REMUNERATION AND ESG: WHAT DO YOU NEED TO KNOW?
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REMUNERATION AND
ESG: WHAT DO YOU
NEED TO KNOW?
MAY 2021
REMUNERATION AND ESG:
WHAT DO YOU NEED TO KNOW?
Tying executive remuneration and broader pay conditions to
environmental, social and governance (ESG) measures continues
to be a hot topic as the 2020-21 AGM and shareholder meeting
season demonstrates.
Global events such as the COVID-19 pandemic, the climate
emergency, economic uncertainty and social and racial justice
are causing companies to accelerate changes to their ESG
priorities, ensuring ever closer alignment between these issues
and their long-term corporate strategies. Increasingly,
companies' boards and remuneration/compensation committees
are recognising that they too have a role to play in addressing
these urgent challenges and are looking to manage the risks by
linking them to conditions on executive pay. The level of interest
in this area will only increase, as investors, consumers, staff and
broader stakeholders put pressure on companies for a strong
commitment to ESG, viewing pay as another way to hold
companies and their executives to account.
Here's what you need to know about the current status of ESG
and remuneration globally.
KEY ISSUES FOR Where ESG measures are used in
LTIPs and bonus plans, most tend to
COMPANIES be industry-focused, such as health
ESG measures are becoming increasingly
and safety measures in the
prevalent and also a more significant part
manufacturing sector and carbon
of bonuses and long-term incentive plans
emissions goals in the energy industry.
(LTIPs), certainly at executive level. Whilst
However, increasingly, environmental
a relatively small number of public
concerns are being put at the forefront
companies have had ESG targets for
across sectors, reflecting the urgency
remuneration purposes for some years,
of the climate crisis.
this has become an increasingly common
feature over the last 12 months. It is important to be clear on
motivations and objectives at the
There are a number of key issues for outset. It may be the case that
companies, their boards and companies want to adopt ESG targets
remuneration/compensation committees for reasons of social pressure alone,
when considering ESG measures for pay regardless of whether shareholder
purposes. These include: value is being created. In these
circumstances, care should be taken
• Clear rationale and strategic link that the right balance is struck and
As with any other performance consultation with shareholders in
conditions, it is essential that ESG advance of implementation will
measures are clearly linked to the be key.
implementation of the company’s
• Robust, measurable
strategy. Setting ESG targets that have
and quantifiable
not been carefully considered, or
ESG issues are constantly developing,
adding an ESG target as an
often aspirational and long-term in
afterthought, can be counterproductive
nature, and so building these factors
for businesses.
2 CLIFFORD CHANCE
REMUNERATION AND ESG: WHAT DO YOU
NEED TO KNOW?
into robustly measurable and ESG measures more broadly within
quantifiable targets can be challenging. their organisations, and not just at the
In evolving regulatory and legal executive level, in order to ensure a
landscapes, certain measures adopted more meaningful and deeper cultural
at the point of grant may, for example, alignment with their strategic aims.
no longer be relevant at the end of the
plan cycle. THE GLOBAL
As with any other target, tying PERSPECTIVE
measures to clear, reported and Comparing the use of ESG metrics for
audited numbers will be more palatable pay around the globe, there is a high
to shareholders and other stakeholders. degree of convergence in the way in
For this reason, companies commonly which companies and stakeholders are
tie measures to identifiable approaching the issue.
outputs such as reductions in carbon
emissions. The UK
Prevalence
Careful planning will also be needed on
the weightings, achievement and Although companies have included ESG
calibration of measures, which can also targets as part of executive pay in the UK
be challenging. Shareholders often view for some time, this has commonly been
strategic measures as 'soft' and are within a ‘balanced scorecard’ type
wary where higher pay outs are framework to be considered as part of a
achieved as against 'harder' purely holistic assessment of performance,
financial metrics. Companies will need rather than having standalone ESG
to take care that the measures are measures. ESG measures are, however,
sufficiently stretching and are not becoming a more material part of bonus
achievable simply as ‘part of the day and LTIP decisions.
job.’ Realistic time frames for the
achievement of targets will also have to A recent survey by the London School of
be considered. Given the long-term Business showed that 45% of the UK's
nature of many ESG issues, is a FTSE100 companies now have an ESG
meaningful assessment possible over target linked to variable pay, with 37%
the time frame that's being proposed? including one in their bonus plans (with a
typical weighting of 15%).
• Shareholder engagement
and disclosure The nature of ESG targets adopted by
Early engagement with shareholders UK companies is also evolving. Perhaps
and other stakeholders will be key to unsurprisingly, the more established
the success of implementation, metrics, largely relating to health and
especially where the ESG targets under safety, risk, employee engagement and
consideration may not obviously tie to governance, are being boosted by newer
shareholder value creation. Enhanced measures, tied to diversity, social justice
disclosure in this area is also critical. and environmental issues. We are seeing
Companies will want to link clearly the an increase in the introduction of climate
ESG strategy and method of change measures across all sectors and
performance measurement in their in financial services in particular, reflecting
annual reports, proxy statements and increased concerns from regulators and
other public disclosures. Investors the real risk that climate change brings to
expect a detailed rationale and the global financial system.
disclosure of achievements that have
led to the payment of any strategic and Investor position
ESG elements. The weightings, Proxy advisers have been strengthening
achievement and outcomes of these their guidance in the area and are very
strategic objectives should also be conscious of the challenges faced by
clearly disclosed and explained. companies. In their 2020 guidance, the
• Extension into the wider business Investment Association (IA), Institutional
Tying pay conditions to ESG should not Shareholder Services group (ISS) and
be a board level issue only. Companies Legal and General Investment
are increasingly thinking about applying Management (LGIM) each recognised the
impact of ESG risks and the benefit of
CLIFFORD CHANCE 3
REMUNERATION AND ESG: WHAT DO YOU
NEED TO KNOW?
incorporating ESG into pay structures. Public companies are not specifically
The IA, for example, is generally required to discuss ESG in their executive
supportive: however it advises caution in compensation disclosures, but the
ensuring that ESG performance targets relevant rules do require that companies
are quantifiable and clearly linked to value explain in detail how performance
creation and strategy. The IA is also clear compensation for the named executive
that financial metrics should comprise the officers is set and determined.
majority of variable pay determination,
stating that a threshold level of financial Companies that have included
performance will be needed before any aspirational language in SEC filings about
award is made. Where some advisers are ESG have faced lawsuits from plaintiffs
cautious in their views, others are actively who allege that actual behaviour has
pushing for ESG targets to be adopted. fallen short of what had been promised in
a formal securities law filing. Most
The US companies take the responsibility for what
Prevalence and market practice they say in SEC filings quite seriously, and
Increasing numbers of private and public a review of recent annual proxy statement
companies in the US are incorporating filings with the SEC shows a great deal
ESG-related criteria into performance about ESG trends in compensation:
goals and targets for their executives.
Starbucks reports using individual
We are aware of growing numbers of performance factors in annual bonus
private companies that are beginning to determinations for senior vice-president
include ESG targets in their executive and above, to help drive achievement of
compensation structures, but the best diversity and inclusion targets. Starbuck's
information available relates to public leadership stock plan includes a
companies, and this discussion is based performance metric that ties payouts to
on public company data. "improvement in Black, Indigenous and
LatinX representation at the manager level
In a Pay Governance survey, 29% of and above, with a three-year target of
respondents indicated that they were improving Black, Indigenous and LatinX
using some kind of ESG metric in their representation by more than 5%
incentive plans in 2021, up from 21% in by 2023."
2020. Pay Governance indicates that
most are including environmental and Intel discloses that the annual bonus for
social metrics. The survey also indicated named executive officers is based, in
that most who use ESG metrics do so in part, on achievement of ESG "metrics
their bonus plans rather than in their encompassing environmental and
LTIPs. This suggests that people have not diversity and inclusion goals."
yet determined what their long-term ESG
goals are, or they anticipate that those TreeHouse has "included progress
goals and priorities will change. against ESG metrics in the merit
component of executive officer
There is some evidence that US compensation and progress on key
companies which see themselves as diversity and inclusion metrics in the
having bigger environmental and social strategic component of their annual
impacts are using ESG performance incentive plan for executive officers."
goals and targets. For example, one
would expect operators in steel, cement, Callon Petroleum adopted ESG metrics
mining, energy and plastics to be at the for the 2021 annual bonus with a 15%
vanguard of using environmental metrics. quantitative weighting plus a qualitative
component tied to sustained progress
There is increasing evidence of towards greenhouse gas reduction
companies using metrics that consider targets. It also uses metrics related to
human capital, diversity and safety, environment, diversity and
inclusion considerations. team development.
4 CLIFFORD CHANCE
REMUNERATION AND ESG: WHAT DO YOU
NEED TO KNOW?
Walt Disney disclosed that the 2021 Sustainability Reporting Directive, which
annual bonus will "further highlight ESG would increase the reporting requirements
metrics, by emphasizing diversity and and the number of companies in scope of
inclusion (e.g. representation, retention reporting from 11,600 (currently in scope
and content), which will have the highest of the Non-Financial Reporting Directive)
weighting among non-financial metrics." to approximately 49,000 (in scope of this
new Corporate Sustainability Reporting
The EU Directive). Reporting requirements will
ESG is high on the agenda of law makers include equal opportunities, including
and is beginning to make its way into gender equality and equal pay for equal
policies of EU based investors and work, training and skills development, in
companies. addition to requirements on working
conditions, including secure and
Rapidly evolving regulations adaptable employment, wages, social
The European Commission has dialogue and the involvement of workers.
demonstrated itself to be a pioneer in
ESG law making on remuneration. It has The fast pace at which the Commission
introduced various new initiatives and is initiating new proposals for ESG
regulations, both in relation to the regulations, including on pay,
remuneration of executives and the demonstrates that the Commission is
wider employee base. serious about its ambitions and
companies will need to adapt swiftly to
In February 2021, the consultation on the keep up with the changing environment.
Commission's questionnaire on
sustainable corporate governance closed. Market practice
The questionnaire built on an earlier study Under the pressure of soft laws on
of the European Commission on corporate governance, local market
director's pay and looked into new authority regulations and proxy advisors
measures to avoid short-term gain and to recommendations, a large number of
increase alignment of remuneration with European listed companies already
companies' long-term goals. Assuming incorporate ESG metrics in their executive
this leads to a European Directive on officers' annual bonus. The weight of the
sustainable corporate governance, the ESG metrics in LTIPs is also growing.
impact on board remuneration structures
may be significant, as requirements on According to the 2020 report on ESG
executives' pay may include: mandatory metrics published by Willis Towers
deferral periods, restrictions to sell shares Watson 68% of the top European
that are awarded as variable pay, and companies use at least one ESG metric in
compulsory inclusion of non-financial, their annual bonus, LTIP, or both.
ESG metrics linked to a company's
sustainability targets. Investor position
In addition to investment group Cevian,
In March 2021, the Commission which has pushed hard for the inclusion
published its new proposals for a of ESG metrics, we are also seeing other
European Directive on pay transparency. investors in the EU emphasising the
The lack of pay transparency has been a importance of ESG in relation to
thorn in the side of the Commission as it remuneration. In its 'voting policy and
is seen as one of the main obstacles to 2021 engagement', Amundi Asset
ensure equal pay between men and Management 'voted against executive
women and pay gap issues in general. compensation plans that did not contain
ESG indicators, resulting in 31% of
The proposal includes a right for workers negative votes on this issue.' Also Dutch
to know the pay levels of other workers APG Asset Management, critically
doing the same work and an EU-wide monitors the remuneration policies of its
gender pay gap reporting obligation for investment companies and has called for
companies with at least 250 workers. the 'inclusion of ESG objectives in
remuneration policies.'
Finally, on 21 April 2021, the Commission
published its proposal for a Corporate
CLIFFORD CHANCE 5
REMUNERATION AND ESG: WHAT DO YOU
NEED TO KNOW?
APAC Similarly, whilst culture reform through
incentive systems is very much on the
Australia
Hong Kong Monetary Authority's (HKMA)
Non-financial measures, including ESG,
agenda and the HKMA has formed a
are a substantial – and an increasing –
Green and Sustainable Finance Cross-
factor in corporate remuneration
Agency Steering Group with the
frameworks in Australia. The emergence
Securities and Futures Commission
of ESG as a factor relevant to determining
(SFC), there is no requirement or
incentives is a relatively recent trend, and
recommendation for ESG metrics in
can largely be attributed to a shift in
incentive plans on that front either.
regulatory focus and public sentiment
following the Hayne Royal Commission
Whilst ESG metrics are used within
into the Banking sector, and inquiries by
reward structures in Hong Kong, this is
the Australian Prudential Regulation
not standard practice. ESG metrics tend
Authority into culture, governance and
to relate to the environment, such as CO2
accountability at a number of Australia's
reduction and sustainability measures
largest financial institutions.
such as safety and customer satisfaction,
and are typically linked to annual bonus.
A report released in January 2021 by
An example is China Light and Power
Guerdon Associates found that Australian
(CLP). CLP takes a balanced scorecard
companies pay more for positive ESG
approach and the measures taken into
outcomes than any other country involved
account include safety performance
in the study, with 81% of ASX100
(fatalities, lost time injury and injury rates)
companies incorporating ESG metrics in
and environmental performance
their CEO's remuneration framework
(regulatory non-compliance, CO2
compared with 67% globally. Amongst
intensity, and emissions and renewable
the Australian companies surveyed, non-
energy capacity). Other companies that
financial incentives were 30% of the
have disclosed incentives for
overall incentive opportunity, compared
management of climate-related issues
with 20% globally.
under the not-for-profit Carbon Disclosure
Project are MTR Corporation and New
In the future, ESG looks set to be an
World Developments.
increasingly important metric for executive
remuneration in Australia. Shareholders
Willis Towers Watson's survey indicated
are demanding action on climate change
further adoption of ESG measures in the
through a move away from traditional
future. The results stated that, in APAC,
Australian investment in non-renewable
seven in ten respondents are planning to
energy sources, and as a result of
change how they use ESG within their
increased social awareness of social,
executive incentive plans over the next
governance and cultural issues.
three years with 69% planning to
introduce ESG measures into their LTIPs
Hong Kong
over the next three years, and 61%
The Hong Kong Stock Exchange's
planning to do the same with their annual
(HKSE) Listing Rules contain a Corporate
bonus. Respondents say that amongst
Governance Code and ESG Reporting
the greatest challenges faced when using
Guide, requiring governance and
ESG metrics in incentive plans, are
oversight of ESG matters and
target- setting (46%), performance
assessment and management of material
measure identification (37%) and
ESG risks, as well as reporting on listed
performance measure definition (34%).
ESG topics on a comply or explain basis
This explains the importance of
and disclosure regarding governance of
performance measures having a clear
ESG issues. They do not, however,
rationale and strategic link, and be robust,
require or recommend the inclusion of
measurable and quantifiable.
ESG metrics in incentive plans and there
is no sign of such a recommendation in
the public consultation launched this
month.
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REMUNERATION AND ESG: WHAT DO YOU
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Japan Some Japanese companies are beginning
The integration of non-financial measures to introduce ESG factors as a
including ESG into remuneration performance evaluation item in executive
frameworks for executive officers has remuneration, but they are still in the trial
become an urgent issue for Japanese stage, with non-financial measures
companies. ESG has recently become an accounting for as little as 10% of
important financial incentive for executives executive remuneration and relying on
in Japan, following global trends in non- evaluations by external evaluation
financial measures. agencies. However, as society becomes
increasingly aware of the need for proper
In Japan, the promotion of ESG has been corporate governance, ESG will become
steadily improving, starting with the increasingly important as an indicator of
formulation of a Corporate Governance executive remuneration and more
Code and a Stewardship Code. The companies are likely to introduce new
Ministry of Economy, Trade and Industry remuneration frameworks that take ESG
(METI) revised guidelines regarding into account. According to a survey
corporate governance systems in 2018, published by Deloitte Tohmatsu and
stating that "environmental, social and Sumitomo Mitsui Trust Bank in November
governance (ESG) factors are becoming 2020, 5.4% of large Japanese companies
increasingly important for investors and used ESG indicators in determining
shareholders in assessing a company's executive remuneration whereas it was
sustainable growth and medium-to long- only 3.6% in the previous year.
term corporate value enhancement."
CLIFFORD CHANCE 7
REMUNERATION AND ESG: WHAT DO YOU
NEED TO KNOW?
CONTACTS
UK
Sonia Gilbert Andrew Patterson Catrin Wright
Partner Partner Head of Practice
London London Development
T: +44 207 006 2041 T: +44 207 006 6160 London
E: sonia.gilbert@ E: andrew.patterson@ T: +44 207 006 2920
cliffordchance.com cliffordchance.com E: catrin.wright@
cliffordchance.com
US EU
Paul Koppel Floris van de Bult Anne Lemercier
Partner Partner Partner
New York Amsterdam Paris
T: +1 212 878 8269 T: +31 20 711 9158 T: +33 1 4405 5214
E: paul.koppel@ E: floris.vandebult@ E: anne.lemercier@
cliffordchance.com cliffordchance.com cliffordchance.com
APAC
Ines Keitel Tim Grave Alexandra Payne
Partner Partner Senior Associate
Frankfurt Sydney Sydney
T: +49 69 7199 1250 T: +61 2 8922 8028 T: +61 2 8922 8508
E: ines.keitel@ E: tim.grave@ E: alexandra.payne@
cliffordchance.com cliffordchance.com cliffordchance.com
Anita Lam Michihiro Nishi Taro Kono
Senior Consultant Partner Lawyer
Hong Kong Tokyo Tokyo
T: +852 2825 8952 T: +81 3 6632 6622 T: +81 3 6632 6657
E: anita.lam@ E: michihiro.nishi@ E: taro.kono@
cliffordchance.com cliffordchance.com cliffordchance.com
CLIFFORD CHANCE 8
REMUNERATION AND ESG: WHAT DO YOU
NEED TO KNOW?
This publication does not necessarily deal with every important
topic or cover every aspect of the topics with which it deals.
It is not designed to provide legal or other advice.
www.cliffordchance.com
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© Clifford Chance 2021
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