Guidelines on the Application of the Proportionality Principle Regarding the Remuneration Policy of Investment Fund Management Companies and the Exemption for Small Remuneration

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GUIDELINES
ON THE APPLICATION OF THE PROPORTIONALITY PRINCIPLE REGARDING THE REMUNERATION POLICY OF INVESTMENT FUND MANAGEMENT COMPANIES AND THE EXEMPTION FOR SMALL REMUNERATION 26 April 2018

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The Croatian Financial Services Agency (hereinafter: Hanfa), pursuant to Article 15(4) of the Act on the Croatian Financial Services Agency (Official Gazette nos. 140/05 and 12/12), at the meeting of its Management Board held on 26 April 2018, adopts GUIDELINES ON THE APPLICATION OF THE PROPORTIONALITY PRINCIPLE REGARDING THE REMUNERATION POLICY OF INVESTMENT FUND MANAGEMENT COMPANIES AND THE EXEMPTION FOR SMALL REMUNERATION

1. INTRODUCTION
   Pursuant to Article 361 of the Act on Open-Ended Investment Funds with Public Offer (Official Gazette no. 44/16, hereinafter: ZOIFJP) and Article 247 of the Act on Alternative Investment Funds (Official Gazette no. 21/18, hereinafter: ZAIF), the Croatian Financial Services Agency (hereinafter: Hanfa) is authorized to inform certain groups of supervised entities and other addressees through various types of publications (instructions, guidelines, etc.) regarding the explanation or method of application of certain regulations within its competence or related general legal acts. Articles 59–61 of ZOIFJP and Articles 61–63 of ZAIF regulate the remuneration policy of investment fund management companies (hereinafter: management company), which must consistently reflect and promote effective risk management and prevent the assumption of risks inconsistent with the risk profile, rules, and/or prospect of the investment funds managed by the management company. The aforementioned provisions have been transposed into Croatian legislation based on:

• Articles 14a and 14b of Directive 2009/65/EU of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities – the so-called UCITS Directive; and
• Articles 13 and 22(2)(e) and (f) of Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010 – the so-called AIFM Directive.
  In addition, the European Securities and Markets Authority (hereinafter: ESMA) has issued:
• Guidelines on remuneration policies under the Directive on undertakings for collective investment in transferable securities (UCITS) (ESMA/2016/575, hereinafter: UCITS Guidelines); and
• Guidelines on remuneration policies under the Directive on alternative investment fund managers (AIFMD) (ESMA/2013/232 and ESMA/2016/579, hereinafter: AIF Guidelines),
  which set out remuneration policy requirements and aim to ensure a common, uniform, and consistent application of remuneration provisions under the UCITS and AIFM Directives.
  Accordingly, Hanfa, through these Guidelines on the Application of the Proportionality Principle Regarding the Remuneration Policy of Investment Fund Management Companies and the Exemption for Small Remuneration (hereinafter: Guidelines), informs management companies about the method of application of the aforementioned regulations and how the proportionality principle should be applied in practice concerning remuneration policies. Hanfa will review these Guidelines and their application and implementation, and may revise them as necessary depending on further developments at the European Union level, taking into account the fact that on 31 March 2016, ESMA addressed a letter to the European Commission, the European Council, and the European Parliament, requesting further clarification and alignment of the proportionality principle (proportionality principle) and remuneration policy rules within the financial sector.1

2. APPLICATION OF THE GUIDELINES
   These Guidelines are drafted based on relevant statutory regulations, ESMA’s UCITS and AIF Guidelines, experience in applying the relevant regulations, and available regulatory practice in EU Member States. In drafting these Guidelines, Hanfa was guided by the following principles:

3. Hanfa will fully comply with the UCITS and AIF Guidelines, including their provisions relating to third parties to whom certain functions have been delegated.

4. Taking into account the convergence present in the UCITS and AIF Guidelines, Hanfa has decided to establish a common framework through which management companies will assess the proportionality principle regarding remuneration policies.

5. Management companies are primarily and ultimately responsible for the extensive and concrete implementation of the proportionality test, which must also be appropriately documented. Management companies are obliged to demonstrate at all times how they have conducted the proportionality test and how they apply relevant remuneration policy provisions, including these Guidelines.

6. PROPORTIONALITY PRINCIPLE
   The applicable statutory regulations, as well as the UCITS and AIF Guidelines, recognize the proportionality principle as relevant to many requirements of management companies, including remuneration policy requirements. Therefore, when fulfilling obligations established by relevant statutory provisions and the UCITS and AIF Guidelines, management companies act in accordance with the proportionality principle, meaning that when establishing and implementing remuneration policies, they should take into account:
   a) the size of the management company and the investment funds it manages; b) the internal organization of the management company; and c) the nature, scope, and complexity of the activities performed by the management company.
   These criteria must be considered and applied cumulatively when conducting the proportionality test, after which it is assessed to what extent the remuneration policy will be applied to a specific management company.
   Exemption from the application of certain remuneration policy requirements According to the AIF Guidelines, the application of the proportionality principle in exceptional cases and taking into account the circumstances of a specific case may result in an exemption from certain remuneration policy requirements – if this is consistent with the risk profile, the level of risk the management company is willing to assume, and the strategy of both the management company and the AIF it manages, within the limits set by the AIF Guidelines itself.2 Specifically, the following requirements may be exempted with respect to all identified employees or only certain categories within identified employees, provided they are applied proportionally:
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7. pay-out process requirements:
   o requirement for variable remuneration in instruments (variable remuneration in instruments) o retention requirement o deferral requirement o ex post risk adjustment requirement for variable remuneration

8. requirement to establish a remuneration committee.
   Regarding the UCITS Guidelines, they do not contain provisions on the possibility of exempting remuneration policy requirements concerning the pay-out process and/or the obligation to establish a remuneration committee and/or certain other requirements. However, given the identity of Level 1 provisions on which the AIF and UCITS Guidelines are based, specifically item 1 of points m), n) and o) of Annex II to the AIFMD and Article 14b(1) points m), n) and o) of the AIFMD, Hanfa considers that the proportionality principle regarding the pay-out process should be applied in the same way to companies managing UCITS funds. Regarding the requirement to establish a remuneration committee, management companies that determine through the proportionality test that they are not significant may be exempted from the obligation to establish a remuneration committee. It is crucial to emphasize that exemptions from applying remuneration policy requirements concerning the obligation to establish a remuneration committee never occur automatically, and management companies must be able at all times to explain, justify, and prove to Hanfa why they consider the exemption from applying these remuneration policy requirements appropriate.

9. PROPORTIONALITY TEST AND SIGNIFICANT MANAGEMENT COMPANIES
   A management company is obliged to conduct a proportionality test to determine whether it is significant with respect to the application of the UCITS and AIF Guidelines, taking into account the criteria from point 7.2 of the UCITS and AIF Guidelines – its size and the size of the investment funds it manages, organizational structure, as well as the nature, scope, and complexity of its activities. Based on the analysis of the criteria from point 7.2 of the UCITS and AIF Guidelines, a management company is obliged to determine whether it is significant with respect to the application of the UCITS and AIF Guidelines, i.e., whether it is more appropriate for it to apply the provisions of the UCITS and AIF Guidelines in a more complex manner and to a greater extent (significant management company) or whether it is more appropriate for it to apply the relevant provisions in a simpler manner and to a lesser extent (non-significant management company). If, after conducting the proportionality test, a management company determines and concludes that it is significant, it must fully apply the remuneration policy requirements, except for the exemption regarding pay-out processes for small remuneration. If, after conducting the proportionality test, a management company determines and concludes that it is not significant, it means that such management company may be exempted from applying remuneration policy requirements concerning the obligation to establish a remuneration committee and pay-out process requirements for small remuneration, while other requirements should be applied proportionally depending on its size and the size of the investment funds it manages, organizational structure, as well as the nature, scope, and complexity of its activities. Regardless of the results of the proportionality test, Hanfa considers a management company significant if it meets two out of three of the following conditions:

10. average total revenues of the management company for the previous three financial years, as stated in the audited financial statements of the management company, exceed 40,000,000 Croatian kunas;

11. the management company has 15 or more employees;

12. total assets of the investment funds managed by the management company at the end of the financial year, as stated in the audited financial statements of the investment funds, exceed 4 billion Croatian kunas;
    as well as those that Hanfa declares significant by its decision, considering size, internal organization, and the nature, scope, and complexity of operations.

13. EXEMPTION FOR SMALL REMUNERATION
    A management company is obliged to maintain a requirement that the ratio between the variable and fixed components of an individual employee’s total remuneration must be determined such that the amount of the variable component does not exceed the amount of the fixed component of total remuneration. Regardless of the aforementioned provisions on the application of principles and the proportionality test, a management company that is significant as well as one that is not significant is not obliged to apply remuneration policy requirements concerning the pay-out process (Article 60(1) points m), n) and o) of ZOIFJP and Article 62(1) points m), n) and o) of ZAIF) to employees whose variable remuneration on an annual basis does not exceed:

14. an amount of 200,000 Croatian kunas; and

15. 45% of fixed remuneration on an annual basis,
    provided that the employee receives a variable remuneration that is absolutely lower than both of the aforementioned amounts.
    A management company may specify in its remuneration policy an absolute and relative threshold lower than the prescribed one.
    For compliance with the requirements of these Guidelines, remuneration amounts are taken on a gross basis.

16. APPLICATION OF THE GUIDELINES TO THIRD PARTIES TO WHOM FUNCTIONS ARE DELEGATED
    When a management company delegates to a third party the functions of managing investment fund assets and/or managing investment fund risks, it must ensure that:

• the function is delegated to an entity subject to equally effective regulatory requirements regarding remuneration policies; or
• appropriate contractual provisions ensure the application of remuneration policy rules.
  In this regard, a management company is obliged to prepare the necessary analyses prior to delegating the aforementioned functions and submit them, along with any additional documentation, upon Hanfa’s request.
  Following the above, Hanfa considers that a third party is subject to equally effective regulatory requirements regarding remuneration policies if, among other things, the following conditions are met:
• remuneration policy provisions from laws governing apply to the third party:
  o open-ended investment funds with public offer; o alternative investment funds; o credit institutions; o investment firms; and
• employees of the third party who are recognized as identified employees within the meaning of these Guidelines and applicable regulation, are subject to the provisions of the aforementioned laws.

7. TRANSITIONAL AND FINAL PROVISIONS
   Regarding exemptions from certain remuneration policy requirements prescribed by these Guidelines, Hanfa considers that a management company is obliged to conduct the necessary assessments of the conducted proportionality test at least every two years. Each such assessment must be documented and justified, and available to Hanfa upon request. Management companies are obliged to conduct the proportionality test within 3 months from the date of entry into force of these Guidelines to determine the significance of the management company. Management companies that, based on the conducted proportionality test, determine that they are significant must align themselves with the requirements of these Guidelines within an additional period of 3 months and notify Hanfa thereof. These Guidelines are published on the Hanfa website and enter into force on the date of publication. CHAIRMAN OF THE MANAGEMENT BOARD dr. sc. Ante Žigman CLASS: 011-02/18-02/01 REGISTRATION NO.: 326-01-440-18-1 Zagreb, 26 April 2018