Financial Services Quarterly Report - Fourth Quarter 2013: Delegated Portfolio Managers – Risk Takers or Not?

by Dechert LLP


German management companies (KVGs, formerly known as KAGs) that manage alternative investment funds (AIFs) within the meaning of the Alternative Investment Fund Managers Directive (AIFMD) are considered to be alternative investment fund managers (AIFMs). Subject to de minimis exemptions, therefore, they are required to comply fully with the AIFMD as implemented in Germany through the KAGB (Kapitalanlagegesetzbuch – the German Investment Code) and the AIFMD’s own Level II regulation.

The AIFMD has – as has been written about previously1 – introduced detailed requirements with regard to the remuneration restrictions to which AIFMs’ portfolio management and certain other staff will be subject.

German AIFMs that are covered by these restrictions – such as KVGs – will, pursuant to Section 37 para. 1 KAGB, need to establish remuneration policies and practices for certain categories of staff, including:

    • senior management whose professional activities have a material impact on the risk profiles of the KVGs or of the AIFs managed by those KVGs, so-called “risk takers;"
    • employees with control functions; and
    • any employees receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers.

These policies and practices will need to be consistent with, and promote, sound and effective risk management, and may not encourage risk-taking inconsistent with the risk profiles, rules or instruments of incorporation of the AIFs managed by the relevant KVGs.

Each KVG is required to determine its remuneration policies and practices in accordance with Annex II of the AIFMD. Section 37 para. 3 KAGB provides an ability for the German Ministry of Finance to pass additional regulations that provide further details on the policies and practices, having regard to the size of the KVG and the size of AIFs it manages, the KVG’s internal organization and the nature, scope and complexity of its activities. Although these additional regulations have yet to be implemented, the European Securities and Markets Authority (ESMA) has published guidance related to sound remuneration policies (ESMA Final Report on the Guidelines on Sound Remuneration Policies under the AIFM Directive, or ESMA Guidance), which BaFin, the German financial regulator, has indicated will apply until domestic German regulations have been enacted.

In its guidance, ESMA stated that the remuneration principles of the AIFMD shall apply to so-called “identified staff” of an AIFM, which includes “senior management and risk takers whose professional activities have a material impact on the AIFM’s risk profile or the risk profiles of the AIF that it manages.” While this interpretation is in line with the AIFMD as implemented in Germany, ESMA has further extended the application of the remuneration principles to “categories of staff of the entity(ies) to which portfolio management or risk management activities have been delegated by the AIFM, whose professional activities have a material impact on the risk profiles of the AIF that the AIFM manages.” As a consequence, the remuneration principles would also be applicable to delegated portfolio managers to whom a German KVG has delegated the management of any of its AIFs, including so-called “Special AIFs” that are eligible for professional and certain sophisticated investors. 

Given that the ESMA Guidance is to apply pending enactment of domestic German regulations, a German KVG managing a German AIF would need to ensure that the entity to which portfolio management is delegated is subject to remuneration requirements that are comparable to (or, in ESMA’s terms, “equally as effective” as) those of the AIFMD.

We had the opportunity to share our views with both BaFin and the German Association of Investment Funds (BVI – the major German funds industry association) as to whether delegates of German KVGs are considered to be “risk takers.” Based on the template outsourcing agreement used by most German KVGs (and proposed by the BVI), we believe there are good arguments that a delegated portfolio manager of a German KVG is not a “risk taker,” because the delegated portfolio manager would not be able to make investment decisions that have a material impact on the risk profile of the AIF without the express prior consent of the KVG.

The arguments can be summarized as follows:

    • According to the wording of the ESMA Guidance, the AIFMD remuneration principles can also be applicable to those third parties that were appointed to conduct the portfolio management function, in order to prevent the application of remuneration principles to the actual portfolio manager (i.e., a circumvention prohibition). Put another way, the application of the remuneration principles to the portfolio manager is only required where the portfolio management function is primarily outsourced by the KVG in order to avoid the application of the remuneration principles. In the case of already existing outsourcing relationships, such an intention would not exist.
    • As noted above, the remuneration provisions would be applicable to those employees of the AIFM who are considered to be “identified staff,” because their activities have a significant impact on the risk profiles of the respective AIFs.

Most German KVGs, when delegating portfolio management, use a form of industry standard agreement that complies with the specific regulatory requirements related to the outsourcing of certain activities. Most, if not all, delegation agreements used by KVGs will contain a provision that can be interpreted such that the delegated portfolio manager has no influence over the risk profiles of the AIFs in relation to which it is providing a delegated investment management function. Rather, these agreements typically make it clear that the delegated manager is permitted to effect investment decisions that have a significant effect on the risk profiles of the AIFs only with the prior approval of the German KVG.

As a consequence, it can be argued that the delegated portfolio manager is excluded from undertaking activities that “have a material impact on the risk profiles of the AIF that the AIFM manages” as contemplated by the ESMA Guidance. The delegated portfolio manager would therefore not qualify as “identified staff” within the meaning of the ESMA Guidance and its remuneration would not be subject to these principles.

It remains to be seen whether BaFin and the German Ministry of Finance, when they do prepare the German remuneration regulations, will include further, or alternative, details on the remuneration requirements (including whether the above-described approach with regard to excluding delegated portfolio managers from the “identified staff” interpretation based on a contractual delegation arrangement with the KVG will continue to hold true). In the meantime, delegated portfolio managers should discuss this aspect with KVGs from whom they intend to take a delegation, when entering into delegation agreements or when updating existing delegation agreements to the new regulatory framework. Such portfolio managers should also consider including explanatory language into their agreements to enable the delegation arrangements to be amended in light of any change in regulatory guidance.


1. For further information, please refer to DechertOnPoint, Financial Conduct Authority Guidance on AIFM Directive Remuneration Provisions.


Written by:

Dechert LLP

Dechert LLP on:

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