FCA Guidance Needed on ESG-based Exec Pay

UKSIF has responded to the UK regulator’s discussion paper, asking for further clarity and innovation when linking sustainability goals to remuneration.  

The UK Sustainable Investment and Finance Association (UKSIF) has called on the Financial Conduct Authority (FCA) to better promote best practice and guidance on sustainability-linked executive remuneration and incentives.  

“Higher levels of remuneration without achievement of sufficient results must be avoided, and we would hope to see ESG-based remuneration instead encouraging much more long-term thinking and behaviour by companies – for example, increasing long-term investing in R&D and promoting staff wellbeing,” said Oscar Warwick Thompson, Head of Policy and Communications at UKSIF. 

“The FCA arguably will have some role to play, at the very least promoting best practice and guidance for the finance and investment industry and further encouraging these considerations among regulated firms,” he told ESG Investor. 

“Investors will also have a role,” Warwick Thompson added, noting that they can “further step-up efforts to scrutinise company management practices and policies on pay, especially with their staff and consumers continuing to experience a cost-of-living crisis”. 

UKSIF has responded to the FCA’s discussion paper (DP23/1) on finance for driving positive sustainable change, which considered firms’ sustainability-related governance arrangements, incentives and competencies, analysing how regulated firms can support and deliver on sustainability-related objectives.  

The FCA was also seeking feedback on how firms are designing their approaches to remuneration and incentives, how they deliver on sustainability-related goals, the practical challenges and gaps, and whether existing rules and guidance is appropriate or needs to be redefined.  

“Remuneration is a crucial tool to help align corporate outcomes with long-term sustainability aims,” the FCA said in its discussion paper, which was open to feedback until 10 May. 

Plugging the gaps 

UKSIF warned the FCA that there are currently opportunities for “deliberate gaps”, with companies “cherry picking” easy-to-achieve ESG objectives linked to remuneration. As an example, it noted that Scope 3 emissions – which are considered the most wide-ranging and hardest to decarbonise – are not always incorporated within companies’ decarbonisation remuneration KPIs.  

Some KPIs could be linked to or informed by senior managers’ “competence of sustainability issues”, UKSIF said, noting that “high levels of competence will be important in establishing meaningful KPIs and ensuring a clear line of responsibilities throughout a company”.  

Companies setting ESG-related remuneration targets should also be expected to provide a clear rationale for why they have chosen these targets, how they will seek to mitigate risks of inflated remuneration at the expense of progress on sustainability, what shorter-term milestones are in place to measure progress and risks over time, and how they intend to link targets to credible, objective frameworks, the UKSIF response said.  

UKSIF recommended linking remuneration more directly to companies’ sustainability or climate transition plans to minimise unintended risks and consequences.  

The response said: “A benefit could be to promote delivery of companies’ transition plans over time, above the achieving of more binary climate targets at a particular point in time. These deliberations would need to vary from business to business and will need to be specific to their operations and activities, meaning any guidance from FCA should take this into account.” 

The association pointed to the International Corporate Governance Network’s (ICGN) guidance on executive and non-executive director remuneration as existing material the FCA could build on.  

Additionally, UKSIF said there may be a case for differentiation in remuneration plans between staff within financial and non-financial companies, as there remains a question around the extent to which financial services firms should base executive pay on outcomes “that they ultimately may not be able to control in comparison to governments and real economy businesses”.  

There may also be a need to differentiate between different groups of firms within the finance industry, as considerations on ESG-linked remuneration look different to a bank compared to an investment management firm, the response added.  

“With companies increasingly aligning remuneration incentives to their sustainability-related strategic priorities, now is a good time for this issue to be looked at further and how remuneration could help to promote delivery of firms’ sustainability approaches in the long run,” said Warwick Thompson. 

We think further work should be kept under consideration by the regulator, and in time new guidance for regulated firms could focus on promoting positive outcomes and avoiding further inflated executive pay as a primary outcome.” 

Company-wide competence  

UKSIF noted in its response that there are “a number of steps” regulated firms can take to ensure they have appropriate skill sets and understanding of material sustainability issues at the board level and below.  

To ensure good governance is embedded throughout the business, UKSIF said firms could consider, where appropriate, the creation of advisory multi-stakeholder bodies to their boards to provide counsel on sustainability factors. 

Acknowledging that a dedicated advisory body “may not be a panacea in itself”, UKSIF noted that it would nonetheless welcome an increased focus from industry and the FCA on more innovative governance mechanisms across all levels of a company that could address “ongoing gaps” in “understanding and competence” across sustainability themes, including social factors, biodiversity and nature. It suggested embedding sustainability-related objectives into the annual appraisal processes for staff as an example.  

Ahead of the planned review of the UK Stewardship Code later this year, which was announced in the recently updated Green Finance Strategy, UKSIF said that this could also be “an excellent opportunity” to consider the “shift” in “our collective understanding of stewardship, which has moved beyond a focus on company engagement alone”, as well as revisiting the application of stewardship for different asset classes.   

UKSIF said the review of the Code could consider a reintroduction of a ‘tiering system’ once there is wider adoption across the UK market, which could help firms learn from each other when producing their reports.  

“With the expectations of clients increasingly driving asset managers and other firms to sign up to the Code, at some point we would expect ‘tiering’ to become more relevant for the regulator,” the response said.  

When considering the role of stewardship in addressing systemic risks, UKSIF noted that these risks are not necessarily always firm-specific and that it can be challenging to demonstrate the materiality of these risks – as well as their positive impacts on these issues – for individual firms.  

“For these reasons, a holistic, whole of industry approach may be required to tackle these types of risks, accompanied by relevant policy measures from government,” said UKSIF. 

In an interview with ESG Investor ahead of its inaugural Stewardship Summit, Mark Manning, the FCA’s Strategy Policy Advisor for Sustainable Finance, said feedback from industry on stewardship will feed into a wider review of UK stewardship policy and influence the FCA’s future approach to the area.  

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