Instead of introducing a bonus cap, Parliament suggested fund managers receive a higher proportion of bonuses in fund shares, as well as deferring part of the payment.
The bonus cap was narrowly defeated by 348 votes to 341.
"This is a dark day for investor protection," said Sven Giegold, a German member of parliament who had campaigned for a strict limit on fund manager bonuses.
"A comprehensive change of the culture in the financial industry has been forestalled."
The bonus cap was planned as a follow-up to limitations placed on banker pay. Support for the move waned amid warnings that the industry, which did not receive taxpayer-funded bail-outs, could be badly damaged.
A 'victory' for asset managers
CBI head of financial services Leo Ringer said the decision was sensible.
"A cap on bonuses works against the idea of performance-related pay, undermines shareholder engagement on pay strategy and does nothing for financial stability," Ringer said.
"This decision should be seen as drawing a line under this flawed idea for good."
Jon Terry, a partner in PwC's reward team, said the bonus cap defeat will be viewed as a major victory for the asset management industry.
"The bonus cap would have left fund managers facing the toughest pay rules across the whole of the financial services sector. The vote against the cap demonstrates an acceptance from rule makers that the asset management sector operates very differently to the banking sector in terms of risk profile," said Terry.
Alex Beidas, employee incentives lawyer at Linklaters, said that today's result may put off European politicians from trying to implement further pay restrictions beyond banking.
"The flurry of lobbying in the last few days has paid off," Beida said. "It will also give other sectors comfort as there has been a concern that the Alternative Investment Fund Managers Directive would be amended to apply the cap to hedge funds and private equity firms, and that the Shareholder Rights Directive could apply a cap to listed EU companies.
"Today's result may lead EU law makers who are in favour of applying the cap to a wider group than banks, to think again."
