Effective credible environmental, social and governance (ESG) strategies implemented by financial services firms could potentially be linked to remuneration, the Financial Conduct Authority (FCA) has highlighted.
It also expects firms to account for emmissions from supply chains and other linked organisations, and espoused the benefits of aligning individual purposes and company goals, which can be “powerful in addressing change through an engaged and motivated workforce”.
The FCA’s latest discussion paper DP23/1 Finance for positive sustainable change details how remuneration can be linked to effective ESG strategies, what these strategies should look like and why the board is ultimately responsible for these strategies.
The regulator emphasised that where a firm has made public sustainability-related commitments, it is reasonable to expect it will develop and articulate a credible strategy to deliver on those commitments.
It added: “A credible strategy would typically include a suitable timeframe and milestones, detail the interaction with other parts of the business plan, identify roles, responsibilities and accountability, and link with incentive structures – potentially including remuneration”.
Elaborating on the point, the regulator said that “remuneration policies can be effective when they are aligned to a firm’s business strategy, purpose and values, promote effective risk management and support positive behaviours and healthy firm cultures”.
Reward outcomes could support delivery
The FCA pointed out that it requires remuneration policies to promote effective risk management, helping to identify and manage risks and support a strong risk culture in the firm.
It added: “Where a firm has made climate or sustainability related commitments, linking reward outcomes to these could – if appropriately designed – play a role in supporting delivery”.
But as progress towards net zero emissions is a long-term undertaking, the regulator said credible sustainability-related objectives will be translated to short and medium-term targets and milestones.
“This will be especially important where targets play a role in remuneration and incentives plans. And when long-term commitments extend beyond the tenure of incumbent executives,” it added.
The regulator suggested firms may consider “linking executive pay to a firm’s sustainability-related commitments to incentivise behaviours and decision-making that aligns with these commitments”.
However it added they may also wish to think about how the whole organisation is mobilised towards delivery, so firms may consider “performance measures linked to sustainability-related factors for their wider workforce or for cohorts of staff”.
But the regulator clarified that where sustainability-related metrics are incorporated into rewards for wider cohorts of staff, these would need to be within those employees’ “influence and control”.
In terms of incentivising the workforce to achieve corporate goals, the regulator revealed there were many ways do this, such as offering participation in share ownership schemes, or non-financial incentives ranging from “a simple ‘thank you’ to recognition of examples of good behaviour for others to follow”.
Business strategies
Providing guidance on what ESG strategies should look like, the regulator suggested that articulating sustainability-related objectives clearly and embedding them in business and financial planning, governance and organisational structures, can reinforce a firm’s message that these are fundamental and material to its business.
It added that a well-designed action plan with robust metrics and targets can provide internal focus and discipline, while also helping stakeholders track progress.
The FCA pointed out that a robust process will “build in regular reviews of targets and measures to ensure they remain consistent with meeting stated objectives and the delivery of the action plan”.
Transition plans should be used to “demonstrate milestones and track short-term actions to achieve long-term net zero aims”.
And the regulator wants to see firms put greater emphasis up and down their supply chains.
It is increasingly expected that firms include Scope 3 emissions – the result of activities from assets not owned or controlled by the reporting organisation – in their targets.
These are on average more than 700 times higher than direct emissions which relates to Scope 1 (indirect greenhouse gas emissions associated with the purchase of electricity, steam, heat, or cooling) and Scope 2 ( indirect greenhouse gas released from business operations).
Healthy cultures
Turning to culture, the regulator said it regarded a healthy culture as one that, “among other things, is purposeful, that has sound controls and good governance, where employees feel psychologically safe to speak up and be listened to, and where remuneration does not encourage irresponsible behaviour that can ultimately damage the business and wider markets”.
The regulator added that when assessing culture, it is focused on four key drivers: “purpose; leadership; governance; and a firm’s approach to rewarding and managing people”.
In terms of embedding purpose and enabling employee understanding and buy-in, the regulator said firms need to “articulate it clearly and make it visible in their actions”.
And however a firm describes its purpose, the regulator added it would expect “evidence of its commitment to achieving its stated purpose, including consistency in its messaging and its actions, and evidence of how its purpose is embedded throughout the firm”.
Touching on individual purpose, the regulator determined this as “where an employee has a meaningful connection and sense of fulfilment to their work”.
When this individual purpose is aligned with company goals, it added that this can be “powerful in addressing change through an engaged and motivated workforce”.
The FCA also pointed out that its upcoming Consumer Duty will “focus firms’ minds on their culture and will require them to think about how their culture and behaviours support positive outcomes for consumers, including the most vulnerable”.
Governance, responsibility and accountability
In terms of who should be held accountable, the FCA noted that firms should be “clear which roles at the firm are responsible for driving change and ensuring that the entire organisation is aligned to the firm’s priorities and commitments”.
This includes on environmental and social matters, such as climate transition, biodiversity, human rights, health and safety, diversity and inclusivity (D&I) and fair pay. The regulator added that “clear buy-in” will be “essential” to achieve this.
But the paper made clear that ultimately the board is responsible for the firm’s business strategy, with its role being to “provide oversight and open, constructive and robust challenge in respect of the delivery of the strategy”.
The regulator added that for the board to “function effectively and be equipped for long term success”, members needed to have the right skills, knowledge and expertise.
These should tie-in with the Prudential Regulatory Authority’s expectations for an effective board which “needs to include individuals with a mix of skills and experience that are up to date and cover the major business areas in order to make informed decisions and provide effective oversight of the risks”.
The FCA said this “may include having members of the board with a background or expertise in sustainability-related matters, or facilitating access to that expertise either internally or externally to support decision making on these issues”.
Governance of products and services
On the governance of products and services, the regulator was clear that it expects all firms making sustainability-related claims about their products or services to “maintain appropriate governance arrangements to deliver the product in line with these” and to have “appropriate arrangements in place to ensure those claims reflect the sustainability profile of the product”.
Firms may also have specific governing bodies in place in relation to their products and the FCA expects those governing bodies to have appropriate oversight of and accountability for the delivery of the product.
The regulator also acknowledged that while its product governance requirements apply to all products, there is “currently no explicit reference to sustainability in relation to product governance in the FCA Handbook”.
But it added that it emphasises “the importance of ensuring appropriate governance around sustainable investment products in our consultation on a disclosure and labelling regime for those products”.
Training
In terms of staff training, the FCA said it knew some firms were considering how to expand their sustainability-related capabilities, and many were already providing relevant staff training.
It added that professional qualification and training providers had been responding to this demand and it had seen an increase in ESG and sustainability-related qualifications and training.