Flash News. Remuneration Requirements under UCITS V UCITS V. 8 May 2014

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1 Flash News Remuneration Requirements under UCITS V 8 May 2014 On 15 April 2014 the European Parliament adopted the proposed text of the fifth iteration of the Undertakings for Collective Investment in Transferrable Securities Directive (UCITS V). The adoption of these rules represents the final step before UCITS fund managers are to adhere to the directive. Certain formalities do remain, with the European Council s final approval required ahead of publication in the Official Journal of the EU. A link to the adopted text can be found here. After CRD III & IV and AIFMD, UCITS V is also impacting the remuneration area. As usual, the devil is in the detail. Some concepts introduced in the first versions have been erased such as capping the variable remuneration and include the fund administration responsibles as Material Risk Takers. We invite you to discover the main principles of UCITS V on remuneration below. In a second chapter we will also cover some interesting developments on the EBA guidelines regarding the notional discount rate for variable remuneration under the fourth iteration of the Capital Requirement Directive (CRD IV) and on data collection for high earners. UCITS V Despite previous proposals to include guidelines that would see UCITS managers subject to remuneration rules as onerous as those that the banking sector is subject to with CRD III & IV, the asset management industry will welcome the news that UCITS V does not include a cap on variable remuneration and does not require to establish and maintain a remuneration committee depending on some criteria. Some areas of uncertainty remain, most specifically concerning the definition of Identified Staff and the application of proportionality. These issues will be clarified in time by the European Securities and Markets Authority (ESMA), which has been tasked with setting out Guidelines, the purpose of which is to provide further clarity on how the rules should be applied by UCITS managers and how these will interact with remuneration regulations under CRD III & IV and AIFMD. We have summarised the key points of the adopted finalised text in the following pages.

2 1. Timing of implementation The proposed date of implementation is currently uncertain. While the adopted text has not indicated the date by which Member States should have remuneration rules in place, marked up notes seem to suggest that this could be 18 months from the publication of the Directive in the Official Journal (due in Q2 2014). Therefore, this would further suggest that UCITS managers will not be expected to comply with the remuneration provisions until The date of implementation should be confirmed in the Official Journal. 2. Identified Staff Identified Staff will be subject to a UCITS-compliant remuneration policy. ESMA is mandated to issue (non-binding) Guidelines on the UCITS V remuneration rules, which are expected to follow the same lines as ESMA s Guidelines on Sound Remuneration Policies under the AIFMD. The Guidelines are expected to provide clarification on a series of matters and in particular on the categories of staff falling within the scope of the remuneration rules (Identified staff) and the application of proportionality. The Directive defines Identified Staff as including the following categories of staff: Senior management; Risk takers; Control functions; and Employees receiving total remuneration in the bracket of senior managers and other risk takers whose professional activities have a material impact on the risk profile of the UCITS manager (or the UCITS managed therein). The recitals that precede the directive mention a number of specific roles to which the provisions should apply. These recitals have no legal bearing in the manner that the directive text does. However they may influence ESMA, in its drafting of guidance around the interpretation of Identified staff and their identification. Such roles include: Employees/members of staff with decision-making authority at the fund/subfund level; Fund managers and other individuals taking real investment decisions; Other individuals able to influence the above individuals (including investment advisors and analysts); and In a proportionate manner, third parties with authority for investment decisions. The European Securities and Markets Authority (ESMA) is tasked with providing guidelines that set out further clarity regarding the roles that should be included within the Identified Staff definition.

3 3. Proportionality The Directive acknowledges that a proportional approach to compliance with the rules is permissible. This is based on consideration of the size, internal organisation, and nature, scope and complexity of activities. This wording mirrors that included within AIFMD, which would suggest that a similar approach may be adopted, based on the disapplication of certain rules. ESMA is tasked with providing Guidelines that address the issue of proportionality. At this stage, it is expected that ESMA will adopt a pragmatic approach and adopt a framework similar to that stipulated in both the AIFMD and the CRD IV. 4. Application to third parties The Directive confirms that the rules should apply, in a proportionate manner, to any third party that takes investment decisions that affect the risk profile of the UCITS as a result of delegation. This is different from the AIFMD, in whose guidelines the application to delegates was first introduced by ESMA. ESMA s interpretation of the word proportionate in the UCITS V guidelines draft will dictate in practice how much impact the remuneration rules will have on the affected operating investment management or risk management under delegation agreements. 5. Structural remuneration requirements Deferral: At least 40%-60% of variable remuneration will be deferred over a period that is aligned with the holding period recommended to UCITS investors. This period should be at least 3 years. The length of deferral has been increased compared to previous proposals to align with similar requirements under the AIFMD and CRD IV. Delivery in non-cash instruments: At least 50% of variable remuneration (both deferred and undeferred elements) should be delivered in UCITS funds, equivalent ownership, or sharelinked/non-cash instruments. Retention: This non-cash element shall be subject to a retention period. Other structural rules: Rules relating to guarantees, termination payments, and performance adjustment are in line with those currently in force under AIFMD and CRD IV. Ratio on variable vs. fixed remuneration: The Directive was finalised without the inclusion of a cap on the ratio of variable: fixed remuneration (this was included within previous proposals). 6. Governance requirements Management body responsibilities: Members of the management body (in its supervisory function) of the AIFM are responsible for establishing, maintaining, and reviewing the remuneration policy on an annual basis. These members should

4 have sufficient knowledge of risk and remuneration and perform a non-executive role in the UCITS manager. Remuneration committee: In a significant departure from similar rules under AIFMD and CRD IV, there is no requirement to establish and maintain a remuneration committee. A remuneration committee will only have responsibility where such a structure already exists. 7. Conclusion Many firms already subject to similar requirements under CRD IV and AIFMD are likely to have the in-house knowledge and processes to allow for a straightforward extension of current remuneration arrangements to a larger population of impacted staff. However, the implementation of these structures will highlight the complexities of working in a multi-regulatory, multi-jurisdictional environment. Employees may fall under the scope of different directives, which in turn are interpreted and transposed by different regulators. This is likely to cause an administrative challenge for firms that are subject to multiple regulations. We expect these new guidelines to be applicable by More news will be available once the ESMA guidelines have been issued. We will keep you updated. EBA guidelines 1. EBA guidelines on an appropriate discount factor On 28 March 2014, the European Banking Authority (EBA) published its final guidelines on an appropriate discount factor for long-term variable remuneration under CRD IV (Directive 2013/36/EU). Background CRD IV stipulates that the variable component shall not exceed 100% of the fixed component of the total remuneration for the categories of staff whose professional activities have a material impact on the risk profile of the institution. A higher ratio of up to 200% may be allowed, subject to shareholder approval. For the purpose of calculating the ratio between the variable and fixed component of remuneration, Member States may allow institutions to apply a discount rate. Firms within the scope of CRD IV can now determine the extent to which they will use the discount factor as a way of mitigating some of the effects of the bonus cap. What's in there? The guidelines concern institutions that make use of the option to apply the discount rate for the purpose of calculating the ratio between the variable and fixed components of remuneration, and to competent authorities in Member States which have implemented the option of applying the discount rate. Regarding these guidelines, the discount rate is the value by which a nominal amount of the awarded variable remuneration which vests in the future is multiplied in order to obtain its discounted value. The discounted value is then

5 used for the calculation of the ratio between the fixed and the variable components of total remuneration for identified staff. Only the 25% of variable remuneration which is deferred for at least 5 years and which is paid in equity or debt-instruments or instruments linked to such instruments which are eligible for the purposes of variable remuneration should be discounted. The notional discount rate, if the Member State has implemented this national discretion, can be applied to the variable remuneration for the performance year 2014 and onwards. For example, if one uses some of the standard values in the formula (inflation rate, length of vesting period, the average interest rate for EU governments bonds, etc.), one will generally end up with a maximum variable remuneration of about 230%. This should, of course, be subject to specific and tailored calculation. 2. Revised EBA guidelines on data collection for high earners On 7 April 2014, EBA launched a consultation on its revised Guidelines on the data collection exercise for high earners. Background The proposed draft Guidelines have been developed on the basis of the Directive 2013/36/EU of 26 June 2013 (CRD IV). Article 75(3) of CRD IV requires the competent national authorities to collect information on the number of natural persons in any one institution who are remunerated EUR 1 million or more per financial year, in pay brackets of EUR 1 million, including their job responsibilities, the business area and the main elements of the salary, bonus, long-term award and pension contribution. What's in there? The major changes in the EBA draft guidelines concern the reporting templates, which have been revised to include more granular data and to ensure an even better quality of the collected data. However, the main approach and processes to gather and process the data are maintained in these updated Guidelines. The revised templates should already be used for the collection of data for the financial year The EBA is expected to finalise and publish the Guidelines by 30 June Contact:. Christian Scharff Partner christian.scharff@lu.pwc.com. PwC Luxembourg ( is the largest professional services firm in Luxembourg with more than 2,300 people employed from 57 different countries. It provides audit, tax and advisory services including management consulting, transaction, financing and regulatory advice to a wide variety of clients from local and middle market entrepreneurs to large multinational companies operating from Luxembourg and the Greater Region. It helps its clients create the value they are looking for by giving comfort to the capital markets and providing advice through an industry focused approach. The global PwC network is the largest provider of professional services in audit, tax and advisory. We re a network of independent firms in 158 countries and employ more than 180,000 people. Tell us what matters to you and find out more by visiting us at and PricewaterhouseCooper, Société Coopérative. All rights reserved.