Strengthening corporate governance rules for sound risk management practices

Introduction

Remuneration policies constitute an important tool to align corporate governance with the long-term interest of companies. They directly shape behaviour at decision-making level and influence the time horizons that guide strategic choices and risk management measures. Yet, despite successive updates of the prudential framework, remuneration requirements in the EU banking sector remain inadequately designed to effectively foster considerations for long term performance. In September 2024, the European Banking Authority (EBA) confirmed in its work programme, its intention to adapt its rulebook in 2025 to better integrate environmental, social and governance (ESG) concerns in remuneration practices. The EBA’s work programme comprised the review of the EBA guidelines on internal governance and on sound remuneration policies to reflect ESG risks. 

As of November 2025, the EBA has only published draft revised guidelines on internal governance which provide targeted adaptations to remuneration rules, in particular regarding gender neutral remuneration policies, third country branches remuneration, and the expertise of the remuneration committee regarding ESG factors. However, these say little on how banks should integrate ESG risks in remuneration policies. The flexibility in the implementation of remuneration policies, including on sustainability matters, does not guarantee that pay structures support the long-term sustainability of banks’ business models, or the achievement of mandatory and voluntary sustainability objectives. 

Without binding requirements on the measures to incorporate ESG risks and transition targets into the remuneration process, resources may remain insufficient for transition planning, commitments may lack credibility, and systemic misalignment with global sustainability objectives could persist. This paper analyses the existing remuneration requirements applying to credit institutions. It highlights their structural limits in the current remuneration processes and concludes with concrete policy recommendations for revising both the guidelines on internal governance and sound remuneration.

I. The existing legislative provisions on remuneration

Successive remuneration provisions have been included in the banking prudential rulebook, including specific requirements for the consideration of ESG risks. 

A. The Capital Requirements Directive (CRD)

Directive 2013/36/EU (CRD IV) introduced governance requirements to ensure that remuneration practices contribute to sound and prudent risk management within credit institutions. Under Articles 76 and 95, the directive details the responsibilities of the risk committee and the remuneration committee to exercise independent and informed judgment on remuneration policies and practices, including their implications for risk, capital, and liquidity. Among others, the remuneration committee makes decisions on pay that have risk implications for the institution, while the risk committee assesses whether remuneration incentives appropriately reflect risk, capital, and liquidity considerations. 

Article 92 of the CRD IV also sets out minimum requirements for the establishment and application of remuneration policies, particularly for employees whose professional activities have a material impact on the institution’s risk profile (so-called identified staff). Institutions must ensure that remuneration policies promote effective risk management, are consistent with the business strategy, values, and long-term interests of the institution, and prevent conflicts of interest. 

Articles 92 and 94 provide quantitative requirements on the structure of remuneration to promote sustainable performance and prudent risk-taking. They provide a maximum variable/fixed remuneration ratio and establish a balance between remuneration in cash and in financial instruments. The articles also introduce a deferral of the variable remuneration payment over several years to ensure that rewards reflect the institution’s longer-term results and risk profile. Article 94 also specifies that guaranteed variable remuneration is generally prohibited, as it undermines the pay-for-performance principle. 

With the publication of Directive 2019/878/EU (CRD V), legislators integrated targeted changes to the remuneration provisions, in particular to the percentage of the variable remuneration to be deferred (up to 60% for particularly high amounts), and to the period of remuneration deferral (minimum of 4 to 5 years, but a minimum of 5 years for the management body and senior management). 

Finally, the recently published Directive 2024/1619 (CRD VI) formalises the link between remuneration and the management of ESG risks. It requires credit institutions to implement remuneration policies and practices that promote sound and effective risk management, notably by reflecting the institutions’ risk appetite in terms of ESG risks. 

B. The EBA guidelines on sound remuneration 

The CRD IV mandated the EBA to develop guidelines on remuneration policies for both all staff and identified staff. The guidelines specify in more detail the requirements within Directive 2013/36/EU on remuneration policies, the respective governance arrangements, and processes that should be applied when remuneration policies are implemented. After the finalisation of CRD V, the 2021 version of the guidelines (last update) integrated targeted sustainability provisions. The provisions state that the remuneration policy for all staff should be consistent with the objectives of the institution’s business and risk strategy, including environmental, social and governance (ESG) risk-related objectives, corporate culture and the values of the institution. 

C. The EBA guidelines on internal governance 

The EBA has also published guidelines setting standards and principles for defining an institution’s objectives, strategies and risk management framework, including further details on the responsibilities, reporting lines and internal control framework for remuneration policies. The guidelines are presently under review, with the public consultation having closed on 7 November 2025.

D. The EBA guidelines on remuneration reporting 

Finally, the EBA has developed guidelines to improve the consistency of the information collected in its reporting exercise on remuneration benchmarking and high-earners, enabling it to monitor trends in remuneration practices. 

II. Understanding the remuneration process and its weaknesses

The requirements mentioned above constitute a strong framework to better align decision-makers’ interests with the long-term interests of credit institutions. However, the provisions on remuneration structure (deferred payment, ratio between fixed and variable remuneration and remuneration in financial instruments) are weakened by the flexibility left for the design of the performance score grid and the link between performance measurement and the attribution of variable remuneration.

Moreover, the current remuneration structure for identified staff remains short-term in nature, with a horizon not exceeding 5 years. This timeframe is insufficient to reflect long-term sustainability challenges, many of which might materially impact on the institution beyond ten years. While Finance Watch recognises the difficulty of envisaging a remuneration deferral and its holding in financial instruments for 10 years or more, this limit justifies including provisions on performance assessment to capture progress on long-term transition plans and sustainability measures.

Variable remuneration is the component of the total remuneration package that has the potential to align decision-making with the long term interests of credit institutions. As a result, this position paper focuses on the process for attributing and paying the variable remuneration, in particular for identified staff. 

Finance Watch considers that a typical variable remuneration process for identified staff follows five main stages, as presented in figure 1 of the annex:

1. First, a weighted list of indicators, based on which identified staff will be assessed, is defined at the beginning of the financial year. The score grid will usually be approved by the credit institutions’ remuneration committee to ensure that it promotes sound and effective risk management. 
2. At the end of the year, depending on the institution’s performance, the remuneration committee will approve the total variable remuneration envelope and its allocation. 
3. In parallel, the performance of identified staff will be assessed based on the score grid.  
4. Considering the total remuneration envelope and the individual performance, the credit institution will determine the individual remuneration envelope that the employee is entitled to receive.
5. Finally, as from a certain amount of remuneration and to promote longer term decision-making, the variable remuneration should be partly deferred and partly paid in instruments subject to retention periods.

Taking into account this process, Finance Watch highlights four key weaknesses.

A. The limits of a 100% weighted score grid

Most banks define key performance indicators (KPIs) that collectively determine the individual bonus envelope. ESG or transition-related indicators are often included, yet they are rarely material. In most cases, the aggregated weight of environmental and social factors remains relatively low. Integrating new indicators in relation to climate and other sustainability matters would reduce the weight of other metrics. 

In fact, an assignment of weights – for a total of 100% – implies that directors may perform poorly on one indicator but still receive a large portion of their potential envelope (80% in the illustrative weighting of Figure 1). To prevent such a situation, credit institutions should introduce a corrective factor that may affect the part of remuneration related to other criteria. To do so, several options can be considered:

1. Defining the remuneration weights so that poor performance on one metric affects the remuneration attributed to other metrics. In the example of Figure 1, it could be decided that each indicator could trigger a 30% decrease of the variable remuneration in case of a performance below a defined threshold. In theory, this could culminate in a 150% decrease of the individual remuneration envelope. This means that the total remuneration would more rapidly decrease in case of mediocre performance on certain metrics. 
2. Considering the sustainability criteria as separate indicators that would apply as a separate factor after calculation of the individual remuneration. Based on Figure 1, this factor could consist of a percentage of the eligible individual remuneration determined after the individual performance assessment. For example, a director could only receive 80% of the individual remuneration if their department does not meet its climate targets, whether those targets are based on expected effort or expected results. 

B. The broad definition of ESG factors

The performance indicators for the allocation of variable remuneration remain disconnected from prudential transition planning. Under the CRD, institutions must develop plans to manage financial risks arising from ESG factors, but the current EBA guidelines do not ensure that executive pay will be linked to the achievement of transition plan commitments. 

While Finance Watch acknowledges that not all financial institutions are required to align their business model with the objectives of the Paris Agreement, it highlights that a misalignment with global sustainability objectives is a risk driver, as recognised by the EBA in its guidelines on the management of ESG risks. Yet, there is no guarantee that transition plans, and a misalignment of transition actions with the risk appetite of the credit institutions, will be considered for the development of the score grid.

The definition of ESG risk factors covers a large range of topics, including governance. Without clear criteria, e.g. on targets for meeting greenhouse gas emissions reduction targets, credit institutions may simply consider that indicators related to risk management and internal audit are already part of the sustainability matters. 

C. The impact of not achieving targets

Beyond the selection of adequate criteria, the impact of not meeting the targets must be sufficient to incentivise long-term decision-making. Thus an adequate weighting of sustainability criteria needs to be complemented with robust provisions on the actual performance assessment. In Figure 1, one could say that a department has performed poorly if half of the audit points are overdue. Yet, the decision could also be taken that half of the objectives have been met and that the director is entitled to receive half of the variable remuneration attributed to this indicator, which may seem unjustified for a poor performance. 

The manner in which the performance is assessed therefore has a major impact on the variable remuneration that staff members are entitled to receive, which ultimately affects the incentives for employees to act in the long-term interest of the company.

D. Ineffective malus and clawback mechanisms

Existing rules provide only generic guidance on ex-post risk adjustment. Institutions retain discretion to determine when malus or clawback applies. In practice, deferred pay is almost never reduced due to sustainability under-performance. This undermines the purpose of deferral and removes any credible threat of sanction for long-term failures.

III. Conclusion

Finance Watch recognises that the remuneration framework applicable to credit institutions, in particular regarding the structure of remuneration, is already more robust than most other sectors. This is rightly justified by the potential impact that excessive short-termism in banking decisions can have on the wider economy. However, the flexibility provided by the current EBA guidelines, combined with the focus on a remuneration horizon of no more than five years, undermines the assurance that variable remuneration truly aligns directors’ incentives with the long-term interests of their institutions.

The draft revised guidelines on internal governance represent a step forward in modernising corporate governance practices, notably through the integration of ESG considerations and improved cross-border supervisory coordination. Provisions on gender-neutral remuneration, the ESG expertise expected of remuneration committees, and the treatment of third-country branches are welcome additions. Nevertheless, these adjustments do not address the structural weaknesses identified in the current remuneration framework.

To meaningfully integrate ESG risks into remuneration practices, and to prevent variable pay from becoming de facto guaranteed, Finance Watch recommends a comprehensive revision of the EBA guidelines on sound remuneration policies. Strengthening these provisions would help ensure that pay structures genuinely promote sustainable performance, prudent risk-taking, and the long-term resilience of the European banking sector.

Annex

Figure 1: Illustrative remuneration process for identified staff

Vincent Vandeloise, Senior Research & Advocacy Officer at Finance Watch

[email protected]

+32 2 880 04 37