How can financial institutions integrate climate-related metrics into their compensation frameworks?
Many jurisdictions are in the early stages of incorporating and monitoring these metrics into compensation frameworks across banking, asset management and insurance.
The Financial Stability Board (FSB) published a report based on a survey of FSB member jurisdictions carried out in 2022 to assess the state of the market on this topic. They highlight:
- Climate-related metrics are included in sustainability scorecards rather than financial metrics by financial institutions, as part of a broader range of ESG factors.
- Only executives and senior management tend to be individually affected by climate-related results, mostly in short-term incentive plans rather than long-term ones.
- The impact of climate-related results on these individuals' compensation remains small, as their weight is negligible when they are not merely used as an adjuster in the compensation computation.
- The adoption of climate-related metrics in compensation frameworks depends on firms' geographical situation, but not really on their activity sectors.
- Challenges regarding the adoption of these metrics include low data availability, reliability, and comparability to perform consistent assessments.
- Coming up with metrics to steer specific climate strategies over the short-term and the long-term is also problematic, as there may be a misalignment of interest between these measures and the firms' other performance KPIs.
The design and incorporation of climate-related metrics in compensation frameworks is still in its infancy and will spread as climate change becomes an increasingly material risk for financial institutions.
Regulators can ease this process by facilitating best practice sharing between practitioners, who in turn need to revise and adapt their measurement frameworks to fit the climate emergency.