Governance, risk & compliance Torsten Jäger,
head of sustainability finance, German Banking Association.
Karolin Kirschenmann, finance expert, Leibniz Centre for European Economic Research.
3.4 times
The amount, since 2019, that the SFDR’s ESG categories have received client flows compared to non-ESG counterparts.
Goldman Sachs 11,700
The number of large companies and groups that NFRD applies to.
European Commission 44
“This means that sustainability-related, non-financial factors should be taken into account by the private sector when making financing and investment decisions,” explains finance expert Karolin Kirschenmann of the Leibniz Centre for European Economic Research. “Within this framework the EU Taxonomy provides a uniform definition and classification system of environmentally sustainable economic activities.” Currently, the European taxonomy classification system aims at listing environmentally sustainable activities to enhance transparency and comparability of ESG performance metrics using six environmental objectives. They include climate change mitigation, climate change adaptation and sustainable use of water and marine resources, among other standards. After it partially came into force in January 2022, the taxonomy delegated act, a regulatory framework for establishing classification systems for environmentally sustainable economic activities, required financial institutions to disclose their ‘taxonomy-eligible’ assets as part of their wider disclosures. This includes economic activities in sectors such as manufacturing, water supply, sewerage, and waste management. Under the Non-Financial Reporting Directive (NFRD) – another regulation, this time requiring certain companies to provide non-financial disclosure documents in annual reports – large listed companies, banks and insurance firms (with more than 500 employees) are required to report on policies regarding social responsibility, human rights, anti-corruption and bribery, and board diversity. Roughly 11,000 of the biggest EU public-interest companies are included here, including listed companies, banks, insurance companies and other designated organisations. These obligations are expected to increase significantly under the so-called Corporate Sustainability Reporting Directive (CSRD), yet another slab of EU regulation, due to come into force in 2024. The CSRD will implement a common reporting framework and encompass more companies. It will unfold in four steps: disclosing taxonomy-eligible and aligned assets for companies under NFRD; extending the requirement to all large companies not subject to NFRD; demand disclosure from listed SMEs; and finally bring in companies with a net turnover of €150m, and at least one subsidiary in the EU. So far, banks are only required to disclose their share of eligible activities for the previous financial year. From January 2024, however, they will also need to disclose the share of taxonomy-aligned activities they hold.
Short of time
Come 2024, banks may be surprised at the number of activities covered and how specific the definitions actually are. As Kirschenmann points out, during a July 2022 ECB climate stress test, most banks did not include climate risk in their credit risk models – and
only a fifth considered climate risk when granting loans. Banks, for their part, have already faced a number of challenges in understanding the requirements. With only the first two climate goals in place, the European Parliament and Council had until October 2023 to consider the delegated acts, which will then be published in the EU’s official journal and come into force 1 January 2024, though any objections coming from the European Parliament and Council could delay implementation.
“The publication of the four additional reporting requirements also implies that banks and corporates will have to report their taxonomy eligibility as of 2024 and in subsequent years their alignment,” Jäger says. “The fact that the new reporting obligations must now be met within less than a year is incredibly ambitious, considering the complexity involved. As a general rule, businesses and banks with an obligation to disclose this information, including their data/software service providers, assume that the implementation period for doing so will be at least 12 months long.” In broad terms, the focus for banks and companies has been the actual disclosures – and getting ready for the deadline, which some insiders see as implausibly tight. “We had previously proposed postponing all new reporting requirements for financial and non-financial companies for a year to give more time for implementation,” Jäger says. “This proposal was unfortunately not adopted. The short implementation period will be a significant challenge for banks and companies alike as internal processes and data management systems need to be adapted. However, I am confident that banks will do their best to fulfil the reporting obligations.”
Kirschenmann agrees that meeting the deadline will be a serious challenge for banks, especially those with large lending portfolios to retail and SME clients. “The ECB climate stress test in July 2022 showed that most banks do not yet have robust climate risk stress-testing frameworks and lack relevant data to measure and manage climate risks,” she says. “This may have improved since then, but a lot of work certainly still needs to be done.”
Challenges ahead
In short, the growing evolution of regulatory requirements around sustainability poses both short- and long-term challenges for financial institutions. One among many is data availability. This is especially true when it comes to company disclosures: while larger companies can invest in reporting, smaller businesses may not be able to provide the necessary information, something they’ll need to do from 2027. “Data is one of the biggest challenges,” emphasises Kirschenmann. “Data on SME and retail portfolios of banks is not readily available, but necessary to calculate the Banking Book Taxonomy Alignment Ratio (BTAR) [an assessment on the taxonomy-alignment of a bank’s
Future Banking /
www.nsbanking.com
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