered in order to properly align risk-taking and rewards for the AIFM, the Identified Staff and AIF investors. X. Specific requirements on risk alignment Q34: Do you consider these common requirements for the risk alignment process appropriate? If not, please provide explanations and alternative requirements. The main difficulties we have with the proposed risk alignment process, and touching on other Draft Guidelines as well, are as follows: share-based awards; and deferral and clawback. Dealing with these elements in turn: (a) Share based awards. Many AIFMs will be small privately owned businesses, structured either as LLPs or (less frequently) as private unlisted companies. With very few exceptions, AIFMs do not issue publicly tradable equities or equity like instruments for which there is a secondary market. Awarding staff equity or equity-like instruments, therefore, raises complex issues in the context of AIFMs which do not apply to publicly traded banks and, in any event, it is far from clear what could constitute equivalent non-cash instruments. Phantom share schemes, whereby members of staff are issued with notional shares whose value is determined by a third party valuer who values the business of the firm periodically, are not an appropriate solution for small privately owned businesses such as AIFMs. Such schemes introduce an unacceptable degree of risk arising from the need for the business to be able to redeem the phantom shares at their revaluation price (even though, where the price has increased, there may be no additional cash to fund that redemption). Moreover valuations of such schemes by third party valuers such as accountancy firms will be expensive as the valuer will have liability for the valuation. As the relevant tax authorities will also have an interest in the valuation attributed to the scheme, the valuation report will have to be robust enough to withstand such scrutiny, increasing the likelihood that the cost for producing such a report will not be insubstantial. One possible solution offered in the Draft Guidelines is payment in shares not of the AIFM but of the underlying AIF would meet the requirement since the AIF would typically be a limited company, albeit perhaps not always non-eu domiciled. This, though, also has its own attendant problems. AIFs are separate legal entities from the AIFM. A position in the AIF would not be entirely representative 10

11 of the risk inherent in the firm, particularly where (as is fairly common) the firm manages the assets of multiple funds. Such an arrangement may result in the need for the AIFM to change its regulatory permissions to include dealing as principal which may have an effect on its prudential categorisation. Where the firm or its consolidation group/sub group has employees in other jurisdictions, it may be illegal to offer employees in those jurisdictions investments in such funds. In some instances, the fund may be closed to new investment while unlisted funds are restricted from allowing investments below a minimum size and from certain types of investor. It is not, therefore, automatically the case that part payment of Identified Staff within the AIFM in shares of the fund would be desirable or achievable. Additionally, the AIFM may also need to be mindful of the Investment Manager Exemption (IME) condition which, in essence, limits the stake which the AIFM and connected persons may hold in a given fund. Given that the purpose of the share-based awards is to strengthen the link between the staff member s remuneration and the longer term future of the firm, we would argue that the existing alignment between the AIFM performance fee structure and investment return has already created the conditions whereby the best interests of the member of staff, so far as remuneration is concerned, lie in ensuring a long term, consistent and non-volatile growth of the fund s NAV year on year. (b) Deferral and clawback. A deferral of at least 40% (and, in some cases, up to 60%) over three to five years bears no obvious relevance to the life cycle of the fund and even the minimum one year deferral period may bear no obvious relevance to that life-cycle. Performance fees tend to be payable on a quarterly or annual basis. Investors may, at specified times (also typically quarterly or annually), choose to redeem their interest and leave the fund at that time. The deferral of some part of the AIFM staff s variable remuneration would, therefore, have no impact on the investor it would not, for example, provide an additional source from which payments could be made back to the investor should investment performance go down in subsequent periods. In such circumstances, the High Water Mark model would ensure that the AIFM does not receive further fees until the NAV of the fund has exceeded its previous level. The requirement to defer 40% to 60% of variable remuneration for at least three to five years in most cases would also have profound and negative tax implications for many UK-based AIFMs, since we estimate that over 85% of the AIFMs in the UK industry are structured as LLPs or limited partnerships. We deal with this and a number of other important tax issues in detail in Appendix A below but, put simply, a Member of an LLP or limited partnership will generally be subject to tax on his or her entire profit entitlement for a year, as adjusted for tax purposes, when this amount is declared and not when it is actually paid. The consequence of this may well be that the Member is liable to pay more in tax in a given year than he or she receives by way of income. Not all UK AIFMs are structured as LLPs or limited partnerships but the vast majority are. As such, in order to avoid creating a skewed playing field for the small number of AIFMs who are not so structured (putting them at a considerable competitive disadvantage resulting from a quirk of their legal structure), any dispensations from the requirement to comply with the relevant Draft Guidelines must be available to the industry as a whole. It is important to also keep in mind that with few exceptions, AIFMs will not typically be publicly traded companies, nor will they have public shareholders who would benefit from the windfall of clawing back bonus remuneration in subsequent years in order to reflect subsequent losses in the relevant fund portfolios. As a result these provisions are much less appropriate to AIFMs than to banks. Q35: Do you agree with the proposed criteria on risk measurement? If not, please provide explanations and alternative criteria. Paragraph 101 of the Draft Guidelines specifies that the principle of proportionality should be taken into account in connection with the risk management calculations. We believe that the principle of proportionality should be taken into account with respect to all of the provisions of the Draft Guidelines, and not just a specific paragraph such as this one. Q41: Do you agree with the guidance on the different components to be considered in relation with the deferral schedule for the variable remuneration? If not, please provide explanations and alternative guidance. 11

12 We agree with the different components set out in paragraph 118 of the Draft Guidelines. However, we believe that two additional components should be considered: first, the length of the accrual period and, secondly, the life-cycle or redemption policy of the AIF. The length of the accrual period The length of the accrual period during which the variable remuneration is earned or awarded should also be taken into account. Where the staff member's entitlement is assessed over a multi-year accrual period, this of itself contributes to the long-term alignment of interests of the AIFM's staff members with those of the AIFM and the AIFs it manages. This alignment is recognised as being a key purpose of the remuneration provisions of the AIFMD. The life-cycle or redemption policy of the AIF The life-cycle and redemption policy of the AIF are also relevant components. Paragraph 150 of the Draft Guidelines states that certain structures may meet the requirements of the Draft Guidelines with respect to the "pay-out process". These include where investors' capital is returned (together with any pre-agreed hurdle) prior to payment of variable remuneration and such remuneration is subject to clawback until liquidation of the AIF. Similarly, the guidelines should recognise that where an investor has redeemed its interest in the AIF, any variable remuneration which was derived from that investor's investment in the AIF can cease to be subject to any further vesting, deferral, malus or clawback arrangements without breaching the guidelines. This is because such arrangements can no longer serve to align the interests between the staff member and the investor. This is reinforced by Section 1(h) of Annex II to the AIFMD which states that the actual payment of performance based components should take account of the redemption policy of the AIF in question. For these reasons we do not believe that it is appropriate to suggest minimum deferral and vesting periods in all circumstances and so we do not agree with the following statements: The minimum deferral period is three to five years, unless the AIFM can demonstrate that the life cycle of the AIF concerned is shorter; this means that if the life cycle of the AIF concerned is, for instance, one year, the minimum deferral period may be one year. (paragraph 119 of the Draft Guidelines) "For the deferral to be really effective with regard to the staff s incentives, the first amount should not vest sooner than 12 months after the accrual." (paragraph 123 of the Draft Guidelines) The length of the deferral period should be allowed to be set by the AIF at a length most applicable to its own business rather than being set to a proscribed minimum. Q42: Do you agree with the types of instruments composing the variable remuneration which have been identified by ESMA? If not, please provide explanations. We generally agree with the types of instruments which have been identified (but see part (a) of our response to Question 34). The application of paragraph 125 of the Draft Guidelines may be relatively straightforward for portfolio managers and traders in larger firms with multiple AIFs, portfolio managers and traders, but this guideline cannot be easily applied to some categories of Identified Staff, such as those in marketing or human resources, or in the case of firms where all of the employees carry out tasks for all of the clients. It would be helpful if EMSA would provide clear guidance on what happens when the management of AIFs accounts for less than 50% of the total portfolio managed by the AIFM. If management of AIFs for example accounts to 25%, will there be no need to pay in instruments? ESMA should also provide clarity on how to measure the 50% threshold. It is not clear whether or not that should be based on net asset value or trading level (which includes notional funds). 12

13 Also, it should be made more clear that assets of an AIF for which the investment firm only acts as a subadvisor and does not act as the AIFM, are not to be included in the determining the percentage of AIF business of an AIFM. Q43: Do you consider that additional safeguards should be introduced in these Guidelines in order to ensure that the payment of the Identified Staff with instruments does not entail/facilitate any excessive risk-taking by the relevant staff in order to make short-term gains via the instruments received? If yes, please provide details. No, we do not consider that additional safeguards should be introduced. We believe the proposed retention policy should be sufficient. That there is no need for additional safeguards is reinforced by the statement (at paragraph 20 of the Consultation Paper) that an investment by Identified Staff into an AIF "is not subject to any of the remuneration requirements set out in the AIFMD and these Guidelines. Indeed, this is consistent with the fact that a key purpose of the remuneration requirements is to align the interests of the AIFM's staff members with those of the AIFM and the AIFs it manages and that in this case the alignment of the interests of the staff members with those of the AIFM and the AIFs it manages is facilitated by the fact that these staff members invest into the AIFs and, therefore, no additional safeguards seem necessary to ensure the alignment of interests." Q44: Do you agree with the proposed guidance for the retention policy relating to the instruments being a consistent part of the variable remuneration? If not, please provide explanations and alternative guidance. In general terms, we agree with the proposed guidance. However, where the Identified Staff member already holds a substantial investment in the AIF the retention policy should be capable of being disapplied where that Identified Staff member will continue to hold a substantial investment. The holding of a substantial investment in itself promotes alignment of interests (as set out at paragraph 20 of the Consultation Paper). The retention period should also end for remuneration paid with respect to an investor when the investor has redeemed (or otherwise exited) its interest in the AIF as there is no longer any need for, or possibility of, alignment of interests with respect to that investor and, in addition, the retention policy could otherwise lead to the identified staff, over time, holding an overly significant stake in the AIF. Q45: Do you agree with the proposed guidance for the ex-post risk adjustments to be followed by AIFMs? If not, please provide explanations and alternative guidance. We consider that certain points within the guidance are contradictory and inconsistent with the AIFMD itself. Paragraph 1(o) of Annex II to the AIFMD states that "the total variable remuneration shall generally be considerably contracted where subdued or negative financial performance of the AIFM or of the AIF concerned occurs, taking into account both current compensation and reductions in payouts of amounts previously earned, including through malus or clawback adjustments". This appears to be the key statement in the AIFMD relating to ex-post adjustments, however, the Draft Guidelines significantly downplay the importance of the subsequent performance of the AIF in relation to ex-post adjustments: Techniques based on the amount of dividends or the evolution of the share price are not sufficient because the link to the performance of a staff member is not sufficiently direct (paragraph 140 of the Draft Guidelines). Under no circumstances should the evolution of the net asset value of the AIF, or for listed AIF, the evolution of the share price be considered sufficient as a form of ex-post risk adjustment (paragraph 146 of the Draft Guidelines). 13