EUROPEAN bankers will soon have to show that they are contributing to a cleaner environment, a better society and good governance – or face a smaller pay package.

In the latest sign that ESG (environmental, social and governance) is reshaping finance, most of the 20 major European banks surveyed by Bloomberg said they were either working on, or already had, a model that links staff remuneration to a firm’s performance on sustainability metrics. European regulators have explicitly added ESG risks to pay guidelines, with the change due to take effect by the end of this year.

Nicole Fischer, who advises German financial institutions on pay at Willis Towers Watson, said the industry is now “in a transformation phase where ESG is being anchored firmly in remuneration”.

The development opens another avenue through which policy makers in Europe are trying to redefine capitalism. The ultimate goal, ideally, is to make it financially attractive to be good. But measuring sustainability is far from straightforward, which the finance industry itself has acknowledged. That means bankers’ pay will in future partly rely on a variable that is harder to quantify than profit, which might make it easier to game.

Despite the absence of common detailed standards, some of the world’s biggest banks say they are already working ESG goals into their remuneration policies.

At HSBC Holdings, executive directors need to cut the bank’s carbon emissions and help clients do the same, failing which a quarter of the grade that determines their variable pay packages through 2023 will be impacted. Last year, when environmental issues made up a smaller share, chief executive officer Noel Quinn and chief financial officer Ewen Stevenson both scored 85 per cent on that particular metric.

UniCredit said 10 percent of its pay scorecard for top and senior management depends on the bank’s ESG ratings and on how satisfied customers and employees are. This year, the Italian bank extended sustainability metrics to include so-called material risk-takers, such as investment bankers. UniCredit’s ability to reduce its impact on the environment and develop more ESG products and services will feed into the bonus pool.

For staff at some banks, not having their pay hinge only on profits has its benefits. Last year, at La Banque Postale, where bonuses for the wider organization are tied to both sustainability and earnings, “the other business objectives weren’t met because of the Covid crisis”, said Adrienne Horel-Pages, the French bank’s chief sustainability officer. She said “the only reason” the workforce got a bonus came from the bank’s ability to remain in the top quartile of ESG rankings given by rating companies.

Another of the Bloomberg poll’s findings was that most banks are not going on hiring sprees to add ESG expertise. Instead, most responded that they expect to rearrange and retrain existing teams to dedicate more people to sustainability.

At La Banque Postale, for example, Ms. Horel-Pages said she is only bringing in one or two people from outside the bank under a plan to add eight people to her team. The rest will join from other departments.

Inevitably, banks will face some skepticism as to how well their ESG metrics actually promote good governance, social justice, and a greener planet. Meanwhile, scientists have warned that time is running out to save the world from a climate disaster, leaving no room for error in the corporate and political response. At the same time, the financial industry itself said measuring ESG performance is fraught with uncertainty.

At a Financial Stability Board workshop in May, participants from banking, insurance, and asset management said they take “ESG, reputational and diversity-related factors” into account when assessing performance and setting pay. But they also said such sustainability criteria are not easily quantified. The workshop participants also acknowledged that while ESG criteria are likely to play a bigger role in the future, implementing a longer-term outlook is “challenging” because some competitors may play by different rules and follow shorter-term incentive structures.

Regulators are aware of the challenges. A 2019 review by the European Banking Authority (EBA) found that while banks in the region supported corporate clients through green loans and bonds, their own planning time horizons, linked partly to remuneration, curtailed their ability to tackle climate risks.

The EBA’s updated remuneration guidelines, which kick in at the end of this year, make clear that firms will be expected to build ESG into staff pay. But even here, there is room for interpretation, as the language indicates.

“The institution’s remuneration policy for all staff should be consistent with the objectives of the institution’s business and risk strategy, including environmental, social and governance risk-related objectives, corporate culture and values, risk culture, including with regard to long-term interests of the institution, and the measures used to avoid conflicts of interest, and should not encourage excessive risk-taking,” the EBA said in its final draft report on the guidelines, published July 2.

European Union transparency rules, which took effect in March require banks to publish information on how they factor ESG risks into remuneration. Such information is usually disclosed in annual reports, meaning many banks will probably wait until early next year to provide it.

But some members of the finance industry say, though, the incentive to incorporate ESG metrics stems from more than just regulations. Banks perceived to be laggards may face public backlash, which has the potential to dent returns.

“Firms that reflect ESG in pay do a better job of looking forward and recognizing risks early on,” said Ingo Speich, head of sustainability and corporate governance at Deka Investment. “Sustainability is a value driver.”