‘Link variable executive remuneration to sustainability goals’

Corporate Sustainability Due Diligence Directive

On 23 February 2022, the European Commission issued its proposal for a Directive on Corporate Sustainability Due Diligence (CSDD) to tackle adverse impacts on human rights and the environment across global value chains. Part of this proposal is the introduction of a link between variable remuneration of directors and the sustainability targets of the company. This requirement could have implications for companies' remuneration strategies, according to PwC expert Yvette van Gemerden.

Complementary to the Corporate Sustainability Reporting Directive

The proposed CSDD directive complements various EU initiatives such as the ‘Fit for 55’ Package and the European Green Deal. More specifically, the proposed directive is complementary to the adopted Corporate Sustainability Reporting Directive (CSRD), states Van Gemerden. ‘This directive aims to create a set of rules that will - over time - bring sustainability reporting on par with financial reporting.’

Under the CSRD, a company should implement processes to properly collect information for reporting purposes. This obligation is closely related to the due diligence duties to identify adverse impacts, as introduced by the proposed CSDD Directive. Furthermore, companies that fall under the scope of both directives should report (on the basis of the CSRD) on their due diligence duties (as obliged by the CSDD). The proposed CSDD Directive will thus lead to more complete and effective reporting under the CSRD.

Directive affects three groups of companies

The European Commission estimates that the scope of the proposed directive will cover approximately 13.000 EU companies and 4.000 third-country companies. These companies can be divided into the following three groups:

Group 1

Companies that are based in the EU with more than 500 employees on average and a net worldwide turnover of more than EUR 150 million in the last financial year for which annual financial statements have been prepared;

Group 2

Companies that are based in the EU with more than 250 employees on average and a net worldwide turnover of more than EUR 40 million, of which at least 50% was generated in one of the following ‘high risk’ sectors:

• Textiles, leather, clothing, footwear and related products;
• Agriculture, forestry, fisheries, food products;
• Mineral resources, metal products, chemicals;

Group 3

Companies established outside the EU which generated a net turnover of more than EUR 150 million in the Union, or, which generated a net turnover of more than EUR 40 million, of which 50% was generated in one of the ‘high risk’ sectors.

Micro companies and Small and Medium Enterprises (SMEs) are not directly affected by the proposed directive. These companies could, however, be indirectly affected if they are part of the value chain of companies that fall within the scope of the directive.

Variable executive remuneration

Article 15 of the proposed directive imposes the obligation for companies falling within the scope of the directive, to adopt a plan to ensure that their business models and strategies are compatible with the transition to a sustainable economy and the limitation of global warming to 1.5 °C. 

‘If climate change is identified as a principal risk for a company, the company’s strategic plan should include emission reduction objectives’, states Frank van Oirschot, remuneration expert at PwC. Currently these type of ESG-goals are often not included in the company’s strategy. ‘The proposed directive links this aspect of the company’s business model and strategy to its variable executive remuneration strategy. If variable remuneration is linked to a director’s contribution to the company’s business strategy and long-term interests, companies need to take into account whether the objectives stemming from the above-mentioned plan have been fulfilled. 

Although it is not mentioned explicitly, the proposed directive seems to suggest that a company’s variable remuneration strategy should be linked to its sustainability goals in certain situations. The introduction of this article can be an encouragement  to include goals related to environmental targets, as well as goals related to social and governance targets, as part of the executive remuneration policy.

From European approval to national implementation

The proposal is subject to the approval of the European Parliament and the Council.. Once adopted, Member States will have two years to transpose the Directive into national law. ‘You can expect further updates from us, once the European Parliament and the Council provide their approval on the proposal and of the implementation of the directive into national law.’

‘Although transposing the directive into national law will take some time, we recommend that you already align your organisation's values, purpose and strategic objectives with the expected applicable legal provisions’, concludes Van Oirschot. ‘It is important that your remuneration policy is transparent, future-proof and socially acceptable under the implementation of the 'Shareholder's Rights Directives'. Therefore this is the right moment to start thinking about how you can link variable remuneration to sustainability objectives. The need for this change is clear from not only a legal point of view, but also from the perspective of society.’