Will linking compensation to climate produce better risk management?

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After a six-month consultation, the Basel Committee on Banking Supervision (BCBS) has published the final version of its ‘Principles for effective management and monitoring of climate-related financial risks‘ June 15. It contains 18 principles covering corporate governance, internal controls, risk management, monitoring and reporting, and capital and liquidity adequacy, with the first 12 aimed at banks and the others at supervisors. banking.

Although much of the final document is analogous to the consultative document published last November, a notable addition is a recommendation to review remuneration policies to take into account that these must be “in line with the company’s strategy and risk, objectives, values ​​and long term”. term interest of the bank”.

While UK and EU regulations and guidance already contain provisions that companies should consider including performance measures regarding sustainability risk, including climate risk, and which the EU requires of companies disclosing how they incorporate sustainability risk into compensation, Alexandra Beidas, Global Head of Employment and Incentives at Linklaters, says the key point in this development is that it can lead to greater global consistency in this area, including in the US, and can encourage UK and EU businesses to go further.

“Currently many UK and European banks take sustainability risk into account, including climate risk, when defining and adjusting global bonus pools. And some companies are going further and tying part of the bonuses/ other incentive compensation for achieving environmental, social and governance performance measures, such as specific climate change targets,” she explains. “But these approaches typically focus on estimating the impact potential risks or on the assessment of performance against environmental objectives in a given year.”

Ms Beidas thinks the BCBS principles could lead to more companies deciding whether to adjust wages or claw back wages if climate-related financial risks arise and possibly extend deferral periods to ensure they are long enough to capture the long-term horizons of climate-related risks. But could it work?

In Europe, deferral periods are typically applied to 40-60% of bonuses and other incentive compensation over three, four, five or seven years, with companies able to reduce deferred amounts and claw back amounts paid if certain things happen. happen, according to Ms. Beidas. However, at present, very few companies include specific adjustment/clawback provisions in relation to climate-related issues. And deferral rules don’t apply in the US, so bonus deferral periods are usually much shorter, unless companies voluntarily impose them.

But there are other options available to banks looking to install this metric. “Another approach that could be taken by companies is to require long-term participation, including after employment, of a certain percentage of salary,” she says, adding that this is currently provided for managers. executives of companies listed in the UK. “This means that management is incentivized to take a very long-term view and ensure that it mitigates current and future risks that may arise, including those related to climate change.”

While BCBS, the world’s leading standard setter for prudential banking regulation, covering central banks and banking supervisors from 28 jurisdictions, including the United States, tries to encourage banks to think longer term, it requires prompt action. It said it expects the principles to be implemented “as soon as possible” and will monitor progress across member jurisdictions to “promote a common understanding of supervisory expectations and support the development and harmonization of sound practices in all jurisdictions”.

Joy Macknight is the editor of The banker. Follow her on Twitter @joymacknight

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