Association of the Luxembourg fund industry

ALFI objects that the definition of “staff” proposed by EBA under Point 3.6 (g) of Chapter 3, Title I of the EBA draft guidelines on sound remuneration policies – “any other person acting on behalf of the institution and its subsidiaries” – is unclear and we would encourage EBA to clarify that only employees of an entity are caught by the definition of “staff”. The definition as it is proposed will lead to very different interpretations in different member states, depending on the national laws of agency. Circumvention should be eliminated by other means.
We would note that only the term “identified staff” was defined in the ESMA guidelines on remuneration under AIFMD. According to Point 3. 6 (g) of Chapter 3, Title I of the EBA draft guidelines on sound remuneration policies “[…] any other person acting on behalf of the institution and its subsidiaries” shall be considered as staff of an institution. This definition is not entirely in line with the approach taken by ESMA in the guidelines on sound remuneration under AIFMD.
Article 13 of the AIFMD gives some guidance on the scope of person falling under the category of “identified staff” according to their occupations and responsibilities.
ALFI agrees entirely with the EBA’s proposals for guidelines on remuneration policies in principle - and specifically with the need to align a firm’s remuneration policies with the firm’s customer’s best interests.
Unfortunately, we believe that the EBA’s effective repeal of variable-based remuneration structures actively works against the best interests of customers of Asset Managers.

Asset Managers’ Remuneration Philosophy

Perhaps more than banking, with its roots in the utility of deposit-taking and lending, the asset management industry has from the start been a people and talent-based industry. As a result, Asset Managers have focused on compensation policy as a tool for attracting and retaining key talent, influencing and maximising portfolio management performance as a matter of course from the very beginning.
ALFI members believe that when calibrated correctly, compensation policy actively aligns the interest of Asset Managers with those of their customers. A key objective of Asset Manager compensation policy has always been to align the interests of discretionary investment professionals (“portfolio managers”) in particular, with the long-term performance of the funds they manage and, thus, the interests of the customers invested in those funds. A key element of our members’ philosophy is therefore to recognise high performance either in rewarding achievement or incentivising individuals to strive to improve; and a key tool in delivering this philosophy is the ability to vary pay in line with performance over the long-term, recognising long-term consistent performance rather than encouraging short-term risk alongside short-term financial gain.
On the reward (pay-out) side, it is market practice to blend cash with non-cash instruments when paying variable remuneration. Non-cash elements can be either units in funds themselves or real or ‘phantom’ shares in the Asset Manager itself (according to whether it is publicly listed or privately owned). All three types of non-cash instruments are ultimately aligned with the long-term performance of the assets under management and thus with the customer’s own interests. It is sometimes practice to require portfolio managers to invest their own money in the funds they manage, while most managers actively wish to do so as a matter of course.
Asset Managers also award (measure) their portfolio managers with the long-term interests of their customers in mind. Rather than making awards on the basis of the annual performance of the appropriate portion of the firm’s balance-sheet, as with banker award systems, Asset Managers measure portfolio managers’ individual performances on a blend of their last 3 to 5 years’ results. In other words, portfolio managers’ compensation already has a 3 to 5 year deferral period built in at the award / attribution stage before becoming subject to actual deferred pay-out or vesting periods (again, commonly 3 to 5 years) on the reward leg. Pay-out of deferred elements of compensation is usually subject to malus and clawback provisions under employment contract. Again, Asset Managers’ compensation philosophies are designed to promote longevity of tenure and the longer-term more stable investment view.

Customer mis-alignment

ALFI’s chief concern then is not so much that Asset Managers are in misalignment with their customers it is that the technical detail required by EBA Draft Guidelines (the so-called “pay-out process rules”) will cut across and damage existing good practices, honed over years of talent management and performance control.
With regard to the EBA’s Draft Guidelines in particular we feel that the damage is the mandatory cap on variable pay at 100% or 200% of the fixed element (the “bonus cap”).
If we assume that Asset Managers will only be able to retain their best staff if staff continue to be able to earn broadly consistent sums with what they are paid today, then the bonus cap will see the fixed component of total compensation rising and the variable component dropping. This will significantly undermine Asset Managers’ entire compensation philosophy badly throwing out the alignment with customers’ interests. Asset Managers will effectively be forced to reward portfolio managers regardless of their performance; or, in other words to reward portfolio managers for failure. This clearly works against the customer’s best interests, which, as EBA rightly notes, should actually lie at the heart of all compensation philosophy. It removes a key tool in incentivizing portfolio managers to maximise the performance of client assets and takes a deal of sensitivity out of the management of individuals by forcing Asset Managers to pay similar amounts across the board.
ALFI thinks that the guidelines regarding shareholders’ involvement in setting higher ratios for variable remuneration are sufficiently clear.
We note that Paragraph 63 of the EBA’s Draft Guidelines proposes that subsidiaries within a CRD IV group which are not themselves subject to the CRD should apply the group-wide remuneration policies to all staff; while also stating that the specific pay-out-process requirements contained in Articles 92(2), 93 and 94 of CRD should be applied at least to those staff members whose professional activities have a material impact on the consolidated group's risk profile.
ALFI believes, firstly, that the application of the CRD IV rules to entities not subject to CRD is beyond EBA’s mandate. Remuneration policy for UCITS and AIF Managers is already established in primary legislation with each type of entity falling within ESMA’s not EBA’s scope along with the relevant Guidelines.
Secondly, the Co-legislators of AIFMD and UCITS V consciously and deliberately modelled their primary legislation on CRD IV in the first instance. In this respect, the application of CRD IV to AIF and UCITS Managers has already been considered in the co-legislation process leading up to AIFMD and UCITS V. Moreover, the AIFMD and UCITS Co-legislators carefully applied their CRD IV model to AIF and UCITS Managers proportionately. The UCITS V Co-legislators explicitly debated and rejected the bonus cap as the AIFMD co-legislators had done previously implicitly; while both sets of Co-legislators also explicitly wrote the concept of neutralisation into law specifically enabling less ‘significant’ Managers to dis-apply the pay-out process rules.
ALFI do not see why – or more importantly how –the EBA can invert the UCITS and AIFMD Co-legislators’ intentions for primary legislation with Level 3 Guidelines, and as a result would urge a complete removal of the application of CRD IV to affiliate entities within a consolidated group.
At the very least ALFI would ask the EBA to explicitly exempt consolidated Asset Management groups (i.e. groups that do not contain large banks or other balance-sheet entities within consolidation) from the provision of having to cross-apply CRD IV controls to consolidated affiliates. This would enable consolidated Asset Management groups to continue to apply AIFMD, UCITS and CRD IV provisions solely to the entities for whom each set of primary legislation was designed in the first instance.
The rationale for this exemption is (again) that agency-based Asset Management businesses do not pose the same risks as larger banking / mixed activities balance-sheet groups, and thus remuneration controls are neither required nor effective. Take for example, a consolidated group that comprises an AIF and UCITS Manager (“supermanco”) alongside a MiFID Portfolio Manager and MiFID Distributor – a consolidated Asset Management Group. Even if the MiFID firms within such a consolidated group have permission to hold money or securities belonging to their clients and / or to place financial instruments without a firm commitment basis (the key permissions that trigger inclusion in CRD IV in the first instance) they are still agency-only firms. They do not have permission to deal on own account or to underwrite financial instruments (place on a firm commitment basis) or to operate an MTF.
Furthermore, any client money held by the MiFID Portfolio Manager or MiFID Distributor will be segregated from the firm’s own money and assets in separate and regulated client money accounts just as the client’s assets will be held within regulated custody accounts and depositaries – again in contradiction to balance-sheet entity comingling of own and client money/assets. In other words, even if senior managers within the wider consolidation group were capable of taking material risks with the consolidated group’s balance-sheet, this balance-sheet belongs to an agency group in the first instance and poses very little risk to the financial system and even less to investor protection.
Thirdly and finally, we would observe that ESMA guidelines on remuneration under AIFMD already embody the alternative approach to cross-sectorial application of remuneration rules that ALFI would suggest the EBA pursue instead. ESMA guidelines on remuneration under AIFMD contain the concept of remuneration rules within parallel sectorial regulation that are capable of having “equivalent effect” over in-scope (delegate) entities as the AIFMD Guidelines themselves. They even explicitly recognise CRD as one such “equivalent” regulation. We would therefore suggest that the proper – and simpler – step under CRD Guidelines would be to reverse the polarity of the EBA’s current direction to recognise UCITS and AIFMD as “equivalent regulation” for the purposes of group compliance with CRD.
ALFI would agree with the numerous objections raised at the EBA Open Hearing on 8th May that the EBA and European Commission’s re-interpretation of the proportionality principle misunderstands or distorts the original intention of the CRD IV Co-legislators. We have concerns both about the re-interpretation itself and about the way in which the re-interpretation has been introduced into the legislative process. We also have some particular concerns with regard to the downstream implications such a re-interpretation might have for the equivalent concept of proportionality in AIFMD and UCITS (in the next section).
The nature of the application of remuneration rules across all three directives has always been subject to the principle of proportionality that stresses that the application of remuneration controls should only be made relatively to an institution’s size, internal organisation and the nature scope and complexity of its activities.
While the EBA expressly recognises that CRD IV continues to include the proportionality principle, it is now of the opinion that the proportionality principle no longer extends as far as complete neutralisation (that is, complete disapplication) of certain elements:
“Although the former CEBS Guidelines on Remuneration Policies and Practices allowed for the so-called ‘neutralisation’ of some provisions in small and less complex institutions, the terms of the CRD do not explicitly grant for such a right and therefore the preliminary assessment of the EBA is that a full waiver of the application of even a limited set of remuneration principles for smaller and non‐complex institutions would not be in line with the CRD.”
Like many others, ALFI takes the opposite view in believing that proportionality still allows firms to neutralise certain elements of policy – rather than having to apply all of the pay-out process rules as a de minimis and having to move upwards from this base, which is the EBA and Commission’s new position.

The application of the proportionality principle to variable remuneration requirements

We invite the EBA to acknowledge that CRD IV (in comparison to the wording of CRD III) did neither substantially alter, nor remove, the existing proportionality principle, stressing that remuneration should be appropriate to an institution’s size, internal organisation and the nature, scope and complexity of its activity – specifically reserving the right to neutralise pay-out process rules to agency-based businesses “in particular”.
It is ALFI’s view that since 1 January 2014 CRD IV has carried forward all of CRD III’s policy with only two amendments – neither of which makes a material difference to CRD III policy. Again, CRD IV makes clear reference to neutralisation:
• CRD IV Article 92 (Remuneration policies)(2) now states that “Competent authorities shall ensure that… institutions comply with the following principles in a manner and to the extent that is appropriate their size, internal organisation and the nature, scope and complexity of their activities”;
• CRD IV Article 94 (Variable elements of remuneration) operates “under the same conditions as those set out in Article 92(2)”; and
• CRD IV Recital 66 states that “the provisions of this Directive on remuneration should reflect differences between different types of institutions in a proportionate manner, taking into account their size, internal organisation and the nature, scope and complexity of their activities. In particular it would not be proportionate to require certain types of investment firms to comply with all of those principles.”
Thus – the two key amendments are:
• CRD III Recital 9 is not carried forward into CRD IV; and
• CAD-exempt firms are no longer called out by name in CRD IV Recital 66 as they were in CRD III Recital 4. Instead they appear as “certain investment firms”
All other elements of CRD III policy remain the same.
To ALFI’s mind, then, the only elements of CRD III that have been consciously excised from CRD IV are:
• the ability of “small credit institutions and investment firms” to neutralise some of the principles – via the removal of Recital 9; and
• the specific clarity that it is CAD-exempt firms who can neutralise the pay-out process rules “in particular”.
Otherwise, the intended operation of ‘proportionality’ under CRD IV continues to be that (i) certain unnamed credit institutions, and (ii) “certain types of investment firms” may still chose to neutralise certain elements (whether principles or requirements) of CRD IV. Again the now-unnamed “certain investment firms” are called out “in particular.”
Notwithstanding the rather confusing slippage in terminology between ‘credit institution’ and ‘investment firm’ (a problem with CRD IV as a whole), ALFI believes that by “certain investment firms” CRD IV Recital 66 clearly means to refer to CRD III Recital 4’s “investment firms referred to in Article 20(2) and (3) of Directive 2006/49/EC” or CAD-exempt firms. The sentences are in all other ways identical and the clearest distinction drawn between types of firms throughout CRD IV (as called out above) continues to be that between balance-sheet entities and agency-based CAD-exempt entities.
We therefore also believe that the ability of CAD-exempt firms to neutralise certain elements of CRD IV survives the transition from CRD III to CRD IV.

The ESMA’s considerations on equivalence of remuneration rules for CRD IV and AIFMD (and UCITS)

ALFI would like to stress the importance of CRD IV Recital 66’s continuing application to CAD-exempt firms, especially in the wider context of legislative slippage from CRD IV into UCITS and AIFMD remuneration policy.
ALFI’s first concern, is again, one of legal process. However, we would also remind the EBA and Commission of the genesis of this correspondence. The Commission Legal Services have responded to a request from a banking authority about a concept contained within a banking directive. They have not responded to a securities or markets authority about a concept contained within management company or any other agency-based legislation.
We therefore think it would be procedurally incorrect for ESMA to take guidance offered to the EBA under the CRD as de facto guidance on remuneration under either AIFMD or UCITS - at least not without considerable further consultation which might, if needs be, push back the compliance deadline for UCITS itself.
To do otherwise would change the nature of proportionality under AIFMD and UCITS not only in contradiction to how the Co-legislators set it, but in denial of the entire sense of a proportionate application of remuneration policy across the financial services landscape – from agency-based fund operators at one of the scale to full balance-sheet risk-takers at the opposite. AIF and UCITS Managers would lose the ability to neutralise bank-like elements of pay control in exactly the same way the EBA propose all CRD IV entities should lose the ability to neutralise under Draft CRD Guidelines.
In other words, legislative slippage would drive two equally disproportionate changes: firstly, all AIF and UCITS Managers would have to comply with pay-out process rules (minus bonus-cap) at a de minimis level; while secondly, significant – that is larger or more popular – UCITS Managers would have to move their controls to higher standards still. Perversely, Europe’s larger UCITS Managers would be put on a par with the FSB’s thirty Globally Systemically Important Banks (“G-SIBs) in all but having to apply the bonus cap. In terms of legislative harmony, this cannot be the FSB’s – nor the EBAs, ESMAs, nor the Co-legislators’ – vision for a coherent and proportionate financial services industry-wide remuneration policy.
In terms of costs, our chief concern is the cost to customer interests, as hitherto well aligned remuneration practices for portfolio managers in particular will be dismantled by EBA policy, and Asset Managers will effectively be required to reward individuals regardless of performance (see our response to Q2 above).
We wish to highlight to the EBA the high number of members of staff of the asset managers’ industry who will be caught as Material Risk Takers (“MRTs”) under EBA policy regardless of the fact that their professional activities do not have a material impact on the institution’s risk profile.
This is because the professional activity of an Asset Managers’ investment professionals – and portfolio manager in particular – is to have a material impact on our customers’ and not the firms’ assets – that is, to risk our customers’ assets by way of investment and not to risk the firm’s balance-sheet by way of balance-sheet speculation or, as, say, an agency-based firm’s director might. The professional activity of portfolio management is unlike the activity the EBA itself mentions in the context of MRT, in mandating that “the percentage of internal capital allocated according to Article 73 of CRD to the business unit where the staff member is active” should be included in notifying NCAs about exclusion. Portfolio management as a professional activity is based entirely on external / client capital not the risking of internal / balance-sheet capital.
Notwithstanding this lack of ‘qualitative’ impact on internal capital, many portfolio managers will fall within scope as MRTs on the EBA’s new ‘quantitative’ basis as their total compensation will exceed €1million.
This being the case, ALFI anticipates that a considerable number of member-firms will wish to take advantage of Article 4(2) of the Regulatory Technical Standards (“RTS”) enabling firms to seek exclusion for ‘quantitative-only’ MRTs from the scope of CRD IV Identified Staff. We would therefore welcome a conversation with the EBA about the best process for seeking and agreeing a possible exclusion – for NCAs, the EBA and firms alike.
We would suggest, in case such exclusions are accepted, that they are allowed to run beyond the EBA’s proposed annual review period. Again, ideally ALFI would suggest that exclusions, if accepted, are ongoing as long as the individual’s professional activity is ongoing and unchanged – that is, only subject to re-approval under set change circumstances and not subject to annual review. We would also suggest that the EBA empowers NCAs to communicate with the Asset Management industry in good time on a likely set of procedures for seeking exclusion. An exhaustive set of criteria and/or proofs that Asset Managers will need to supply in order to satisfy NCAs and/or the EBA itself would also aid the efficiency of the exclusion mechanism for NCAs, EBAs and firms alike.
ALFI believes that guidelines are sufficiently clear, but would again raise the point that fixed-based compensation practices have knock-on effects for Asset Managers’ P&L that in turn have effects for the balance-sheet and individuals Asset Manager’s ability to ride out downturns in the market. As CRD IV capital is based on Fixed Overhead Requirements (“FOR”) then the Asset Management industry’s capital base will also rise exponentially in line with the shift of remuneration from variable to fixed elements.
ALFI thinks that the proposals regarding categories of remuneration are sufficiently clear.
ALFI thinks that the proposals regarding allowances are sufficiently clear.
ALFI does not think Draft Guidelines are entirely clear as to what kind of remuneration would be considered as a retention bonus.
In cases where staff earns a fixed amount on the only condition that staff stays in the institution for a predefined period of time the remuneration can hardly be regarded as variable. It is not variable; its pay-out is contingent to predefined conditions and should therefore be regarded as fixed remuneration or at least treated as guaranteed variable remuneration. If the EBA’s intention is therefore to treat those parts of fixed remuneration as variable remuneration we would consider this as inappropriate. Those retention bonus incentivise firms only to keep those members of staff who are a real benefit for the firm. They help to establish a culture of long term and sustainable values within their institutions and they incentivise members of staff not to take inappropriately high short-term risk and to move on if things go wrong. We would agree to set minimum periods which staff would have to stay with the entity before a retention bonus could be regarded as fix remuneration. Treating all retention bonuses as variable remuneration is not appropriate.
ALFI thinks the proposals regarding severance payments are sufficiently clear.
ALFI would observe that awarding variable remuneration despite there being effectively no positive performance from the staff member, business unit or institution would, according to Paragraph 162 b) I, be seen as circumvention of the principles. This paragraph does not take into account cases of guaranteed variable remuneration and needs further clarification.
ALFI has some doubts about the EBA’s proposal to exempt members of the supervisory function in principle from variable remuneration. Such an exemption is not foreseen by CRD. Furthermore, variable remuneration can help in a very efficient manner to establish a cultural change in institutions when the incentives are set in the right way. It is not helpful to ask for an improved role for the supervisory function in institutions and making their positions unattractive at the same time. Improvements in risk management, successful challenges of business decisions and early identification of problems should be rewarded. We consider the exemption of the supervisory function from variable remuneration in principle as counterproductive and harmful.
As in our response to Q 13, ALFI have concerns about the variable remuneration of control functions. We consider EBA’s proposal in Paragraph 206 as inappropriate. The limits on the ratio between fixed and variable remuneration of 1:1 is already tight enough to prevent conflicts of interest with regard to control functions. Shareholders will only decide under extraordinary circumstances to raise this limit to 1:2 for control functions, but they should be able to do so if necessary. The control functions are crucial with regard to a cultural change in some firms and variable remuneration can be the right tool to achieve such a change.
It will also be operationally difficult to operate one type of non-cash instrument for rewarding control staff and another for rewarding all other members of staff. Furthermore, the EBA’s proposed metrics are (again) based on control of a balance-sheet entity and not an agency-based firm.
ALFI thinks the provisions with regard to deferral are sufficiently clear.
ALFI would suggest that the EBA proposal could be clearer with regard to Paragraphs 253 and 254. It would be helpful if EBA could clarify that the valuation of deferred instruments at the end of deferral and retention periods is only used for the application of potential ex-post risk adjustments and malus or claw back measures. The ratio between fixed and variable remuneration is based on the valuation of instruments at the point of their award.
ALFI thinks the provisions with regard to the retention policy are sufficiently clear.
ALFI thinks the requirements on the ex post risk adjustments are sufficiently clear.
ALFI thinks the requirements in Title V are sufficiently clear.
ALFI thinks the requirements in Title VI are sufficiently clear.
ALFI maintains that the impact of EBA’s policy on Asset Managers and their customer base has been either incorrectly calibrated or overlooked (see our response to Q. 2).
Equally, however, we think EBA policy is misaligned against four other axes: the proper treatment of Asset Managers in terms of systemic riskiness; the properly harmonised application of remuneration policy across the financial services landscape; the proper operation of a talent pool across the financial services industry and the efficient delivery of the European Commission’s own policy agenda going forward – and not least the CMU.

Systemic risk mis-alignment

Higher fixed components will have an impact on the systemic footprint of Asset Managers by forcing them to load more permanent cost onto their profit and loss (“P&L”). Unlike variable compensation elements, the compensation element of P&L is much more difficult to flex in a downturn. In fact, in such circumstances, Asset Managers’ choices are binary: they can either retain members of staff and risk the P&L or fire members of staff and risk poor customer outcomes by operating with fewer investment professionals. Indeed this risk to customer outcomes is significantly increased as potential staff reductions would likely impact the back office thereby increasing risk across the business as a whole.
In a business where customers value individual portfolio managers’ track-record and experience over anything else a ‘hiring and firing’ culture is the last thing customers wish to experience – especially in a period of downturn when continuity and experience are precisely what is needed for customers and the stability of the markets equally. The clear alternative to the boom and bust culture of ‘hiring and firing’ is the ‘heightening and lowering’ culture of variable-based compensation practices, and yet this is the very culture that EBA Draft Guidelines would dismantle.

Regulatory mis-alignment

Against the background of systemic risk, ALFI would also ask the EBA to remain conscious of the origins of EU remuneration policy when understanding some of the (perhaps unintentional) consequences for Asset Manager compensation we elucidate below.
Published in 2009, the Financial Stability Board’s (“FSB”) founding-documents, Principles for Sound Compensation Practices and Implementing Standards were developed to align compensation with prudent risk-taking. Importantly, however, they were targeted solely at significant financial institutions and at significant banking institutions in particular. It was the European Commission that took the decision to extend the FSB Principles across banks, balance-sheet investment firms and agency-based investment firms , such as MiFID Portfolio Managers, by implementing them though the Capital Requirements Directive (“CRD III” in 2010). Part of this problem of scope, to be sure, was the inclusion of agency-based investment firms within the remit of CRD in the first place – the Commission having amalgamated the Banking Directive and Capital Adequacy Directives into CRD II in 2009.
In recognition, however, the Commission, European Parliament and Council (“Co-legislators”) extended CRD II’s capital rules and, when they applied, CRD III’s remuneration rules, in a proportionate way allowing agency-based investment firms to dis-apply.(“neutralise”) the pay-out process rules while maintaining the requirement for banks and balance-sheet investment firms. The Committee of European Banks (“CEBS”) published Guidelines on the same basis and local regulators implemented CRD III with the same right for agency-based investment firms, such as MiFID Portfolio Management Firms to dis-apply.
The Commission continued the trend of extending FSB Principles more expansively than global peers across the EU financial services landscape with AIFMD, applying to AIF Managers, and amendments to UCITS (“UCITS V”), applying to UCITS Managers, respectively. In each case, however, the Co-legislators again implemented FSB Principles in a proportionate way – albeit now to fund managers that are solely agency-based. Under ESMA AIFMD Guidelines, AIF Managers that are not deemed ‘significant’ in terms of their size, their organisation and the nature, scope and complexity of their activities, can dis-apply the pay-out process rules in the same way that all MiFID Portfolio Management Firms can under CRD III. We await ESMA UCITS Guidelines, but the logic of allowing MiFID Portfolio Management Firms and non-significant AIF Managers to dis-apply the pay-out process rules should prevail for non-significant UCITS Managers too (although there is some difficulty here).
The inclusion of all three types of Asset Management entity within scope of EU remuneration controls is already a considerable way away from the original intention of FSB and before them the Basel Committee on Banking Supervision (“BCBS). However, so far, the problem of bringing Asset Managers within scope of banking remuneration regulation has been ameliorated by the proportionate rather than absolute application of bank remuneration policy to non-bank entities.
CRD IV continues to retain agency-based investment firms such as MiFID Portfolio Managers within scope. Although there is now a lighter-touch regime for Portfolio Managers devoid of certain key regulatory permissions (including the right to dis-apply the remuneration regime in its entirety), a considerable number of Portfolio managers will remain within full scope of the directive simply because they cannot operate without those key permissions. Agency-based investment firms will continue to sit alongside balance-sheet investment firms and banks under the full scope of CRD IV as a matter of course. However, going forward the EBA effectively now proposes to treat all three entities as equals, without any of CRD III’s acknowledgment of the fundamental differences in their systemic and investor protection risk profiles.
Furthermore, this equality will require the pay-out process rules apply as a de minimis to all CRD V firms. The pay-out process rules will actually be more stringent for ‘significant’ CRD IV firms, including ‘significant’ agency-based Portfolio Managers of which there are a number. Staff within MiFID Distributors that hold large amounts of client assets and money on fund distribution platform, for example, will become subject to the same pay-out process rules as bankers within the FSB’s 30 Global Systemically Important Banks – despite the fact that client assets and money within the Distributor, as within all agency firms, are segregated from the firm’s assets as a matter of law and subject to stringent custody and client money regulations.
ALFI maintains that this is itself a disproportionate treatment of agency-based Portfolio Managers. However, we also wish to ensure that the EBA, ESMA and the European Commission (on whose legal ‘interpretation’ this volte face turns) are fully aware of the effects downstream from CRD IV – that is, for UCITS and AIF Managers and thus for Asset Management groups more widely. As outlined in more detail in the next section, one very natural and probable consequence of EBA’s proposed re-interpretation of ‘proportionality’ in its Draft Guidelines is for the same re-interpretation to be applied to UCITS and AIFMD and to drive the same de minimis application of the pay-out process rules (albeit without the bonus cap) across all Fund Management entities, with ‘significant’ Fund Managers (however one might calibrate that) again subject to higher standards. Again, given the agency-based nature of UCITS Managers ALFI considers this a disproportionate application of FSB policy; but more so when one considers the fact that UCITS funds are the most highly regulated retail products in Europe and pose virtually no threat to the Manager’s balance-sheet or the financial system.
None of the entities traditionally found within Asset Managers are subject to any of the other elements of regulation reserved for SIFIs (for example, recovery and resolution legislation and ring-fencing); while the FSB and the International Organisation of Securities Commissions (“IOSCO”) are still to determine whether a handful of the world’s largest funds or Asset Managers might qualify as systemically important. In the absence of coverage in any other area of SIFI regulation, ALFI therefore maintains it is entirely inappropriate to bring Asset Managers within the third leg of control – complete bank-like remuneration control. The FSB clearly never intended to capture fund operators, distributors or discretionary portfolio management firms within its net.
As stated in ESMA’s final report on guidelines on sound remuneration under AIFMD, the various sets of guidelines under CRD, AIFMD, UCITS and MiFID are complementary while applying consistent principles. In ALFI’s view EBA guidance should therefore be consistent to what is already in place under UCITS, AIFMD and MiFID .

The talent pool

The fact that this constitutes so radical a departure from FSB’s original intentions is important for more than reasons of regulatory proportionality and legal process. It will also have a direct bearing on Asset Managers’ ability to attract and retain talent – at least within the EU. If set on a par with banks and balance-sheet investment firms, Asset Managers can expect to lose valuable investment talent to both other entities in the first instance as well as management talent to entities outside the financial services industry. However, they also risk losing investment talent (and portfolio management talent specifically) to Asset Managers outside the EU where the FSB Principles have been correctly restricted in their application to systemically important banks only. Again, for a people- and talent-based industry such loss is not to be underestimated. The impact of these draft regulations on remuneration should therefore not be assessed in isolation within the European Union but rather on a more global scale. ALFI’s fear is that some non-EU Promoters/ Asset Managers of UCITS funds, which have been inclined to take advantage of the UCITS product, might consider other fund jurisdictions instead in the future, in particular in the situation where those funds are distributed, at least in part, in their home countries. As mentioned in a Commission Staff Working Document Impact Assessment in the context of the UCITS IV directive [SWD(2012) 185] on 3 July 2012, and based on Eurostat statistics for the year 2010, it is estimated that 36% of UCITS’ assets are placed with retail and institutional investors outside the EU.


Policy mis-alignment – the CMU

Finally, we would suggest that the EBA also retains a focus on economic growth and the future – as the Commission is itself doing with the Capital Markets Union (“CMU”) dossier – and not just on systemic risk.
We feel that Asset Managers are not only currently well-positioned to carry out this new role but are controlled to do so efficiently – efficiency being the key characteristic in any transmission mechanism. Asset Managers’ compensation practices are already geared to reward the long- rather than short-term performance of funds under management as well as to align portfolio managers’ and customers’ interests – a key requirement if reticent investors are to entrust their money to managers in the first instance.
Indeed, any move towards mandatory fixed compensation patterns can only introduce inefficiency into the mechanism, by requiring Asset Managers to reward their staff regardless of performance and removing the inability of senior management to incentivise portfolio managers to maximise return for customers and efficiently steward the firms in which they invest. In short, Asset Managers can clearly play the role of transmission mechanism that the Commission envisages, however EBA policy risks turning them into a more complacent less accountable and therefore inefficient mechanism on the very eve of their renewed utility to the economy.
EBA policy also risks tipping the asset management industry into becoming a more volatile transmission mechanism, by forcing Asset Managers into a ‘hiring and firing’ fixed compensation culture rather than a ‘heightening and lowering’ variable compensation culture. And, of course, as with retaining rather than acquiring customers, it is simply cheaper to retain existing and experienced investment talent than it is to hire and train (let alone fire) it. This change in culture would risk destabilising the recruitment market through eroding the psychological contract as trust between employer and employee weakens proportionately. We think both are key considerations in the best interests of maximising the efficiency of market-based financing mechanisms. It is also worth noting that the process of training a portfolio manager up ‘through the ranks’ from investment analyst, through portfolio manager to investment director is a long-term process and that a more volatile hiring and firing culture will lean against the training as well as the retention of portfolio management talent.
Isabel Hog-Jensen