At a glance

  • The EBA is consulting on disclosures for ESG risks under the Pillar 3 framework. By mid-2022, banks will be required to disclose quantitative information on their exposure to climate-related risks, covering both physical and transition risk; and qualitative information on their exposure to wider ESG risks.
  • The publication includes details of the proposed Green Asset Ratio KPI, which integrates the EU Taxonomy into bank disclosure requirements for the first time. Mapping the taxonomy onto portfolios will be a significant undertaking for banks. It will require extensive client engagement and potentially necessitate significant investment in data collection capabilities.
  • The consultation is the latest in a series of initiatives at the EU-level developing the ESG risk disclosure framework. It is crucial for banks to have a holistic, joined-up understanding of how the various initiatives apply, to identify synergies and dependencies across different requirements and banks’ implementation workstreams.
  • Data remains a particular challenge, and progress relies on the advancement of other EU initiatives.  Banks will be reliant on data provided directly by clients or via third-party data providers in order to be able to meet disclosure requirements.
  • Although the requirements will not be applicable in the UK, the publication is also of interest to UK banks because it provides an indication of the possible direction of travel of UK supervisors’ expectations on ESG disclosures.

The European Banking Authority (EBA) is consulting on draft implementing technical standards (ITS) on Environmental, Social and Governance (ESG) risk disclosures under the Pillar 3 framework.  The ITS sets out the quantitative disclosures on climate risks and broader qualitative disclosures on ESG risks (e.g. covering environmental risks beyond climate change, and social and governance risks) that banks will need to produce.  The publication is a key step in efforts to align the response of the banking sector to ESG risks with the EU’s sustainability goals, and to improve transparency and market discipline.

The ITS should be read alongside the EBA’s response to a European Commission call for advice (CFA) on KPIs and disclosure methodologies for taxonomy aligned activities, under the EU Taxonomy Regulation. In particular, the EBA’s response sets out its proposal for a Green Asset Ratio (GAR) for banks (and investment firms), whilst the ITS provides information on disclosure templates for the GAR. The ITS forms part of the fast-developing framework for climate risk disclosures in the EU. Prudential disclosures are one of the key pillars of the strategy on disclosures to support the European Green Deal.  The ITS is one of the key mandates under that pillar on prudential disclosures, and is the first of a number of publications planned by the EBA that relate to key metrics and disclosures, as set out in its sustainable finance action plan.

For banks, compliance with the exercise will be a significant undertaking that could necessitate material new investment and changes to current practices, although some of these costs and changes will anyway be needed in order to meet other requirements, such as supervisory expectations of banks’ capabilities for assessing and managing ESG risk.

Who is the ITS relevant to?
The ITS will apply to EU banks with securities listed on a regulated market of any EU Member State. Although the ITS will not be applicable in the UK, the ITS will also be of interest to UK banks because it provides an indication of the possible direction of travel of UK supervisors’ expectations on ESG disclosures. The Climate Related Financial Risk Forum (CFRF) Guide recommended that UK banks should include all material climate-related and TCFD disclosures in their existing regulatory reporting (including Pillar 3 reporting) by 2022.

 Figure: Pillars of the disclosure strategy under the European Green Deal


Source: EBA

Timeline for disclosures
The EBA is proposing a phased approach to implementation, with a transition period for certain disclosures for which data collection will be the most challenging. Disclosure will be on an annual basis for the first year, and semi-annual thereafter.

What will banks be required to disclose?
The ITS introduces eight templates, covering transition risk and physical risk, and requiring a combination of quantitative and qualitative information:

Source: EBA CP on Draft Implementing Standards on prudential disclosures on ESG risks in accordance with Article 449a CRR

Transition risk (quantitative information): The disclosure requirements focus on banking book exposures, although banks with trading books over a certain size threshold (in excess of EUR 20 million or 6% of the bank’s total assets) will be required also to produce ESG disclosures in relation to their exposures.

  • For Non-Financial Corporates (NFCs), banks will need to disclose information on exposures to corporates undertaking activities that make a significant contribution to climate change, to fossil fuel companies and other carbon-related sectors (on a more granular basis). Disclosures include information on the credit quality of exposures, including forward-looking information based on average PDs and Stage 2 exposures, and backward-looking information on non-performing exposures and provisions.
  • For retail mortgages and Commercial Real Estate (CRE) loans, banks will be required to capture transition risk through disclosure of the distribution of loans according to the Energy Performance Certificate (EPC) of the collateral.
  • Banks will be required to disclose the maturity profile of those parts of their portfolios that are most exposed to transition risk.
  • Banks will also be required to disclose information on their financed (scope 3) emissions by June 2024 – both as part of their disclosures in relation to NFCs and real estate, and in relation to portfolio alignment metrics.

Physical risk (quantitative information): Banks will be required to disclose information on banking book exposures to NFCs, and on their activities in geographies and sectors that are most exposed to chronic and acute climate change physical risk. They will also be required to disclose information on how collateral held is exposed to physical risks.

Risk mitigating actions (quantitative information): Beyond the disclosures mentioned above, there is a requirement to disclose additional quantitative information on those assets and exposures that are aligned with the EU Taxonomy Regulation. The EBA’s intention is that stakeholders should be able to analyse the evolution of the level of alignment over time, and the targets for alignment set by banks.

  • This will involve disclosure of banks’ exposures to Taxonomy-aligned activities that contribute to climate change mitigation and adaptation, including the calculation and disclosure of the bank’s GAR. The GAR is a KPI proposed by the EBA for measuring the portion of banks’ EU-level banking book exposures that contribute to climate change adaptation or mitigation. Banks will be required to disclose a breakdown of the ratio by environmental objective and type of counter-party, alongside the total GAR.
  • Banks will also be required to disclose information on other activities that mitigate transition/physical risks, but do not meet the screening criteria proposed in the Taxonomy Regulation. This is important for banks, as many are likely to have exposures that contribute to climate change mitigation or adaptation but which do not meet the strict Technical Screening Criteria to be considered Taxonomy-aligned.

Wider ESG risks (qualitative information): The ITS also considers disclosure requirements for wider ESG risks. At this stage, banks will only be required to disclose qualitative information. Quantitative disclosures will be introduced at a later stage, via separate ITS. 

What banks should take away from the proposal

A holistic understanding of the EU ESG disclosure framework is vitalMany of the (methodological and framework) inputs for bank disclosure requirements will be drawn from other EU initiatives, including the EU Taxonomy Regulation. The disclosures will rely on data produced as a result of the implementation of the NFRD and the EBA Guidelines on Loan Origination and Monitoring. Given the interaction of the ITS with other parts of the EU framework, it is important that banks fully understand the overall reporting and disclosure requirements being developed for the EU.

Data remains a challenge, and progress relies on the advancement of other EU initiatives: Banks will be reliant on data provided directly by clients or via third-party data providers in order to be able to meet disclosure requirements. Although a large amount of the required data will be generated through the implementation of the NFRD and the EBA Guidelines on Loan Origination and monitoring, gaps will remain. Banks will be expected to disclose their GAR for non-NFRD counterparties, including SMEs and retail counterparties from 2024. Obtaining sufficient, and reliable, data will be challenging as the information is unlikely to be readily available for all counterparties. Extensive client engagement will be required. Banks also need to be alert to the liability risks that could arise if their disclosed GAR subsequently proves to be inaccurate, even if the cause is poor quality external data. Banks need to ensure that their reliance on third party data providers sits within their risk appetite, and it is key that they are able to understand the methodologies, assumptions and limitations in the data that they rely on.

Banks have a long way to go: An ECB report on institutions’ climate-related and environmental risk disclosures, published in November 2020, found that “virtually none” of the banks in the SSM directly-supervised by the ECB currently meet the minimum level of disclosures set out in the ECB Guide on climate risks, or the TCFD recommendations.

Looking to the future
Banks have a long journey ahead and must make a concerted effort now to put the building blocks and framework in place to commence gathering the relevant information, in order to be fully compliant with the disclosure requirements by June 2022.