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Why UK companies should link executive pay to ESG

Disclosure obligations

Companies listed in the UK are used to financial information and in recent years there has been an increasing emphasis on compensation information. This concentration has been accompanied by an increase in ESG-related disclosure requirements. For example, a company listed on the UK stock exchange is required to include in its annual report a statement indicating the extent to which information, including remuneration information, complies with the recommendations of the financial reporting task force. climate-related.

Durability requirements

With specific regard to sustainability requirements, the UK Corporate Governance Code makes it clear that sustainability must be addressed in a meaningful way by requiring that the remuneration policies and practices of listed companies, whether incorporated in the UK or elsewhere, are designed to support the strategy and promote long-term sustainable success.

Moreover, under the Sustainable Finance Disclosure Regulationsome financial institutions must also ensure that their compensation policies promote effective sustainability risk management.

Finally, the raison d’être, the convictions, the strategy and the culture of the signatories of the UK stewardship guide aim to create long-term value for customers and beneficiaries, leading to lasting benefits for the economy, environment and society.

Transparency requirements

On the governance side, transparency requirements push UK companies to be mindful of ESG when dealing with executive compensation. The UK Corporate Governance Code requires a listed company to establish formal and transparent procedures for developing compensation policies and determining compensation.

Shareholder engagement

Growing shareholder interest in ESG outcomes and shareholder engagement in compensation is perhaps one of the most compelling reasons to consider linking executive compensation to ESG metrics.

Some 77% of UK investors are likely to consider investing ethically. Globally, 88% of investors give ESG the same level of scrutiny as operational and financial matters. ESG is clearly a high priority for most investors, with annual compensation reports for UK listed companies subject to an annual shareholder advisory vote, and a binding shareholder vote on compensation policies every three years, it is essential that executive compensation reflects shareholders’ ESG priorities.

Recommendations and public strategies

Finally, public recommendations and strategies can lead a British company to link executive compensation and ESG. The Investment Association Remuneration Principles indicate that compensation committees should consider including strategic or non-financial performance criteria in variable compensation. The FCA’s current strategy also includes developing a policy approach to ESG compensation within regulated companies.

One of the most difficult parts of linking compensation to ESG goals is setting goals that are clear, specific, and measurable enough to achieve the desired outcome. One way to do this is to define ESG KPIs that can be used as stand-alone targets for executive compensation (much like financial targets) or as discretionary targets for the compensation committee to consider when the quantification of executive compensation.

ESG KPIs tend to vary by industry. Financial services companies could focus on making progress towards green finance commitments, while construction companies could focus on occupational health and safety. However, companies wishing to implement KPIs for each of the “E”, “S” and “G” components are spoiled for choice.

In the “E” sphere, typical KPIs include reducing carbon emissions, increasing the use of renewable energy, achieving net zero targets, and reducing food waste. Common “S” KPIs relate to investing in communities, increasing leadership diversity, improving workplace health and safety and accessibility, educating and training staff and data confidentiality. “G” KPIs are less common, but still important. These may relate to compliance, corruption and bribery prevention, reporting and communication, or risk management. There are also KPIs that combine all ESG aspects such as sustainable production and supply chains and responsible sourcing.

Going forward, public demand will demand that companies be seen to be addressing ESG issues. Many will need to review their compensation policies and practices through an ESG lens.

Mark Walker is a lawyer at CMS