HOLD Alapkezelő (Financial market regulation - Investment funds - Remuneration policies of capital management and investment companies - Opinion) [2021] EUECJ C-352/20

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(Request for a preliminary ruling – Financial market regulation – Investment funds – Directives 2009/65/EC and 2011/61/EU – Remuneration policies of capital management and investment companies – Principles on sound remuneration policies – Guidelines 2013/232 and 2016/575 of the European Securities and Markets Authority (ESMA) – Dividends paid to senior executives of a fund management company who are simultaneously shareholders of that company – Incentive to take excessive risks – Circumvention of the principles on sound remuneration policies)

1. The stability and integrity of financial markets require sound risk management on the part of financial institutions and investment firms. However, according to the European legislature, inappropriate remuneration practices may induce excessive risk-taking by certain financial market participants, such as investment advisers and fund managers, since such remuneration practices are liable to create false incentives in that regard. (2)

2. For that reason, Directives 2009/65/EC (3) and 2011/61/EU, (4) in particular, provide that Member States are to require the investment fund industry to establish and apply remuneration policies that promote sound and effective risk management and that do not encourage risk-taking which is inconsistent with the relevant risk profile, rules or instruments of incorporation of the investment funds concerned.

3. Magyar Nemzeti Bank (National Bank of Hungary, ‘the MNB’) has intervened in the main proceedings in its function as the financial market supervisory authority in respect of a fund management company that distributes dividends to various members of its senior management because they directly or indirectly hold shares in that company. According to the MNB, those dividend payments form part of a remuneration policy capable of counteracting sound risk management. Because of their financial self-interest in the highest possible dividend distributions, fund managers could be tempted to take excessive risks in their investment decisions in the short term, which could be to the detriment of the investors in the managed funds in the long term.

4. In that context, the referring court asks the Court whether the requirements of EU law concerning remuneration in the financial services sector are applicable at all in such a situation, since dividends do not formally constitute consideration for services rendered. As will be shown below, that conceals behind it the question of when participation, under company law, in the profits of a fund management company may result in fund managers being induced to take risks similar to those that may be taken when certain variable components of remuneration are paid.

5. The provisions of EU law relating to remuneration in the investment fund industry provided for in Directive 2011/61 (relating to alternative investment funds, ‘AIF’) and Directive 2009/65 (relating to undertakings for collective investment in transferable securities, ‘UCITS’) are based on Commission Recommendation 2009/384 (5) and are given concrete expression at sub-statutory level by guidelines issued by the European Securities and Markets Authority (‘the ESMA’).

6. Recitals 1 to 5 of Commission Recommendation 2009/384 set out the main motives of the European Union’s remuneration policy in the financial services sector:

‘(1) Excessive risk-taking in the financial services industry and in particular in banks and investment firms has contributed to the failure of financial undertakings and to systemic problems in the Member States and globally. These problems have spread to the rest of the economy and led to high costs for society.

(2) Whilst not the main cause of the financial crisis that unfolded in 2007 and 2008, there is a widespread consensus that inappropriate remuneration practices in the financial services industry also induced excessive risk-taking and thus contributed to significant losses of major financial undertakings.

(3) Remuneration practices in a large part of the financial services industry have been running counter to effective and sound risk management. These practices tended to reward short-term profit and gave staff incentives to pursue unduly risky activities which provided higher income in the short term while exposing financial undertakings to higher potential losses in the longer term.

(5) Creating appropriate incentives within the remuneration system itself should reduce the burden on risk management and increase the likelihood that these systems become effective. Therefore, there is a need to establish principles on sound remuneration policies.’

7. Directive 2011/61 regulates, pursuant to Article 1 thereof, the authorisation, ongoing operation and transparency of the managers of alternative investment funds (‘AIFM’). In accordance with Article 4(1)(b) of that directive, AIFMs are legal persons whose regular business is managing one or more AIFs.

‘In order to address the potentially detrimental effect of poorly designed remuneration structures on the sound management of risk and control of risk-taking behaviour by individuals, there should be an express obligation for AIFMs to establish and maintain, for those categories of staff whose professional activities have a material impact on the risk profiles of AIFs they manage, remuneration policies and practices that are consistent with sound and effective risk management. Those categories of staff should at least include senior management, risk takers, control functions …’

‘“carried interest” means a share in the profits of the AIF accrued to the AIFM as compensation for the management of the AIF and excluding any share in the profits of the AIF accrued to the AIFM as a return on any investment by the AIFM into the AIF.’

10. According to the second subparagraph of Article 13(1) of Directive 2011/61, the AIFMs must determine the remuneration policies and practices in accordance with Annex II to that directive.

‘1. When establishing and applying the total remuneration policies, inclusive of salaries and discretionary pension benefits, for those categories of staff, … AIFMs shall comply with the following principles in a way and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities:

(h) the assessment of performance is set in a multi-year framework appropriate to the life-cycle of the AIFs managed by the AIFM in order to ensure that the assessment process is based on longer term performance and that the actual payment of performance-based components of remuneration is spread over a period which takes account of the redemption policy of the AIFs it manages and their investment risks;

(j) fixed and variable components of total remuneration are appropriately balanced and the fixed component represents a sufficiently high proportion of the total remuneration to allow the operation of a fully flexible policy, on variable remuneration components, including the possibility to pay no variable remuneration component;

(m) subject to the legal structure of the AIF and its rules or instruments of incorporation, a substantial portion, and in any event at least 50% of any variable remuneration consists of units or shares of the AIF concerned, or equivalent ownership interests, or share-linked instruments or equivalent non-cash instruments, unless the management of AIFs accounts for less than 50% of the total portfolio managed by the AIFM, in which case the minimum of 50% does not apply.

The instruments referred to in this point shall be subject to an appropriate retention policy designed to align incentives with the interests of the AIFM and the AIFs it manages and the investors of such AIFs. … This point shall be applied to both the portion of the variable remuneration component deferred in line with point (n) and the portion of the variable remuneration component not deferred;

(n) a substantial portion, and in any event at least 40%, of the variable remuneration component, is deferred over a period which is appropriate in view of the life cycle and redemption policy of the AIF concerned and is correctly aligned with the nature of the risks of the AIF in question.

The period referred to in this point shall be at least three to 5 years unless the life cycle of the AIF concerned is shorter; remuneration payable under deferral arrangements vests no faster than on a pro-rata basis; in the case of a variable remuneration component of a particularly high amount, at least 60% of the amount is deferred;

(o) the variable remuneration, including the deferred portion, is paid or vests only if it is sustainable according to the financial situation of the AIFM as a whole, and justified according to the performance of the business unit, the AIF and the individual concerned.

The total variable remuneration shall generally be considerably contracted where subdued or negative financial performance of the AIFM or of the AIF concerned occurs, taking into account both current compensation and reductions in payouts of amounts previously earned, including through malus or clawback arrangements;

(r) variable remuneration is not paid through vehicles or methods that facilitate the avoidance of the requirements of this Directive.

2. The principles set out in paragraph 1 shall apply to remuneration of any type paid by the AIFM, to any amount paid directly by the AIF itself, including carried interest, and to any transfer of units or shares of the AIF, made to the benefits of those categories of staff, … whose professional activities have a material impact on their risk profile or the risk profiles of the AIF that they manage.

12. Articles 14a and 14b of Directive 2009/65, as amended by Directive 2014/91, (6) contain rules on remuneration policies that must be established by the management companies of UCITS for certain categories of staff whose professional activities have a material impact on the risk profiles of the UCITS that they manage. The content of those provisions is, in essence, identical to that in point 1 of Annex II to Directive 2011/61.

13. In accordance with Article 13(2) of Directive 2011/61 and Article 14a(4) of Directive 2009/65, the ESMA shall issue guidelines on the application of the principles on sound remuneration policies. With regard to the remuneration policies of UCITS management companies, these are Guidelines 2016/575 and, with regard to AIFMs, Guidelines 2013/232 (‘the guidelines’). As required by recital 9 of Directive 2014/91, those guidelines are aligned with one another in many of the points relevant to the main proceedings.

14. Point 10 of Guidelines 2013/232, which is essentially the same as point 11 of Guidelines 2016/575, provides:

‘Solely for the purposes of the guidelines and Annex II to the AIFMD, remuneration consists of

For the purpose of item (ii) of this paragraph, whenever payments, excluding reimbursements of costs and expenses, are made directly by the AIF to the AIFM for the benefit of the relevant categories of staff of the AIFM for professional services rendered, which may otherwise result in a circumvention of the relevant remuneration rules, they should be considered remuneration for the purpose of the guidelines and Annex II to the AIFMD.’

15. Point 15 of Guidelines 2013/232, which corresponds to point 14 of Guidelines 2016/575, states:

‘AIFMs should ensure that variable remuneration is not paid through vehicles or that methods are employed which aim at artificially evading the provisions of the AIFMD and these guidelines. … Circumstances and situations that may pose a greater risk under this perspective may be: the conversion of parts of the variable remuneration into benefits that normally pose no incentive effect in respect of risk positions; … the setting up of structures or methods through which remuneration is paid in the form of dividends or similar pay outs (e.g. improper use of performance fees) and non-monetary material benefits awarded as incentive mechanisms linked to the performance.’

‘The so called “carried interest vehicles” are typically limited partnerships (or other kinds of vehicle) being themselves limited partners in the AIF together with third party investors and are used by senior executives of an AIF either to regulate the executives’ entitlements to carried interest among themselves as a consequence of a modest capital contribution or to commit capital which is more than merely nominal – i.e. co-investments – in transactions along with the AIF. If payments made by the AIF to the relevant staff members through these carried interest vehicles fall under the definition of carried interest, they should be subject to the remuneration provisions of these guidelines, whereas if they represent a pro-rata return on any investment by the staff members (through the carried interest vehicle) into the AIF, they should not be subject to such provisions.’

17. Point 17 of Guidelines 2013/232 corresponds to point 15 of Guidelines 2016/575:

‘Consideration should also be given to the position of partnerships and similar structures. Dividends or similar distributions that partners receive as owners of an AIFM are not covered by these guidelines, unless the material outcome of the payment of such dividends results in a circumvention of the relevant remuneration rules, any intention to circumvent such rules being irrelevant for such purpose.’

18. According to point 94 of Guidelines 2013/232, which corresponds to point 96 of Guidelines 2016/575:

‘Having a fully flexible policy on variable remuneration implies not only that variable remuneration should decrease as a result of negative performance but also, that it can go down to zero in some cases. For its practical implementation, it also implies that the fixed remuneration should be sufficiently high to remunerate the professional services rendered, in line with the level of education, the degree of seniority, the level of expertise and skills required, the constraints and job experience, the relevant business sector and region. Individual levels of fixed remuneration should be indirectly impacted by the basic principle on risk alignment.’

19. Points 132 and 133 of Guidelines 2013/232 are, in essence, identical to points 134 and 135 of Guidelines 2016/575 and read as follows:

‘132. Staff should only be remunerated using instruments if it does not trigger interest misalignment or encourage risk-taking which is inconsistent with the risk profiles, rules or instruments of incorporation of the relevant AIF(s) …

133. For AIFMs managing several AIFs, in order to align the interests of the identified staff with those of the relevant AIF(s), when possible according to the organisation of the AIFM and the legal structure of the managed AIF(s), the identified staff should receive instruments related mainly to the AIF(s) in relation to which they perform their activities, provided that no excessive concentration in the holding of the instruments – facilitating an excessive risk-taking by the identified staff – is created …’

20. Points 139 and 141 of Guidelines 2013/232 correspond to points 141 and 143 of Guidelines 2016/575 and provide as follows:

‘139. In the case of upfront instruments, retention periods are the only mechanism available to emphasise the difference between cash paid upfront and instruments awarded upfront in order to align incentives with the longer-term interests of the AIFM and the AIFs it manages and the investors of such AIFs.

141. The minimum retention period should be sufficient to align incentives with the longer term interests of the AIFM, of the AIFs it manages and of their investors. Different factors may tend to suggest that this period could be longer or shorter. Longer retention periods should be applied for staff with the most material impact on the risk profile of the AIFM and the AIFs it manages.’

21. The applicant in the main proceedings is a company which manages various AIFs and UCITS (‘the management company’).

22. From 2014, it established a remuneration policy comprising fixed and variable components that it has applied to certain categories of its staff. These employees include four individuals, all of whom are members of senior management.

23. The employees concerned are linked to the management company not only through their employment relationship but also because they have both direct and indirect interests in that company. Specifically, on the one hand, some of these employees are direct holders of preference shares with preferential rights to dividends in the management company. On the other hand, some of them are the sole members of – unlisted – limited companies operating within a closed setting which in turn have preference shares with preferential rights to dividends in the management company. The respective (indirect) interests of the employees concerned or of the limited companies owned by them in the share capital of the management company amount to 2% in two cases, and to 4%, 5%, 12% and 25.1%.

24. The management company distributed annual dividends on the organisation’s retained earnings for the financial years 2015 to 2018 to the employees concerned and the aforementioned single-member companies. In 2016, the total amount of dividends distributed to these shareholders was approximately 661 million forint (HUF), and in 2017 approximately HUF 110 million. The payments designated as remuneration that were made to the employees concerned amounted to a total of approximately HUF 17 million in 2016 and approximately HUF 10 million in 2017.

25. By a decision of 11 April 2019, the MNB called on the management company, within a period of 90 days, to adapt its remuneration policy to the prudential requirements. It also imposed a penalty on the management company for infringement of the national provisions relating to remuneration policies in the financial services sector, which transpose the relevant provisions of Directives 2009/65 and 2011/61.

26. According to the MNB, the dividend payments, by their nature, create an incentive for the employees concerned to generate particularly high profits for the management company over the short term. They may therefore induce them, when making investment decisions, to take risks which are incompatible with the risk profile of the funds managed and which may be detrimental to the investors in those funds in the long term. As a result, that would circumvent the rules on the deferral of performance-based remuneration components.

27. In its action against that decision, the management company took the view that the dividend payments did not constitute remuneration at all within the meaning of Article 13 of, and Annex II to, Directive 2011/61 and of Articles 14a and 14b of Directive 2009/65. This is because the employees concerned did not receive those payments in return for their services, but for providing capital in their capacity as shareholders. In that regard, it would be contrary to the principle of equal treatment of shareholders to subject the receipt of dividends by the employees concerned to the rules regarding remuneration. In any event, it is not apparent why the receipt of dividends should create an incentive to generate short-term profits. On the contrary, as majority shareholders of the management company, the employees concerned would have an interest in that company achieving the best possible results in the long term.

28. The court of first instance ultimately rejected those arguments. In particular, it agreed with the MNB’s view that the dividend payments would circumvent the rules on the deferral of variable remuneration components, as there would be a strong imbalance between the total amount of the payments designated as remuneration and the dividend payments.

IV. The question referred for a preliminary ruling and the proceedings before the Court

29. The appeal brought by the management company against that decision is pending before the referring court, the Kúria (Supreme Court, Hungary). That court decided to stay the proceedings and refer the following question to the Court of Justice for a preliminary ruling under Article 267 TFEU:

(a) directly by virtue of their status as holders of preference shares with preferential rights to dividends in the investment fund manager, and

(b) through single-member companies owned by the [directors concerned], which hold preference shares with preferential rights to dividends in that fund manager

30. Written observations on that question were submitted by the applicant in the main proceedings, the MNB, the Polish Government, the Hungarian Government and the European Commission. With a view to preparing for the hearing of 28 October 2021, the ESMA submitted written observations, at the Court’s invitation, in accordance with Article 24(2) of the Statute of the Court of Justice of the European Union. The participants at the hearing, namely the applicant in the main proceedings, the MNB, the Hungarian Government and the Commission, were given the opportunity to comment on those observations.

31. By its question, the referring court seeks to ascertain, in essence, whether, or in what circumstances, the payment of dividends to senior executives of a fund management company who at the same time have a direct or indirect interest in that company must be structured in such a way as to satisfy the requirements relating to sound remuneration policies for fund managers, as laid down, in particular, in Directives 2009/65 and 2011/61.

32. In the main proceedings, the MNB, in its capacity as supervisory authority, ordered the applicant management company to adapt its remuneration policy regarding such payments to those requirements and imposed a fine for the alleged infringement.

33. Under Article 13(1) of Directive 2011/61 (relating to AIFs) and Article 14a(1) of Directive 2009/65 (relating to UCITS), investment funds or the companies managing them must develop and apply, for certain categories of employees, in particular members of senior management, (7) remuneration policies that are consistent with and promote sound and effective risk management. That requires that the remuneration policies concerned neither encourage risk taking which is inconsistent with the risk profiles, rules or instruments of incorporation of the managed funds nor impair compliance with the management company’s duty to act in the best interest of the funds.

34. Thus, the purpose of these provisions is twofold. (8) On the one hand, the aim is to ensure the stability of the financial markets, because excessive risk-taking can lead to the formation of bubbles or the ‘mispricing’ of high-risk securities. On the other hand, it is necessary to protect the interests of investors, which may conflict with the interests of fund managers with regard to both the risk and the sustainability of investment decisions. That risk may arise from fund managers having a self-interest in short-term increases in the value of the funds they manage, as a result of inappropriate performance-based remuneration.

35. Annex II to Directive 2011/61 and Article 14b of Directive 2009/65 contain a number of principles and specific criteria with which such remuneration policies must comply. These include, inter alia, provisions on the balance between fixed and performance-based components of remuneration (see subparagraph (j) of the respective directives) and provisions on the deferral of performance-based components, as well as on the substantive requirements for their payment (see, for example, subparagraphs (h), (n) and (o) of the respective directives).

36. The referring court takes the view, however, that those provisions could already be inapplicable in the main proceedings, since the dividends are in any event not formally paid to the employees concerned in return for the services they are required to perform under their contract of employment. On the contrary, they are granted to them by reason of their status as holders of (preference) shares in the management company. For that reason, according to that court, the payments cannot, a priori, be covered by the concept of ‘remuneration’ within the meaning of the abovementioned provisions.

A. The concept of ‘remuneration’ within the meaning of Directives 2009/65 and 2011/61

37. Neither Directives 2009/65 and 2011/61, nor Commission Recommendation 2009/384, on whose principles those directives are based, (9) contains a legal definition of the term ‘remuneration’. They merely show that the remuneration policies and practices include fixed and variable components of salaries and discretionary pension benefits. (10)

38. The ESMA guidelines (11) issued on the basis of the directives clarify the term ‘remuneration’ to the effect that it includes, firstly, all forms of payments and benefits paid by the management company or the AIFM. Secondly, the term accordingly includes any amount paid by the UCITS or AIF itself, including any portion of performance fees that are paid directly or indirectly for the benefit of the employees concerned, as well as carried interest. (12)Thirdly, this includes any transfer of units or shares of the UCITS or the AIF. The common feature of all the above components of remuneration, according to these guidelines, is that they are granted in exchange for professional services provided by the relevant employees of the AIFM or the UCITS management company. (13)

39. Against that background, there seems to be much to suggest that dividend payments such as those at issue in the main proceedings cannot be subsumed under the concept of ‘remuneration’.

40. However, in that regard, it is apparent from point 17 of Guidelines 2013/232 or point 15 of Guidelines 2016/575 that dividends or similar distributions that the employees concerned receive as owners of a management company are not covered by those guidelines, ‘unless the material outcome of the payment of such dividends results in a circumvention of the relevant remuneration rules’. Point 15 of Guidelines 2013/232 confirms that dividend payments may constitute forms of circumvention of an appropriate remuneration policy and may lead to an improper use of performance-based remuneration. Accordingly, Article 14b(1)(r) of Directive 2009/65 also provides that variable remuneration may not be paid through vehicles or methods that facilitate the avoidance of the requirements laid down in that directive.

41. Thus, the guidelines state that the applicability of the remuneration rules depends only on the effects of an expected payment and not on its designation. In the light of the spirit and purpose of those provisions, that is in fact imperative. This is because, according to recitals 1 to 5 of Commission Recommendation 2009/384, the establishment of remuneration policies is about controlling behaviour. (14) Consequently, any structures that may create potentially harmful and thus inappropriate financial incentives must be designed in such a way as to meet sound risk management requirements.

42. Thus, the question of whether a dividend payment must be regarded as ‘remuneration’ within the meaning of those directives is not decisive for the resolution of the dispute in the main proceedings. That dispute concerns the legality of the MNB’s decision ordering the applicant management company to adapt its remuneration policy as regards dividend payments to the national provisions transposing Directives 2009/65 and 2011/61. Ultimately, however, those provisions must be respected even if a payment of dividends through (preference) shares to the senior management of the management company of the investment funds concerned is to be regarded as circumventing the rules applicable to remuneration.

43. The starting point for assessing whether there has been circumvention of the rules on remuneration must, once again, be the spirit and purpose of those rules, as has already been discussed, in particular, in points 33, 34 and 41 of this Opinion.

44. Accordingly, circumvention of those rules must be assumed if the specific form of the payments, which are not formally made as ‘remuneration’, may equally create an incentive for the employees concerned to take decisions in the management of the funds which are inconsistent with the risk profiles, rules or instruments of incorporation or may induce them to act against the interests of these funds or their investors. Such an incentive would be incompatible with the remuneration rules and must therefore not be created by way of other payments.

45. The question of whether that is the case can be assessed only in the light of the specific individual case, which is a matter for the referring court. However, in order to provide the national court with an answer that will be of use to it in resolving the dispute before it, it is appropriate for the Court of Justice to provide guidance on the criteria which the national court must consider in making that assessment. (15)

46. According to the MNB, there is, in the main proceedings, a risk of circumvention of the remuneration rules, since the employees concerned, as (indirect) shareholders of the management company, would have a financial self-interest in the management company generating the highest profits possible in the short term, part of which would then be distributed to them in the form of preference dividends. They would therefore tend to take particularly high risks and to aim for short-term profits when making investment decisions in respect of the funds managed by that company.

47. However, the ownership interests held (indirectly) by the employees concerned initially result merely in them having a financial self-interest in the highest possible profits for the management company, since it is profit that determines the extent of the dividend distributions to be expected.

48. However, high profits of the management company cannot simply be equated with profits generated by investments in the managed investment funds. On the contrary, very different situations may be envisaged in that regard, depending on the organisation and operation of the various funds. It often happens, for example, that an investment fund is organised as a special fund, which is co-owned proportionally by the investors in the fund in question and is completely separate from the assets of the management company. Typically, a portion of the income of the special fund is in some way allocated to the assets of the management company and thus affects the extent to which the management company distributes dividends. Depending on the investment conditions and organisational form, however, only fixed amounts can be paid to the management company to cover staff and management costs, which amounts do not depend on the performance of the funds, that is to say are owed regardless thereof.

49. Accordingly, the MNB also acknowledged at the hearing that there may be cases in which the right to receive dividends does not provide a significant incentive for risky investment decisions regarding the managed funds.

50. The prospect of dividend payments thus only creates an incentive, with regard to the funds managed by the management company, to seek particularly high – and thus possibly particularly risky – profits if such profits are the main factor determining the extent of the dividend distributions.

51. Consequently, it is necessary, first of all, to examine whether the distribution of dividends by the management company is dependent on the performance of the managed funds in such a way that this results in similar behavioural incentives as those created by variable or performance-based remuneration (see point 1).

52. In this case, only the relationship between the management company and the funds concerned is relevant for establishing whether there has been a circumvention of the remuneration rules. In that regard, it is necessary, secondly, to examine whether that relationship is structured in a manner consistent with the principles on sound remuneration policies (see point 2).

53. In the present case, the Hungarian Government submitted, during the proceedings before the Court, that the management company’s income – which ultimately determines its ability to pay dividends to the employees concerned – consists of fixed management fees and a kind of performance fee. That performance fee is equal to a predetermined percentage of that part of the return of the investment fund concerned which exceeds the return sought or fixed under the fund rules or relevant instruments of incorporation. That description was not contradicted by the applicant in the main proceedings at the hearing.

54. That configuration – assuming that it accurately describes the functioning of the applicant management company, which is for the referring court to determine – resembles a carried-interest model. (16) The only difference seems to be that the pre-determined share in the return is not paid directly by the managed funds to the employees concerned – in which case the payments would unquestionably be covered by the remuneration provisions. (17) Rather, that share in the return is first allocated to the management company and distributed, only in a second step, to the employees concerned via the dividends.

55. As a result, however, that configuration – just like a carried-interest model – seems capable of providing an incentive comparable to performance-based remuneration. This is because, once the performance fee has become part of the assets of the management company, part of it is, in any event, distributed to the shareholders – that is, the employees concerned – in the form of dividends. From an economic point of view, the management company acts, in that regard, merely as a paying agent. The same applies to any other interposed corporate entity. Consequently, it has no bearing on the existence of a relevant behavioural incentive whether the dividend resulting from the increased return is paid to the employees concerned directly or indirectly through interposed single-member companies. (18)

56. Contrary to the submissions of the applicant in the main proceedings, the link between the performance of the managed investment funds and the dividend distributions is not too indirect in either case. That is the case irrespective of whether the employees concerned or the corporate entities allocated in full to their assets hold preference shares with preferential rights to dividends or voting shares in the management company, which could not be definitively clarified at the hearing. This is because, in the former case, they are entitled to a dividend guarantee, and in the latter case, the employees concerned can in any case decide on the distribution of dividends since they together appear to hold more than 50% of the share capital. (19)

57. However, it is an oversimplification to see this, per se, as a circumvention of the remuneration rules. This is because, according to the legislature, a financial self-interest in the performance of the managed funds does not necessarily create an inappropriate behavioural incentive for the fund manager employees concerned.

58. In that regard, Article 14b(1)(m) of Directive 2009/65 and point 1(m) of Annex II to Directive 2011/61 expressly provide that at least 50% of any variable remuneration should consist of units or shares of the AIF or UCITS concerned or other instruments with equally effective incentives. The idea behind this is that a financial self-interest in the performance of the fund, created by a personal entitlement to an economic share in the return, is in principle a desirable incentive. That is, however, the case only if the interests of the employees concerned are, in that regard, comparable to those of the investors in the funds. (20)

59. It is therefore necessary to examine separately, in a second step, whether the specific configuration of the payment provides an appropriate behavioural incentive.

60. Since and to the extent that the management company acts solely as a paying agent, that examination must consider the circumstances in which the management company obtains the right to receive the performance fee described in point 53. The distribution of dividends to the employees concerned is merely the consequence of the distribution of the performance fee.

61. In that regard, recital 7 of Directive 2014/91 expressly states that the principles regarding sound remuneration policies should also apply to payments made from UCITS to management companies or investment companies. The reason for this is precisely that, otherwise, the rules on remuneration could be circumvented by the mere interposition of a corporate entity.

62. It is apparent from an analysis of the principles and criteria set out in Article 14b of Directive 2009/65 and point 1 of Annex II to Directive 2011/61, which relate to the configuration of variable or performance-based remuneration, that they are aimed precisely at bringing the interests of the employees concerned closer to those of the investors and ensuring that the employees concerned are also affected by any losses that may occur and do not merely participate in the profits. Otherwise, the risk of loss involved in an investment decision does not, from the point of view of the employee concerned, play a direct role in the amount of his or her remuneration. That entails the risk that those employees take decisions that are inconsistent with the risk profiles, rules or instruments of incorporation of the managed funds or that are contrary to the interests of the investors.

63. More specifically, an alignment of interests under those provisions may be achieved, for example, through appropriate deferral periods for the payments to which those instruments give rise (see subparagraphs (m) and (n) of the respective directives) or retention periods for their disposal, (21) which are aligned with the holding period of the units or shares of the other investors. This ensures that a short-term increase in value that dissipates within the typical period during which units or shares in the relevant fund are held by an investor does not prematurely and thus unfairly confer an advantage on participating fund managers (see also subparagraph (h) of the respective directives). Moreover, this can be achieved by appropriate corrections, up to and including the elimination of the variable remuneration in the event of poor performance of the funds concerned (‘internalisation of losses’, see subparagraph (o) of the respective directives).

64. In addition, an appropriate balance between fixed and performance-based remuneration (see, in that regard, subparagraph (j)) contributes, on the one hand, to ensuring that fund managers are not entirely dependent on variable remuneration, which is largely dependent on market developments over which they have no control. It follows that the fixed remuneration should be sufficiently high to remunerate the professional services rendered in the event that the variable remuneration decreases as a result of negative performance of the funds managed, or even goes down to zero. (22) On the other hand, the intention is that this should nevertheless set effective performance incentives.

65. It is not possible to infer from the order for reference whether mechanisms such as those described in point 63 above exist in the main proceedings. Specifically, the referring court must take into account in its examination, for example, the period under consideration in order to determine whether the target return has been exceeded, thus entitling the management company to payment of the performance fee (see, in that regard, subparagraph (h) of the respective directives), or whether deferral periods are provided for (see subparagraphs (n) and (o)).

66. Indeed, such mechanisms can ensure that the fee is paid only if justified by the performance of the funds over the longer term. If, on the other hand, the performance fee is already due if the target return is exceeded by a certain deadline, which completely disregards the performance of the fund after the expiry of the contractually agreed term, the interests of the investors in the fund and the employees concerned are not comparable in that regard.

67. From the point of view of the applicant in the main proceedings, it cannot, in any event, be assumed in general terms that the prospect of dividend payments would induce the employees concerned to take short-term or excessive risks, since they have an interest in receiving dividend payments of an appropriate amount on an ongoing basis. However, the Hungarian Government rightly points out that in a model such as that at issue in the main proceedings, (23) performance is remunerated unilaterally. This is because, if the funds concerned do not exceed the target return, or even make a loss, this merely results in no performance fee being paid to the management company, which may also mean that no dividends are paid in the year in question. In that case, however, the employees would still retain their fixed remuneration and possibly also part of their variable remuneration. If, in particular, the latter is the case, which is for the referring court to ascertain, there might be an insufficient internalisation of losses in that regard.

68. Moreover, for the employees concerned, an entitlement to dividend payments from the management company will not arise at all unless the fund performs better than expected. Consequently, from the outset, the employees concerned are interested only in particularly high profits of the managed investment funds, which typically also have high risks of loss. That circumstance – especially in the absence of mechanisms such as those described in points 63 and 65 of this Opinion – may consequently encourage excessive risk-taking.

69. The MNB also highlights the striking discrepancy between the total amount of dividend payments and the total amount of payments designated as remuneration. The former, according to the information at its disposal, amounted to approximately ten times the total amount of remuneration in 2017, and almost 38 times in 2016. (24)

70. In that regard, the ESMA Guidelines suggest that a strong imbalance between the variable remuneration and the fixed remuneration, or between the total amount of the dividend payments and the total amount of remuneration, as in the present case, may also be contrary, in itself, to the rules on remuneration. They assume, in that regard, that too great a financial interest on the part of the fund managers concerned in the performance of the funds managed may encourage excessive risk-taking. In particular, they consider that there is too great a financial interest if there is an excessive concentration of ownership of shares in a managed fund by one of its managers. (25) However, that idea seems to be transferable to a situation such as that in the present case, in which the employees concerned might have too great an interest in the profits of the managed funds due to the extent of their indirect participation in those profits.

71. Consequently, if the referring court were to conclude, when examining all the aforementioned circumstances, that the specific form of the dividend payments could induce the employees concerned to take excessive risks or to act against the interests of those funds and their investors, it would have to find that the rules on remuneration were circumvented.

72. It follows from the foregoing considerations that the payment of dividends to senior executives of a fund management company who at the same time have a direct or indirect interest in that company must comply with the provisions on sound remuneration policies where such payment may have the effect of circumventing those provisions.

73. This presupposes that the extent of the right to receive dividends is so dependent on the performance of the managed funds that it creates behavioural incentives similar to those created by variable or performance-based remuneration and that the fund management company therefore acts only as a paying agent. In such a case, there is circumvention if the participation of the fund management company in the profits of the managed funds would in turn violate the rules on remuneration. That is, in turn, the case where the specific form of that participation encourages excessive risk-taking or in the absence of mechanisms enabling a reasonable balance of interests to be struck between the incentives created and the longer-term interests of the management company, the funds it manages and its investors.

C. Encroachment on shareholder rights through the application of the rules on remuneration to dividend payments

74. Against that conclusion, the applicant in the main proceedings argues that recital 28 of Directive 2011/61 and recital 10 of Directive 2014/91 provide that the provisions on remuneration should be without prejudice to the full exercise of fundamental rights and applicable legislation regarding shareholders’ rights. It infers from this that the dividend payments received by the employees concerned by virtue of their shareholder status should not be subject to the provisions on sound remuneration policies.

75. It must be accepted, first of all, that the application of the rules on remuneration to dividend payments is liable to lead to a restriction of shareholders’ rights. In that regard, it is apparent from the case-law of the Court that both the ownership of shares and the resulting right to receive dividends are protected by Article 17(1) of the Charter. (26) In particular, the Court has already ruled that the delayed or limited redemption of shares in the event of withdrawal of a shareholder constitutes an encroachment on the fundamental right to property. (27) Accordingly, certain rules relating to remuneration, such as deferral rules that modify or restrict the right to receive dividends over time, (28) or retention periods that prohibit the disposal of shares during a certain period, (29) should also be considered as an encroachment on that fundamental right.

76. However, in the present case, the basis for the application of the rules on remuneration is not the distribution of dividends but the preceding payment of the performance fee to the management company. (30) Although this determines the extent of the dividend, the right to receive dividends is not limited or modified by the fact that the management company’s entitlement to the performance fee is subject to certain requirements.

77. However, even if one wished to view this as an encroachment on shareholders’ rights, it cannot be inferred from recital 28 of Directive 2011/61 or recital 10 of Directive 2014/91 that such interference would generally be unacceptable.

78. The applicant in the main proceedings rightly points out that the guidelines, at various points, expressly exclude the application of the rules on remuneration to legal positions arising from shareholder status. Point 16 of Guidelines 2013/232, for example, states that payments made through carried interest vehicles should not be subject to the provisions on sound remuneration policies if they represent a pro-rata return on any investment by the employees concerned into the AIF. The reason for this, however, is that, in such a case, the employees concerned are merely investors in the fund and, consequently, their interests are the same as those of the other investors. There is therefore no need to limit their shareholder rights.

79. However, in the case in the main proceedings, the situation is different. Although the employees concerned, as shareholders in the management company, did at some point invest in that company, the return that is channelled to the management company via the model described in point 53 of this Opinion and distributed to the employees concerned in the form of dividends was certainly not generated using that capital. Consequently, it cannot be ruled out that a conflict of interests arises in that regard which could encourage excessive risk-taking on the part of the employees concerned when managing the investors’ capital.

80. According to settled case-law, however, the exercise of the fundamental right to property may be subject to restrictions where such a conflict of interests creates a risk that a fund manager may be induced to act contrary to the interests of investors, the financial stability or the integrity of the market. This is subject to the condition that those restrictions genuinely meet the objectives pursued and do not constitute, in relation to the aim pursued, a disproportionate and intolerable interference, impairing the very substance of the fundamental right to property. (31)

81. As regards the objective of ensuring the stability of the financial markets, the Court has already held that this serves a public interest and is thus in principle capable of justifying a restriction of shareholders’ rights. (32) The same must apply with regard to the objective of protecting investors.

82. As explained above, the application of the rules on remuneration may help to strike a balance of interests between, on the one hand, the financial incentives created by the dividend payments and, on the other hand, the long-term interests of the fund and its investors. (33) Thus, the application of those rules objectively meets the objective of promoting sound risk management and thus ensuring the greatest possible protection of investors and stability of the financial markets as a whole.

83. Finally, the limitation on the rights of shareholders provided for by the rules on remuneration should also not be regarded as disproportionate, since this is always merely a temporal limitation of certain rights, such as in the case of deferral rules and retention periods.

84. In those circumstances, the legislature was entitled to take the view that shareholders’ rights should take second place in situations where there is a risk of endangering the objectives of investor protection and financial market stability. Such a risk exists not only in the situations directly governed by the rules on remuneration, but also in the event of their circumvention. That does not constitute an infringement of Article 17(1) of the Charter or, therefore, of the principles set out in recital 28 of Directive 2011/61 and in recital 10 of Directive 2014/91.

85. On the basis of the above considerations, I propose that the Court should answer the question referred by the Kúria (Supreme Court, Hungary) as follows:

The payment of dividends to senior executives of a fund management company who at the same time have a direct or indirect interest in that company must comply with the provisions on sound remuneration policies set out in Article 14b of Directive 2009/65/EC and Article 13 of, and Annex II to, Directive 2011/61/EU where such payment may have the effect of circumventing those provisions.

This presupposes that the extent of the right to receive dividends is so dependent on the performance of the managed funds that it creates behavioural incentives similar to those created by variable or performance-based remuneration and that the fund management company therefore acts only as a paying agent. In such a case, there is circumvention if the participation of the fund management company in the profits of the managed funds would in turn violate the rules on remuneration. That is the case where the specific form of that participation encourages excessive risk-taking. The same applies in the absence of mechanisms enabling a reasonable balance of interests to be struck between the incentives created and the longer-term interests of the management company, the funds it manages and its investors. It is for the national court to determine this in the context of an overall assessment of all the circumstances of the individual case.

2 See, in essence, recitals 1 to 5 of Commission Recommendation 2009/384/EC of 30 April 2009 on remuneration policies in the financial services sector (OJ 2009 L 120, p. 22), on which the relevant legal acts (see footnotes 3 and 4 below) are based. This connection has been confirmed by empirical research; see, for example, Bebchuk/Fried, ‘Pay without performance’, Harvard University Press, Cambridge, 2004; Kaplan, ‘Are U.S. CEOs Overpaid?’, Academy of Management Perspectives, Vol. 22 (2008), pp. 5-20.

3 See, in particular, Articles 14a and 14b of Directive 2009/65/EC 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 (UCITS) (OJ 2009 L 302, p. 32), as amended by Directive 2014/91/EU of the European Parliament and of the Council of 23 July 2014 amending Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) as regards depositary functions, remuneration policies and sanctions (OJ 2014 L 257, p. 186) (‘Directive 2009/65’).

4 See, in particular, Article 13 of, and Annex II to, 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 (OJ 2011 L 174, p. 1) (‘Directive 2011/61’).

7 The fact that the employees concerned in the main proceedings fall within the personal scope of the remuneration arrangements of Directives 2009/65 and 2011/61 is not doubted by the referring court and also seems to me to be beyond question. For that reason, this Opinion only examines the material scope of the provisions on sound remuneration policies.

10 See, for example, Article 14a(2) of Directive 2009/65 and point 1 of Annex II to Directive 2011/61.

14 See point 1 above and footnote 2 of this Opinion. See also recital 2 of Directive 2014/91, according to which the appropriate design of remuneration structures is intended to bring about a ‘control of risk-taking behaviour by individuals’.

15 See, to that effect, judgments of 26 January 2010, Transportes Urbanos y Servicios Generales (C‑118/08, EU:C:2010:39, paragraph 23); of 10 June 2010, Fallimento Traghetti del Mediterraneo (C‑140/09, EU:C:2010:335, paragraph 24); and order of 22 October 2014, Mineralquelle Zurzach (C‑139/14, EU:C:2014:2313, paragraph 28).

17 See Article 14b(3) of Directive 2009/65: ‘… any amount paid directly by the UCITS itself, including performance fees …’ and point 2 of Annex II to Directive 2011/61: ‘… any amount paid directly by the AIF itself, including carried interest …’.

18 See, as regards the shareholder structure of the management company, point 23 of this Opinion.

20 See points 132 and 133 of Guidelines 2013/232 and points 134 and 135 of Guidelines 2016/575.

21 See points 141 and 143 of Guidelines 2016/575 and points 139 and 141 of Guidelines 2013/232 on the justification of retention periods and deferral periods.

22 See, in that regard, point 94 of Guidelines 2013/232 and point 96 of Guidelines 2016/575.

26 See, to that effect, judgments of 20 September 2016, Ledra Advertising v Commission and ECB (C‑8/15 P to C‑10/15 P, EU:C:2016:701, paragraph 73), and of 16 July 2020, Adusbef and Others (C‑686/18, EU:C:2020:567, paragraph 88).

27 Judgment of 16 July 2020, Adusbef and Others (C‑686/18, EU:C:2020:567, paragraph 88).

28 Article 14b(1)(m) of Directive 2009/65 and point 1(m) of Annex II to Directive 2011/91.

31 Judgments of 20 September 2016, Ledra Advertising v Commission and ECB (C‑8/15 P to C‑10/15 P, EU:C:2016:701, paragraphs 69 and 70), and of 16 July 2020, Adusbef and Others (C‑686/18, EU:C:2020:567, paragraph 85). See also, by analogy, Article 52(1) of the Charter.

32 Judgments of 19 July 2016, Kotnik and Others (C‑526/14, EU:C:2016:570, paragraphs 66, 88 and 91); of 8 November 2016, Dowling and Others (C‑41/15, EU:C:2016:836, paragraphs 51 and 54); and of 16 July 2020, Adusbef and Others (C‑686/18, EU:C:2020:567, paragraph 86).

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You are here: BAILII >> Databases >> Court of Justice of the European Communities (including Court of First Instance Decisions) >> HOLD Alapkezelő (Financial market regulation - Investment funds - Remuneration policies of capital management and investment companies - Opinion) [2021] EUECJ C-352/20_O (16 December 2021) URL: http://www.bailii.org/eu/cases/EUECJ/2022/C35220_O.html Cite as: ECLI:EU:C:2021:1023, [2021] EUECJ C-352/20_O, EU:C:2021:1023

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