Are ESG performance indicators becoming a must-have in bonus plans ?

Environmental, Social and Governance (ESG) factors are a key way to measure organisations’ commitment to sustainability. There is a long road ahead to build an ESG-compliant corporate world, but creating a working environment that is as close as possible to human and planetary needs has become a necessity. It is also particularly crucial for organisations that are a target of media attention around ESG-related issues.

Pay and benefits matters can play a crucial role in shaping an ESG-oriented HR mentality and attracting talents and investors. Ius Laboris carried out a survey of 27 countries across the world to understand whether organisations should include ESG indicators as key performance indicators, KPIs, in bonus plans. The full results are available here.

The survey shows a common trend among decision-makers across the world, from Australia to South America: encouraging ESG values by including them among the KPIs in bonus plans.

ESG-themed KPIs are not generally mandatory in the 27 countries surveyed, but the tendency is that it is absolutely advisable to include them in the bonus plans.

Currently, EU law requires certain large companies to disclose information on the way they operate and manage social and environmental challenges. This helps investors, civil society organisations, consumers, policy makers and other stakeholders to evaluate their non-financial performance and encourages them to develop a responsible approach to business.

The Non-Financial Reporting Directive (NFRD, Directive 2014/95/EU) sets rules on disclosure of non-financial and diversity information by certain large companies.

According to the NFRD, large companies must publish information related to:

• environmental matters;
• social matters and treatment of employees;
• respect for human rights;
• anti-corruption and bribery.

In addition, as the Belgian survey response reminds us, inside the EU, financial market participants and financial advisers must include information in their remuneration policies on how those policies are consistent with the integration of sustainability risks (this is regulated in the European Regulation on sustainability-related disclosures in the financial service sector, EU 2019/2088). Including ESG indicators as KPIs in bonus plans may be a way to comply with these reporting requirements.

In Italy and Croatia, in compliance with the requirements described above, listed companies are required by law to set their remuneration policies taking into account the pursuit of sustainability.

Among other European countries, in Austria and France large corporations (i.e. those with more than 500 employees) are required to provide an annual non-financial statement about the impact of the organisation’s policies and activities on environmental, social and employee matters. French listed companies must include clear, detailed financial and non-financial KPIs in corporate officers’ variable remuneration policy, including relating to the company’s social and environmental responsibility. Many French companies also include ESG key performance indicators in the list of performance criteria used to calculate bonuses under collective incentive agreements.

Even outside the EU, the trend is uniform. In both the UK and US, it is not currently mandatory to include ESG KPIs in bonuses, but the need for this is becoming increasingly apparent in view of requests from investors and job applicants. During 2021, both countries introduced additional disclosure obligations on ESG metrics.

In addition, in the UK, for accounting period starting on or after 1 January 2021, premium listed FTSE (Financial Times Stock Exchange) companies are required to provide climate-related financial disclosures to comply with the latest Financial Conduct Authority (FCA) requirements. The FCA has proposed extending the disclosure requirements to asset managers, life insurers and pension providers.

In the US, last year (June 2021), the House of Representatives passed a new ESG-related bill (the Corporate Governance Improvement and Investor Protection Act). This would require the Securities & Exchange Commission to establish rules requiring public companies to disclose certain ESG metrics. Although this bill has not yet become law, the trend is clearly in favour of including ESG KPIs as indicators in bonus plans.

ESG is for the planet, but also its inhabitants. Correctly applied, ESG safeguards the working environment as a whole. An example of this can be seen in Greece, where a recent piece of legislation (Labour Law 4808/2021) states that employers have an obligation to draw up an anti-violence and anti-harassment policy and to assist the competent bodies in investigating worker complaints on these issues. These events could constitute an ESG indicator affecting bonuses. In addition, the majority of Finnish listed companies include employee satisfaction and retention as ESG KPIs. In Luxembourg, designated companies must include a non-financial statement that includes information relating social and personnel issues, respect for human rights and the fight against corruption (as well as environmental issues) in the management report.

Traditional ESG KPIs focus on health and safety, issues which may result in material reputational damage, employee engagement and risk but increasingly, ESG KPIs cover broader issues such as diversity and inclusion and environmental responsibility. These are only examples of possible concrete applications of ESG KPIs. The use and type of ESG metrics in bonus plans varies considerably depending on the size of the organisation and the sector or industry in which they operate.

An interesting data point to highlight is that in some countries, companies in the energy sector are cutting edge in implementing ESG indicators, with ESG KPIs in bonus plans common practice. In Australia and New Zealand, even if there are currently no laws or regulations requiring companies to include ESG as indicators in incentive agreements, it is increasingly common practice for listed companies to incorporate ESG metrics into executive remuneration arrangements. The uptake of ESG KPIs in bonus plans is driven by the dominance of energy and resources in the domestic economy.

Additional legislation on ESG requiring extra financial statements is expected in the near future in the EU and beyond.

On 21 April 2021, the European Commission adopted a proposal for a Corporate Sustainability Reporting Directive (CSRD), which would amend the existing reporting requirements of the NFRD. The proposal aims to extend the scope of application of the requirements described above to all large companies and to all the organisations listed on regulated markets (except micro-enterprises). Furthermore, it would require reported information to be audited, the introduction of more detailed reporting requirements and the provision requiring reporting based on mandatory EU sustainability reporting standards. Companies will also be required to digitally ‘tag’ the reported information, so it is machine readable and feeds into the EU single access point envisaged in the capital markets action plan.

Keeping pace with the times, organisations should be ready to prepare well-reasoned bonus plans based on ESG KPIs, not only to improve their attractiveness to investors and talent, but also to achieve concrete results for their employees and for the whole community in which they operate.