Embedded in the final version of the Basel Committee’s principles on managing climate risks is a recommendation for banks to rethink pay and bonus structures, aligning them with long-term goals on tackling climate change. 

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Following a six-month consultation, the Basel Committee on Banking Supervision (BCBS) released the final version of its ‘Principles for the effective management and supervision of climate-related financial risks’ on June 15. It contains 18 principles covering corporate governance, internal controls, risk management, monitoring and reporting, and capital and liquidity adequacy, with the first 12 aimed at banks and the remaining at banking supervisors.

While much of the final paper is analogous to the consultative document released last November, one notable addition is a recommendation to review compensation policies to take into account that these should be “in line with the business and risk strategy, objectives, values and long-term interests of the bank”.

While the UK and EU regulation and guidance already contains provisions that firms should consider including performance metrics around sustainability risk, including climate risk, and the EU requires firms to disclose how they incorporate sustainability risk into pay, Alexandra Beidas, global head of employment and incentives at Linklaters, says that the key point about this development is that it may lead to more global consistency in this area, including in the US, and may encourage UK and EU firms to go further.

“Currently many UK and EU banks consider sustainability risk, including climate risk, when setting and adjusting overall bonus pools. And some firms go further and tie a portion of bonuses/other incentive pay to the achievement of environmental, social and governance performance metrics, such as specific climate change targets,” she explains. “But those approaches are generally focused on estimating potential risk impact or assessing performance on environmental targets within a particular year.”

Ms Beidas believes the BCBS principles could lead to more firms deciding to adjust pay or clawback pay if climate-related financial risks transpire and possibly extending deferral periods to ensure they are long enough to capture the long-term horizons of climate-related risk. But could that work?

In Europe, deferral periods are typically applied to 40-60% of bonuses and other incentive pay over three, four, five or seven years, with firms able to reduce deferred amounts and clawback paid amounts if certain things happen, according to Ms Beidas. However, at the moment, very few firms include specific adjustment/clawback provisions in relation to climate-related issues. And deferral rules don’t apply in the US, so bonus deferral periods are typically much shorter unless the firms voluntarily impose them.

But there are other options are available to banks looking to install this metric. “Another approach that could be taken by firms is to require long-term shareholding, including post-employment, of a certain percentage of salary,” she says, adding that’s currently expected for the executive directors of UK-listed companies. “That means that management are incentivised to take a very long-term view and ensure they are mitigating current and future risks that could transpire, including those that relate to climate change.”

While the BCBS, the primary global standard setter for the prudential regulation of banks, covering central banks and bank supervisors from 28 jurisdictions, including the US, is trying to encourage banks to think longer term, it is asking for prompt action. It said that it expects implementation of the principles “as soon as possible” and will monitor progress across member jurisdictions to “promote a common understanding of supervisory expectations and support the development and harmonisation of strong practices across jurisdictions”.

Joy Macknight is editor of The Banker. Follow her on Twitter @joymacknight

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