This article will help you in amending your remuneration policy to make sure it complies with the SFDR requirements on incorporating sustainability risk into the firm's remuneration.
To find a description of each of the different approaches you can use, please consult this article on Incorporating Sustainability Risk into the Remuneration Policy.
Please note that you will likely need to select a few different tools for incorporation to ensure a comprehensive consideration of sustainability in your remuneration policy.
The following Guidelines for practical implementation of each of the approaches for sustainability incorporation into remuneration include:
1. Offer sustainability-related professional development opportunities
Offer comprehensive training and education on sustainability risks and opportunities to employees, in the form of:
Workshops
Seminars
Online courses
Trainings
Attendance to sustainability-related events
Mentoring programs.
Communicate the opportunities with your employees and support them in participating in the latter. Effective communication can consist of:
Sending regular emails with a revised list of opportunities
Creating a newsletter
Hosting promotion webinars.
Provide ongoing funding in support to ensure your employees have easy access to these opportunities. Support can be necessary in the form of:
Paying for registration fees
Covering travel expenses
Guaranteeing time off work to attend the trainings.
Measure the impact of the opportunities on employees' knowledge and competence of sustainability. Assessments can be performed using varying tools of assessments, surveys and other evaluation instruments.
2. Integrate sustainability into individual performance goals
2.1 Setting sustainability targets:
Set specific, measurable, achievable, relevant, and time-bound (SMART) sustainability targets which align with the firm's sustainability strategy and objectives.
This guide helps you navigate through the SMART framework.
Ensure that the sustainability targets are ambitious enough to motivate employees and create sustainable value yet achievable enough to avoid lack of motivation.
Align employees' job functions with the targets to ensure that they have a direct impact on the investment decisions made.
2.2 Including sustainability metrics in KPIs:
Choose relevant and measurable sustainability metrics which align with the firm’s sustainability strategy and objectives. Make use of the framework your firm generally employs to identify.
Assign appropriate weights to sustainability metrics to ensure that they have the same influence as financial metrics in determining remuneration.
Set benchmark targets for sustainability metrics to help employees understand what the definition of 'success' is for each target.
3. Create a sustainability-focused bonus pool
Allocate a portion of the bonus pool specifically to remunerate sustainability-related performance.
Define which sustainability objectives the bonus pool will be tied to, ideally using the SMART or other similar frameworks. The objectives should also align with the fund's and the portfolio companies' overall sustainability strategy, and to their performance.
Develop transparent and objective criteria for determining the distribution of the sustainability-focused bonus pool. The criteria should be linked to the sustainability objectives and should be measurable and clearly communicated to all stakeholders, including investors and fund managers.
Tie the sustainability-focused bonus pool to employees' individual and team performance goals. You should also ensure that you inform employees of their performance and how it is contributing to the bonus pool periodically.
4. Use ESG ratings to determine compensation
Set clear minimum targets and thresholds for ESG ratings required to be met for employees to obtain their remuneration in full. The targets should be achievable but ambitions, and should align with the firm's overall strategy.
Balance the weighting of ESG ratings in remuneration against other performance objectives to ensure a fair and balanced approach. The weighting of ESG ratings should be based on:
The materiality of sustainability risks to the fund's investments
The level of influence that the employee has over those risks.
Employees need to periodically monitor and report on the fund's ESG ratings to ensure the fund remains aligned with its sustainability goals and the employee is accountable for accomplishing the ESG ratings.
Choose a credible and reliable ESG rating agency which resorts to a transparent and consistent methodology to calculate ESG ratings.
5. Tie carry to specific ESG criteria
The firm should select ESG criteria to tie to the carried interest which are:
Relevant to the fund's investment strategy
Material to the fund's sustainability goals
Aligned with the fund's values and mission.
This may include criteria such as carbon footprint reduction, diversity and inclusion, labor standards, and governance practices.
The weighting of ESG criteria in the carried interest should reflect:
The materiality of sustainability risks to the fund's investments
The level of influence that the fund manager has over those risks.
The carried interest should be designed to incentivise the fund manager to prioritise sustainable investment practices without compromising the fund's overall financial performance.
Employees should be given clear targets and thresholds for ESG criteria, which they must achieve to receive a portion of the carried interest. These targets should be challenging but achievable, and must reflect the fund's overall sustainability goals.
Employees need to periodically monitor and report on the fund's progress towards achieving the ESG criteria to foster accountability and alignment with the overall sustainability goals.
The firm should communicate with investors to ensure the ESG criteria used to determine carried interest aligns with their sustainability goals and values.
6: Implement clawback provisions
The firm needs to establish clear criteria for clawbacks, including:
The circumstances under which clawbacks may be triggered
The types of remuneration that are subject to clawback
The proportion of remuneration that can be clawed back.
Clawback provisions should be tied to specific sustainability risks. The latter should be:
Identified as material to the fund's investments
Aligned with the fund's overall sustainability goals.
This may include risks related to environmental, social, and governance (ESG) factors, such as climate change, labor standards, and board diversity.
Clawback provisions should be proportionate to the severity of the sustainability risk and the level of responsibility of the employee.
E.g., a fund manager may be subject to a higher proportion of clawback for a serious ESG breach than for a minor breach.
Establish an independent committee to review and approve clawback decisions. Ideally, the committee should be comprised of:
Individuals who are independent of the fund manager
Individuals who have the expertise to assess the materiality and severity of the sustainability risk.
The firm should communicate the clawback provisions with investors and ensure that the latter are aware of the fund's approach to managing sustainability risks.
Hopefully these guidelines can help you select the most relevant tools within your specific context, and can help you in effectively amending your remuneration policy to align with the requirements set by the SFDR.