Sustainability in Remuneration Systems? Is that possible? And if so, how?

Everyone wants it. Everyone claims it. But in practice, are sustainability criteria actually met?

Have insurance companies and investment houses really made progress or have sustainability targets remained with the beehives on the roof - i.e. greenwashing - in the practice of fund providers?

What has become of the seal of the Forum Nachhaltige Geldanlagen (FNG) trade association? Is the FNG seal comparable to the "organic" seal: nice and colorful, but empty of content?

The news alone that the FNG seal wants to "reposition itself in 2024" sounds like this has not been a great success story. What is it all about?

Sustainability is about minimum standards in the consideration of labor and human rights, environmental protection, and the fight against corruption.

If the fathers of the FNG seal have their way, applicants will have to also demonstrate the extent to which remuneration systems - i.e. salaries and variable bonuses - are linked to the specific sustainability performance of their companies.

It's all about credibility and neither the beehives on the roof of the company headquarters, the number of digital training options for endless ESG webinars, the increased volume of donations, nor the use of the job bike (which has not really caught on in the world of asset managers) will help here. Joking aside, the ESG compliance jungle has become more confusing for everyone involved.

The following laws and regulations contain far-reaching obligations for many stakeholders in the financial world (and beyond), with an ever-growing list of ESG compliance demands and reporting obligations:

  • Corporate Sustainability Reporting Directive/CSRD (EU Directive 2022/2464, the so-called EU Disclosure Regulation) contains sustainability reporting obligations for SMEs since the beginning of January 2023;
  • ARUG Il / Act on the Implementation of the Second Shareholders' Rights Directive in conjunction with Section 87a (1) AktG contains regulations on remuneration systems of listed companies since July 2019;
  • Corporate Sustainability Due Diligence Directive / CSDDD (also referred to as the EU Supply Chain Act) in its last draft from December 14, 2023, contained reporting obligations with a two-year implementation period for Berlin from 2024, but failed to achieve final approval by the European Council on February 28, 2024, following last minute objections from Germany, Italy and France;
  • Carbon Border Adjustment Mechanism / CBAM contains reporting obligations since January 31, 2024;
  • German Supply Chain Due Diligence Act / LkSG regulates the responsibility of German companies to respect human rights in global supply chains as on January 1, 2023 (the failed EU Supply Chain Act (CSDDD) would have broadened the catalog of risks and affected far more enterprises than does the German LkSG);
  • Battery Ordinance / BATT2, applicable since February 18, 2024;
  • EU Deforestation Regulation will be applicable as of December 30, 2024;
  • European Green Deal of the EU Commission, a non-binding abstract package of measures targets climate-neutrality by 2050.

Additional compliance and increasing bureaucracy demands relating to the Whistleblower Protection Act, the Evidence Act, and the Fourth Bureaucracy Relief Act must be closely observed in the future not to mention the new wave of red tape to be feared if the proposals in the bill to amend the Working Hours Act/ArbZG are implemented.

The heated debate over the EU Supply Chain Act at EU Council level seemed to ignore the multitude of administrative burdens already placed on enterprises to follow the above-mentioned regulations. But let's approach these highly politicized concerns from a more constructive point of view:

How can SMEs effectively implement the Corporate Sustainability Reporting Directive (CSRD) to comply with their social responsibilities under ESG criteria?

These seven (7) steps may serve as a checklist worth following:

  • define a clear CSR strategy along the lines of your own values and goals,
  • train and coach your management team and your workforce respectively,
  • provide financial means for CSR projects,
  • allow and support open communication lines for CSR projects,
  • engage external experts and trusted advisors,
  • keep an eye on progress and monitor your CSR strategies,
  • be open for continuously adjusting and improving your CSR strategies.

Compliance Officers be aware! Take action now, Sustainability and Human Resources, in Labor Law Magazine, Issue 2, June 2022.

Can remuneration systems provide incentives to implement the above ESG regulations?

And if so, how?

First, in Germany and from an employment law perspective, it is important to point out that remuneration systems that provide for target bonuses need to be carefully considered. Companies that do not proceed cautiously here can quickly be exposed to undesirable consequences.

As soon as the amount of variable remuneration components is determined for employees who achieve targets, companies must also clearly describe these targets and the mechanisms for and extent to which employees are meant to achieve these targets.

US companies are often under the misconception that variable remuneration components and bonuses can be changed arbitrarily and unilaterally at any time, or that target parameters can be adjusted retrospectively in such a way as to "prevent" the targets from being achieved – and hope to thus avoid having to pay out bonuses.

So how do you do it properly in Germany?

Companies must:

  • set target agreements in good time, i.e. regularly, at the beginning of each calendar year,
  • define and agree on targets that can be achieved based on realistic forecasts,
  • describe the company's overall visions, goals and objectives to the workforce.

If these are not provided, employees may be entitled to claim damages in the form of an enforceable 100% target remuneration.

Summary & Recommendation

The following can serve as a checklist of seven (7) steps worth following:

  • define ESG incentive parameters;
  • develop ESG criteria;
  • keep an eye on the long term;
  • establish benchmarks and weighting;
  • set ESG targets and integrate them into the remuneration structure;
  • measure key performance indicators against the real commitment of managers;
  • provide for capping and cap mechanisms.

If a mutual agreement with the employees is not reached in good time, with a documented and verifiable arrangement, the company must leave enough time and leeway to set up the proposed variable remuneration system in a fundamentally different way via, for example, a model of unilateral right of determination on the part of the employer.

If mutually agreed target agreements fail, the legal risks lie with the employer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.