Asset Manager Remuneration in UCITS V and AIFMD

The “Harmonization” of these two regulatory directives.

Since the early days of the AIFMD (and UCITS V) proposal and the lead up to its implementation, there has been one facet of this directive that has not been well understood. The limitations and parameters around remuneration has been an ongoing conundrum, especially variable remuneration and the entire directive’s unintended consequences to US asset managers who manage either UCITS or AIFs as AIFMs or as unregistered sub advisors to an EU AIFM. How do these remuneration guidelines apply in this extra territorial situation, and how is the US asset manager to align their EU and ex-EU remuneration (especially in regards to variable remuneration)? What is the base “salary” on which a US manager’s variable remuneration is based? If a portion of the remuneration is still to be taken in shares of the fund, how is the asset manager to comply when many EU registered funds disallow US shareholders and if that restriction is removed, it creates an unfair consequence where such a requirement may have significantly negative tax implications? A taxable US holder of UCITS or AIF shares can generate a significant tax exposure triggered through either or both PFIC and/or CFC rules.

My client base is heavily US asset managers. These managers have long-established funds and strategies that service both the retail and institutional client bases in the US. They are searching to establish a more global footprint and service the international market through an offering of these same funds either via UCITS or AIFMD. The increasing regulatory barriers and the continuing uncertainty surrounding the ultimate definition of many of these new rules is met with the decision to “sit on the sidelines” by a number of US asset managers.

Dechert LLP has done a great job in condensing the recent UCITS V and AIFMD harmonization and viewed some of the issues faced by US asset managers living under the new AIFMD and UCITS V. The full text of their write-up can be found at the link below. I have extracted the section on remuneration and added it below as it explores the unique situation facing US asset managers who manage EU registered funds under UCITS V and/or AIFMD.


The issue of remuneration was the major battleground in the negotiation of UCITS V and for a piece of financial services regulation, it became quite politicised, particularly in March 2013, when the European Parliament’s Economic and Monetary Affairs Committee (ECON) voted to cap bonuses for asset management staff at a 1:1 ratio with their annual salary. Unusually, and to the relief of many in the asset management industry, the bonus cap proposal was voted down at the plenary session of the European Parliament.

Consistent with AIFMD, under the final text of UCITS V, UCITS management companies will be required to establish remuneration policies and practices that are consistent with and promote sound and effective risk management. These remuneration policies must not encourage risk-taking which is inconsistent with the risk profiles, rules or instruments of incorporation of the UCITS under management and cannot impair compliance with the management company’s duty to act in the best interests of the UCITS.

These remuneration provisions are subject to a proportionality test and UCITS management companies must comply with the remuneration principles set out in UCITS V in a way that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities.

In addition, UCITS V empowers the European Securities and Markets Authority (“ESMA”) to issue guidelines on the scope of staff to be caught under the new remuneration rules and the application of the new remuneration principles for UCITS management companies. These guidelines are intended to add flesh to the bones of the UCITS V remuneration principles and are expected to be largely aligned with ESMA’s Guidelines on Sound Remuneration Policies under AIFMD (the “Guidelines”), which provided guidance on proportionality, which remuneration would be affected and how to identify categories of staff covered by the Guidelines. The guidelines expected to be issued by ESMA in relation to remuneration policies under UCITS V will not be binding, however, financial regulators and market participants will be expected to comply on a ‘comply or explain’ basis. To date under AIFMD and the Guidelines, the sole proponent of explain rather than comply has been Malta.

Variable Remuneration

Under UCITS V, 50% of any variable remuneration of UCITS management companies must consist of units of the UCITS concerned. During the negotiations, it had been strongly argued that variable remuneration should be in the form of shares of the management company or its parent company. This position was ultimately rejected as it was argued that this would have led to a situation where fund managers were rewarded for increasing profits of the management company rather than the value of the funds under their management.

Under the final text, 40% of variable remuneration will be deferred for at least three years and 60% will be deferred for very high bonuses.

Application to Delegates

In a late change to the text, UCITS V now includes a recital which states that the new remuneration rules “should apply in a proportionate manner, to any third party which takes investment decisions that affect the risk profile of the UCITS because of functions which have been delegated.

There is no corresponding provision in the operative parts of UCITS V and there is now a significant question of how effect will be given to this recital. It is most likely that, as was the case with AIFMD, the application of the rules to delegates will be dealt with under guidelines issued by ESMA.

This has been a hot topic under AIFMD, particularly for funds that are advised by US advisers, who are not subject to equivalent remuneration provisions and who find the extraterrestrial application of EU regulation troubling.

Close attention will be paid to the consultation process that will precede the issue of any guidelines by ESMA and to the application of the equivalent Guidelines under AIFMD in the period up to the expected implementation of UCITS V in 2016.

There will be a particular focus on how the proportionality rule will be applied by regulators under AIFMD.

The Financial Conduct Authority (“FCA”) produced guidance on AIFM remuneration which provides an interesting and helpful analysis of how the principle of proportionality will be applied by regulators and the Irish Central Bank has indicated that it sees “considerable merit in the interpretations which the UK FCA have provided which align the interests of risk-takers and investors and which seek to ensure that the effective management of AIF assets is preserved.

Among the factors that will need to be taken into consideration by AIFMs are:

  • Assets under management
  • Scale and complexity of structure:
    • whether listed or not
    • having additional permissions such as receiving and transmitting orders
    • simple structure e.g. internal v external ownership
    • use of AIFM passport
  • Complexity of strategies:
    • volatility
    • use of leverage
  • Delegates:
    • application of group CRD remuneration requirements to delegates
    • limiting investment discretion through strict investment guidelines
  • Fee structures aligned with investors’ interests

An additional concern for US managers is whether acquiring shares in a UCITS will be practical or feasible. Many UCITS prohibit investment by US persons, so it might be impermissible for US fund managers to hold the shares. If a UCITS changed its constitutional documents to allow US persons to invest, this could result in extra legal and regulatory registration and compliance obligations for the fund and the investment manager, thereby increasing the costs borne by the UCITS. In any event, even if a UCITS changed its constitutional documents to allow US persons to invest, some fund managers might be ineligible to invest based on the fund’s investor criteria and investor criteria imposed by US securities laws. Finally, holding shares of UCITS structured as a corporate vehicle would result in negative tax ramifications for US fund managers who are US taxpayers.

(Full text of the material referenced can be read here.)

AIF Distribution Options in the EU – A Short Story

In response to the gathering and ongoing confusion about AIFMD and what a US alternative manager can do to distribute their AIF in the EU, I have gathered some general information with regard to alternative strategies distribution in the EU post AIFMD. This body of information includes the information in the matrix below, which was developed by PWC Ireland.

Essentially, there are two available modes of distribution sanctioned by the EU regulators and laid out below, one is registering as an EU Alternative Investment Fund Manager (AIFM), filing a EU registered Alternative Investment Fund (AIF) and distributing (eventually) via the EU passport facility. Or, the second distribution option of a EU AIFM (or non EU registered AIFM) distributing a non EU registered AIF via the national private placement regimes (NPPRs) that are currently still in force.

The first option gives a non EU alternative investment manager EU wide access to distribute their Irish registered AIF via the new AIF passport facility. This option is a well trod path based on the paradigm of the UCITS manager registration and distribution regime that exists today. This existing process has been applied with asset and remuneration specific changes to the new AIF regime.

The second distribution option is that of a non EU AIFM selling a non EU AIF into the EU. This option required a filing for AIFM registration exemption (until mid 2014), then subsequently filing a full AIFM registration and then complying with the National Private Placement Regimes (NPPRs) on a country by county basis for as long as those regimes continue. ESMA is reviewing this mode of distribution, but has indicated it will not close this avenue until 2018 at the earliest. This distribution option is less well know as the NPPRs have not been commonly invoked by the pre AIFMD non EU managers. It has been the habit previously to “fly in” and sell to larger institutions under a non existent, but de facto, de minimus regime. Because of this general unfamiliarity with NPPRs, I have included a short discussion (again borrowed from PWC) of this topic below.

One can see the confusing registration options and combinations of options in the matrix below and that for some time, the NPPRs will still exist as a possible avenue for EU distribution. However, as of mid 2015, there is a high likely hood that the EU passport only requirement will be invoked.

Domiciles / marketing

Does AIFMD apply?

Marketing Arrangements

EU AIFM/ EU AIF – marketed in EU Yes EU Passport (July 2013)
EU AIFM/ EU AIF – not marketed in EU Yes None
EU AIFM/ Non-EU AIF – marketed in EU Yes NPPRs
(2013 to 2018)
EU Passport (from mid 2015) *
EU AIFM/Non-EU AIF – not marketed in EU Yes None
Non-EU AIFM/ Non-EU AIF – marketed in EU Yes NPPRs
(2013 to 2018)
EU Passport (from mid 2015) *
Non-EU AIFM/ Non-EU AIF – not marketed in EU No None
Non-EU AIFM/ EU AIF – marketed in EU Yes NPPRs
(2013 to 2018)
EU Passport (from mid 2015) *
Non-EU AIFM/ EU AIF – not marketed in EU Yes None

One issue that no one addresses with any clarity is selling to and maintaining client relationships with existing customers and/or reverse enquiry situations for those non EU managers who do not register as AIFMs. The first seems to be permitted, especially for the near term. The latter seems to be problematic but hardly stoppable. Both instances would assume the EU investor is an institution and sophisticated enough to deal with a non EU AIF in a variety of jurisdictions.

Not very encouraging options but this is how the distribution market is shaping up in Europe for the non EU AIFM and the regulators seem to be inclined to harmonize with the UCITS paradigm going forward so this may not be the final word for some time.

The following helpful write up about NPPRs, is from the most recent Distributing our Knowledge Fund Distribution: UCITS and Alternative Investment Funds (AIF) by PWC Ireland.

How do the NPPRs work?

National Private Placement Rules (NPPRs) must be used by non-EU AIFMs that cannot avail of the European passport in order to market their AIFs in Europe. However, individual member states may move to abolish or restrict the use of NPPRs, now that the AIFMD is in force. The majority of EU countries intend to allow some form of private placement but the requirements vary among member states. All countries that intend to allow private placement will apply at least the minimum AIFMD standards outlined below and require notification to the home state regulator of the intention to market in the country.

AIFM Minimum Standards

-the manager must comply with the provisions of the AIFMD relating to the annual report and disclosure to investors (including disclosure as to aggregate remuneration);

-the manager must comply with detailed reporting requirements under the AIFMD to national Regulators in each of the member states in which they intend to privately place their AIFs. Such reporting must be completed quarterly, semi-annually or annually depending on the value of the assets under management of the AIFM. The reporting requirements includes details on the principal markets on which an AIFM trades, instruments traded, principal exposures, important concentrations, illiquid assets, special arrangements, risk profiles, risk management systems, stress testing results, list of all AIFs managed, leverage in the AIFs and sources of leverage. Individual Member States may impose stricter reporting rules;

-if the manager manages an AIF which acquires control of a non-listed company, the provisions of the AIFMD relating to major holdings and control must be complied with;

-appropriate cooperation arrangements must be in place between the regulator of the member state where the AIF is marketed and the regulator of the AIFM’s non-EU country;

-appropriate cooperation arrangements must be in place between the competent authorities of the member state where the AIF is marketed and the country where the non-EU AIF is established; and

-the non-EU country must not be listed as a Non-Cooperative Country and Territory by the Financial Action Task Force.

Some countries have additional requirements to what is outlined above. For example, France has elected to impose such significant additional requirements on non-domestic AIFMs seeking to market under France’s private placement regime that it could be extremely difficult to market AIFs in France. Germany is one of a small number of EU countries that will require non-EU AIFMs of non-EU AIFs to appoint an entity to carry out the so called “depositary-lite” duties of cash monitoring, safekeeping of assets and oversight and verification, a requirement under the Directive applied only to EU AIFMs marketing non-EU AIFs. Austria has imposed a tax treaty condition for non-EEA AIFs. The UK, Ireland, Luxembourg and Sweden are part of a group of countries that have not imposed additional conditions. The list of countries that are open for private placement are as follows: Austria, Bulgaria, Cyprus, Czech Republic, Estonia, Finland, France, Germany, Ireland, Lithuania, Luxembourg, the Netherlands, Romania, Slovakia, Sweden and the UK.

Thoughts on Why US Asset Managers Should Consider UCITS Funds

As an international product development specialist, I often get asked why a US manager should consider an “offshore” UCITS fund?

The question actually comes up surprisingly often, and many times as a result of a non-US institutional investor approaching the US manager wanting to invest in one of the manager’s strategies.  The conversation goes something like this: “I really like your investment strategy but I can’t invest through your US mutual fund or private placement and I don’t want the cost and complexities of a cross border managed account.  If you were to  launch a UCITS fund, we would be interested in being the seed investor.”

Thus the US asset manager begins to explore what this means to him and his organization in terms of opportunity, cost, hassle, etc.  

The following is my general response. Most of the points I will provide are universal reasons why any US asset manager should take a serious look at the international investment market. However, there will also be a few points, scenario specific, as to why I believe a manager faced with a seed money offer should understand that this moment could be an inflection point where capability and opportunity are aligning to facilitate that manager’s entry into the global market with a number of risk factors eliminated or reduced substantially.

There is a larger investment fund market outside the US than inside the US.

The US market now accounts for only 48% of the global investments in packaged products.  Therefore, the larger and faster growing investor base now exists outside the US.

The UCITS fund structure is a global brand that can service a vast majority of the international (ex-US) investment fund market.

UCITS are acceptable as “salable” in over 70 countries worldwide vs. the ’40 Act funds’ limitation to the US market only. Granted, there are jurisdiction registration requirements in each country, but the UCITS is still a single fund and the national “wrappers” are significantly easier to create than de novo funds per jurisdiction.  An additional benefit available to US fund managers, who have an existing US mutual fund, is that the majority of the heavy lifting in product creation is already done. Based on the existing operations and disclosures, the UCITS product development is simplified by applying their current fund experience and processes to the new UCITS package. Between the two funds, the fund manager can now access the majority of the world’s investors, leveraging the same fund development effort.

Global private wealth is growing substantially, the world is pulling out of global recession, and there is now a cost effective, less risky way to access this trend.

The US is leading the world out of a long and deep recession and we are also coming out the other side from a global financial crisis.  US markets are the preferred market to invest in as the world’s wealth is recovering, growing and looking for a “safe” investment.

Regulatory changes, though seen as a negative right now, are providing a path to approach the ex-US investor in a transparent, responsible way.

The “offshore” market is no longer the Wild West. Accessing the correct global structure and jurisdiction allows quality asset managers to conduct business on a global scale in the transparent responsible way they currently do in their own domestic environment.  Regulation may increase operational and administrative costs but it brings legitimacy to products and comfort to investors that only grow the total investor market.

The existence of mature registration jurisdictions, coinciding with a mature, comprehensive and turnkey operational environment, reduces the inherent risks of entering a new market.

Over the last 20 plus years, the development of Ireland and Luxembourg as quality, regulated jurisdictions for creating investment structures, has culminated (post financial crisis) in the development of regulatory and operational platforms created specifically to service non-domestic asset managers. The development of turnkey regulatory and operational platforms has allowed and encouraged the growth of a unique financial industry offering, predicated on the concept that asset managers can now distribute their expertise globally, leveraging pre-packaged regulatory and operational fund services.  This means that the managers’ registration status in their home jurisdiction is accepted by notification rather than re-application.  AML, compliance, call centers and fund governance are all provided turnkey, and under the provider’s registration, so that the cost and risk of entry into the global fund marketplace is substantially reduced.  As a result, most US asset managers do not need to put any people on the ground initially and only will do so when success and/or growth demand it.  C-suite managers (CCO, CFO, COO) will have to take on additional oversight responsibilities but most of the extra operational and regulatory workload is actually performed by the third party service providers.

The development of comprehensive third party distribution services will reduce risk by eliminating the need to put “boots on the ground” and build a distribution network from scratch.  This new development greatly reduces entry cost and failure risks.

Historically, access to the non-US investor was costly and difficult.  Each little nation had its own registration requirements for both funds and distributors of funds. There were multiple currencies and languages and extensive cross border selling restrictions.  Banks dominated the funds’ distribution and like their US wire house counterparts, asset managers found getting shelf space was costly and time consuming.  With the advent of the EU, the Euro, and UCITS, the European fund and investing market became more integrated and began to act as a single market in most respects – except distribution.  However, in the last three years there has been the emergence of firms who call themselves third party marketers but are in fact aggregators and syndicators of networks of domestically established and registered distribution groups.  These TPMs in Europe are not wholesalers for hire as we know in the States but are essentially sales departments for hire who will actually get your product into investors’ hands via local and trusted distributors known and coordinated by this new breed of TPM.  One of the biggest risks in setting up a fund overseas is the commitment in fixed costs for personnel and a legitimate commitment to these individuals not to “cut and run” when fear begins to grow around this new venture.  Much of what has been created in Dublin and Luxe is designed to remove the fixed costs of regulatory, operational and distribution investments by providing good quality turnkey services to accomplish these functions, thereby substantially reducing a new manager’s entry risk.

The existence, in our seed partner case, of a catalyst to initiate the entrance into the global fund market cannot be underestimated.  Having an institutional partner who is willing to come alongside the new fund manager, as a seed investor, is a huge and critical point of validation to other investors.

It is a question of striking while the iron is hot.  If you have an investor who is willing to be “first in” with a substantial allocation as seed for the fund, you have eliminated significant cost and reputation risk in your new fund launch.  This seed investment allows the manager the benefit of knowing the launch date with certainty, knowing that the fee minimums are exceeded and are well on their way to breaking even, day one.  There is also a huge benefit with this institutional investor seen as “first in” which can substantially reduce other institutions’ reluctance to invest in a new fund.

Existing US funds success in asset growth and strategy returns, added to the fact that the US strategies use US securities, creates a unique and timely combination. 

This is more of a timing and momentum comment.  In many respects, the desire to expand a manager’s footprint globally is a logical extension of a US fund’s current momentum. The fund’s growth and strategy success almost begs for expansion into the global market.  Outside a manager’s internal momentum, the global financial markets are recovering and the US is seen as leading that recovery.  The world is currently in an investment cycle where the demand for US exposure is high.  However, non US investors can only access the US market via UCITS funds or their “domestic” funds using a US based strategy.  Access to these buyers is extremely limited for a US manager without their own UCITS fund.

So there appears to be a convergence of turnkey fund services, broad and effective TPM fund distribution, US market momentum, a beneficial investment cycle and (in some cases) a seed investment partner, all of which have combined to create a unique environment for the US fund manager that is hard to ignore!

The Consultant

A little story to illustrate the roll of a consultant.

There was a shepherd looking after his sheep by the side of a deserted road. Suddenly a brand new Porsche comes roaring down the lane and screeches to a halt. The driver, a young man dressed in an Armani suit, sporting Cerutti shoes, Ray-Ban sunglasses, a TAG-Heuer wrist- watch, and a Pierre Cardin tie, jumps out and asks the shepherd: “If I can tell you how many animals you have, will you give me one of them?”

The shepherd looks at the young man, and then looks at his large flock of grazing sheep and replies: “Sure.”

‘The young man parks his Porsche , connects his Apple MacBook Air laptop to the internet via his iPhone mobile hotspot, navigates to a live NASA satellite site, scans his location using his phone’s GPS coordinates, opens a database, selects a number of parameters and does a data dump to a spreadsheet filled with preset macros and pivot tables, and finally prints out an extensive PowerPoint deck on his high-tech wireless mini-printer. He ponders the information for a bit, turns to the shepherd and says, “You have exactly 1,586 sheep.”

The stunned shepherd replies, “That’s correct, I guess you can choose your sheep.” The young man makes his pick and stuffs the animal in the back of his Porsche. The shepherd watches him and then asks: “If I guess your profession, will you give me my animal back?”
The young man answers, “Sure, why not?” The shepherd answers, “You’re a consultant.”
“How did you know?” asks the surprised young man.

“Very simple,” answers the shepherd. “First, you showed up without being asked. Second, you charged me a fee to tell me something I already knew, and third, you don’t understand anything about my business… Now give me back my dog?”