By Dawn Cowie:

Asset managers face growing pressure to link employee bonuses to environmental, social and governance targets.

Calls from institutional clients, regulators, investee companies and the public for asset managers to improve their ESG practices, including remuneration, are pushing firms to look at ways in which they can integrate these considerations into short and long-term variable pay, experts say.

The 2020 manifesto from the World Economic Forum in Davos earlier this month says the “performance [of a company] must be measured not only on the return to shareholders, but also on how it achieves its environmental, social and good governance objectives”.

“Executive remuneration should reflect stakeholder responsibility,” according to the manifesto.

Corinne Carr, founder of independent remuneration consultancy PeopleNet, says: “Asset managers are putting pressure on companies they invest in to pay responsible rewards, but they have not yet factored ESG into their own rewards packages.” “They are getting pushback from companies they invest in,” she says.

Integration of ESG factors is likely to start with executive pay, but could be rolled out across all employees who receive an element of variable pay, Ms Carr says.

She has been talking to asset managers for three years about “responsible rewards” that link sustainability to remuneration.

Firms used to ask “why should I do this?” but more and more the question they ask is “how do I do this?” says Ms Carr.

Till Jung, managing director at ISS ESG, the responsible investment arm of proxy adviser Institutional Shareholder Services, says there is “growing pressure” for large asset managers to support climate-related shareholder resolutions as part of their risk oversight of companies, as well as calls for fund houses to “enhance” their own ESG disclosures and practices.

“Taken together, I expect there to be continued pressure for asset managers to provide greater transparency around their ESG reporting,” Ms Jung says.

Only 2 per cent of financial services firms have any disclosure on the integration of environmental and social performance measures in their short-term incentive plans, according to ISS ESG.

For long-term incentive plans, just over 1 per cent of financial services firms disclose ESG pay links, the firm says.

Ms Carr says most firms start by integrating ESG into short-term bonuses and then extend it to long-term rewards as they become more familiar with the process.

ESG issues are long-term issues, she adds.

For example, 12.5 per cent of the long-term incentive plan at HSBC group is dependent on the rating of the company by ESG research firm Sustainalytics.

If the firm achieves an average Sustainalytics score, then 25 per cent of the ESG portion of the LTIP is paid. If the firm achieves an outperformer rating then 100 per cent is paid.

Firms often start by making a portion of executive pay dependent on sustainability factors to set the tone from the top, according to Ms Carr.

Some stop there but the best approach is to “cascade it down to all individuals who receive variable pay shortly afterwards”, she says.

 Ms Carr says firms should develop their own responsible business index, which lists all of the sustainability factors that are material to the business and gives each a weighting.

For each factor, such as diversity of workforce, the firm needs to assess where it is now and set targets for where it wants to be.

Firms can disclose an aggregate sustainability weighting or go into more granular detail on each factor.

“The more transparent it is, the more effective it is,” says Ms Carr.

Alternatively, a proportion of the bonus pool can be linked to the overall index score.

A minimum of 10 per cent of variable pay should be linked to ESG performance to be meaningful, she says.

The most progressive firms may link about 25 per cent of variable to pay to ESG performance.

Tim Wright, a partner in the rewards practice at PwC, says asset managers would “love to embed ESG factors into their performance appraisal system but they are struggling a little to know how to do it in a quantifiable way”.

As firms develop new funds and strategies they are trying to ensure that ESG performance is embedded appropriately within remuneration, he says.

Athanasia Karananou, head of corporate governance at the United Nations-backed Principles for Responsible Investment, says integrating ESG into variable pay can be a good idea but it does not always work in practice.

There has to be transparency about the weighting of different ESG factors within bonus calculations for them to “meaningful”.

Where ESG metrics are vague or the company has discretion in terms of how it pays out, there can be a lack of accountability, Ms Karananou says.

For example, if sustainability is one of 20 metrics and only accounts for 0.01 per cent of a bonus then it is not meaningful.

However, Ms Karananou does not support proposals in Australia for non-financial performance measures to comprise 50 per cent of executives’ variable pay.

She says there is a potential for unintended consequences, such as massaging ESG results so executives do not miss out on bonuses.

Corinne Carr is an independent remuneration consultant specialising in Responsible Reward and founder of PeopleNet Ltd.  Read her Responsible Reward: how to fulfil your environmental, social and governance promises through performance and pay and watch her 2-minute video. www.peoplenet.ltd.uk