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Applying the FCA's AIFMD Remuneration Code to LLPs, or using draughts to play chess


United Kingdom

Many hedge, property, and VC fund managers are established in the form of an LLP and are having to come to terms with the implementation of the AIFMD.

The (chequered) background

Many hedge, property, and VC fund managers are established in the form of an LLP and are having to come to terms with the implementation of the Alternative Investment Fund Managers Directive (the AIFMD) relating to remuneration apply to the members (partners) in those partnerships. This is no easy task as it involves applying rules designed for one context (employment) in an entirely different one (partnership). It is like trying to play chess using draughts.

These requirements, implemented in the UK by means of the FCA's AIFM Remuneration Code, apply to all "AIFM Remuneration Code Staff".  These are defined categories of staff of Alternative Investment Fund Managers (AIFMs) whose professional activities are deemed to have a material impact on risk. The rules apply to AIFMs established within the EU except where they are exempted because they manage funds below certain aggregate size thresholds.

The rules of the game

The AIFMD seeks to control the way that remuneration can be provided to staff in an AIFM.  It applies a number of principles that are designed to promote "sound and effective risk management consistent with the risk profiles, rules and constitutions"… of the relevant funds including principles requiring performance related remuneration to be based on a combination of the performance of the individual, his or her business unit, the AIFM itself and of the fund and that they should include financial as well as non-financial criteria.

It also includes some hard edged rules, including a principle that "guaranteed variable remuneration" should be exceptional and occur only in the context of new staff in their first year and the so-called the "Pay-out Process Rules".  These include the requirements that:

  • a substantial proportion and in any event at least 50% of any variable remuneration should consist of units or shares of the AIF concerned or equivalent ownership interests

  • such units, shares or interests must be subject to an appropriate retention policy designed to align incentives to the long-term interests of the AIFM and the AIFs it manages

  • a substantial portion, and at least 40% of variable remuneration must be deferred over a period that is appropriate to the life cycle of the AIF concerned(generally to be at least 3 to 5 years); and

  • variable remuneration is paid or vests only if it is sustainable according to the financial situation of the AIFM and justified according to the performance of the AIF.

The FCA applies a principle of "proportionality" to exempt certain smaller AIFMs from compliance with the pay-out principle rules, although there is some controversy as to whether the FCA has the power to do this.

These rules have been drafted to apply to a typical corporate setup where an employee is provided with a fixed salary and bonuses (with perhaps the latter being structured through a Short Term Incentive Plan and a separate Long Term Incentive Plan). It is difficult to see how they apply to an LLP where partners get a profit share which is related to the profits of the business.  Partnership law and LLP constitutions make no distinction is made between the fruits of ownership of the business and the compensation provided for working in the business.

Nevertheless, the rules do apply. ESMA (the European body tasked with providing guidance on AIFMD) was lobbied to exclude business owners from the definition of "identified staff" but refused.  They did agree to clarify that dividends paid to shareholders and profit allocations to members of an LLP should not be considered "remuneration" but only if this is "not being used as a means of circumventing the requirements of the Directive".  But it was left unclear how far this principle goes.

Game Strategy

The FCA in its guidance in the FCA Handbook has gone further in explaining how one might distinguish between "remuneration" and profit allocation in the case of an AIFM that is structured as a partnership or LLP.  Broadly it sees two possible approaches to such an allocation.

(A)        The look and feel approach 

The first approach would be to look at how profit-sharing is carried out to see if this discernibly breaks down into an equivalent of fixed salary, bonus and residual profit share.

For example if there are senior or founding partners who receive residual profit share (and other partners working within the business do not), their share could be regarded as the true profit element and not regarded as remuneration.

If there are arrangements for a fixed drawing taken out in advance of profits being earned, this can be regarded as a fixed element of remuneration.

This approach seems a little confused from the strict legal viewpoint.  It confuses drawings, which technically may be a borrowing against future profit allocations with the allocation of profit. However, the approach could be a practical one in some circumstances as it will often accord with how the partners in question see their remuneration being structured, especially in the traditional hedge fund set up in a corporate context where individuals who are members of the LLP may have profit tranches that are designed to look very similar to salary and bonus and residual profits go largely to a corporate member. As a result of the recent changes to tax law (covered in previous alerters) which treats individual members like this as employees anyway, this structure is no longer a preferred one, so this approach may become less useful

(B)        The benchmarking approach 

The second possible approach is based on benchmarking against what is paid as salary by competitor companies; or considering what can be regarded as a reasonable return on investment; or looking at how the payout of partnership earnings occurs and how profits are shared.

The concept of benchmarking in this context seems an extremely difficult one to apply. First as practical matter the accounts of general partnerships are not publicly available and the accounts of LLPs do not break down the remuneration of members between salary equivalent, bonus and other profit share.  Even if figures can be obtained, there is no agreed basis on which the benchmarks will apply. For example the precise scope of the function of a staff member may not be clear from his or her job title. There may be different levels of responsibility according to the arrangements in place for delegation of functions. The responsibility levels may be very different from different sizes of fund. Founder members of an LLP with an ownership arrangement may be happy to take a very small fixed remuneration and have no arrangements for bonus houses factored in.

No doubt the remuneration consultancies are looking forward to good times ahead in compiling benchmarks and charging for these figures.


A Zugzwang is a term used in chess to describe a position where a player to move loses because he has to move.  It may be apt to describe the position of a firm that is caught by the AIFM Remuneration Code. There probably will be a need to make a move and certainly, there is a need to take a long hard look at the compensation arrangements within your partnership and it is likely that something may have to change. Logically, there are a number of distinct possible approaches.

  • to arrange things so that there is nothing that looks like "remuneration", or if there is remuneration, none of this looks like a bonus to which the more difficult remuneration rules will apply.

  • to finesse the arrangements to create something that clearly falls within the model of fixed remuneration, bonus tranche and variable profits tranche and to sidestep the difficult questions raised by the concept of benchmarking. 

  • to bite the bullet and undertake a full benchmarking exercise, which will probably require external support.

Which approach is right will depend on the circumstances of the firm, its culture, what remuneration arrangements are already in place and how far it is wished to move away from them.

Any consideration of this topic needs to take account of the further background of the recent changes in partnership taxation and the desirability of avoiding, where this is possible partners been deemed to be "salaried partners" to whom PAYE applies. Another tax wrinkle is relevant where the pay-out process rules apply to require the deferral of a profit payout, or a pay-out otherwise than in cash.  There was concern that, this could give rise to a difficult tax position, as the tax is payable by partners or members of an LLP whether or not profits are paid out.  However, HMRC has introduced a way of dealing with this by allowing the LLP itself to pay the tax at the time the profits arise and then for the partner to receive the benefit of the payment in a later year free of tax.


The FCA's guidance has been helpful but still leaves many issues to be dealt with, and a wide scope for considering how the rules should be applied. In the end this is inevitable because the logical flaw in a policy of applying rules relating to employee remuneration to partners in an LLP is just too big a crack to paper over. One cannot get over two basic facts. The first is that the profit of an LLP is what it is and not what some remuneration policy says it should be. The second is that if a remuneration policy results in less of the income of the firm being paid out as what is deemed to be "remuneration", the only result will be that more of the income ends up as profit in the hands of partners. These being the case it is difficult to see how a remuneration policy will act as a motivator to drive conduct in the case of a true partnership.

There is a need to be seen to comply with the new rules, but given the basic inconsistency at the heart of the rules as applied to an LLP, maybe it is appropriate to be fairly relaxed in how one seeks to do this. The rules of this game are at least as complex as those of chess, but hopefully one will not need to call upon Deep Blue to arrive at a winning strategy.

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