On April 20, 2023, the Financial Stability Board (FSB) published a report on the impact of climate change on compensation frameworks in financial institutions.
As climate change becomes a top priority for financial institutions and regulators, many are adopting climate-related metrics in their compensation frameworks. Several jurisdictions have already incorporated or plan to incorporate rules or guidance in regulatory and supervisory frameworks.
The latest report issued by the Financial Stability Board examines compensation practices around climate-related objectives and how financial institutions are integrating their stated goals into their compensation frameworks. Although climate-related financial risk factors in compensation frameworks are still a new concept, this report aims to offer early insights to assist the ongoing initiatives of regulators and financial institutions.
“Climate-related metrics tend to be included in the non-financial measure of financial institutions’ balanced scorecards rather than as a financial measure. They are often part of an environmental, social and governance (ESG) category that incorporates broader ESG factors such as diversity and inclusion, while there are separate climate-specific categories in some cases.
Climate-related metrics incorporated in compensation frameworks include the reduction of carbon footprint, provision of sustainable finance and products, and accountability type measures such as leadership in the climate-related area. Some financial institutions also use external-based metrics, such as ratings and indices, to benchmark themselves against their peers.”
The report identifies several common challenges, including gaps in data availability and reliability that make it difficult to apply consistent metrics, the development of objectively measurable metrics that align with financial institutions’ strategies, and the misalignment of timeframes between compensation assessment periods and the materialization of climate-related results.
The report suggests that the incorporation of climate-related metrics into compensation frameworks will continue to evolve, and that financial institutions need to continuously revise and adapt their metrics to respond to a rapidly changing environment to ensure effective alignment of compensation with prudent risk taking. Financial regulators can facilitate this process by sharing regulatory and industry practices with each other and with the industry.
The FSB report is available here.