Climate-related Financial Risk Factors in Compensation Frameworks
Climate-related metrics are often part of the environmental, social and governance (ESG) factors that are increasingly used by financial institutions as part of performance measurement to determine variable compensation.
The impact of climate change on the financial system is becoming a strategic priority for financial institutions and regulators. In turn, financial institutions are increasingly adopting climate-related metrics in compensation frameworks and many jurisdictions have incorporated or plan to incorporate rules or guidance in regulatory and supervisory frameworks across banking, insurance and asset management.
This report reviews compensation practices around climate-related objectives and how the stated goal of financial institutions is incorporated into their compensation frameworks. Climate-related financial risk factors in compensation frameworks are still an emerging theme. Therefore, this report does not aim to present and compare practices across jurisdictions, but rather to identify challenges and to provide an early insight in a fast-moving field to assist ongoing initiatives of regulators and financial institutions.
Common challenges include:
gaps in data availability and reliability that make it difficult to apply consistent metrics and monitor them in performance evaluation and compensation determination
development of objectively measurable metrics that are aligned with financial institutions’ strategies
misalignment of timeframes between compensation assessment periods and the materialisation of climate-related results.
Incorporation of climate-related metrics into compensation frameworks is expected to evolve further. Continuous revision and adaptation of metrics by financial institutions, in response to a fast-changing environment, is needed to ensure effective alignment of compensation with prudent risk taking. Financial regulators can facilitate this process by helping share regulatory and industry practices with each other and with industry.