Time is running out for bank climate-related risks disclosures
The ECB has released its third review on banks’ climate-related and environmental (C&E) risk disclosures practices and trends. Supervisors recognise developments and improvements, but confirm that financial institutions are still lagging behind their expectations . The report also revealed that most banks are not yet prepared to comply with EBA ITS Pillar 3 reporting guidelines. Banks need to further substantiate their disclosures and reports and start providing less generic information.
The ECB has recently published its review on banks’ climate-related and environmental risks (C&E) disclosures practices and trends (). The central bank recognized that banks have improved their disclosures, but still identified severe weaknesses concerning the level of details of the disclosures. Since publishing its ) in 2020, the ECB already conducted three reviews of financial institutions C&E risk disclosures. Each review aims to assess both the existence and the substantiation of banks’ climate-related disclosures, and provide feedback to each bank, as well as give examples of good practices.
Furthermore, in January 2022, the European Banking Authority (EBA) published the on ESG risks, promoting standardized and transparent disclosures for all large financial institutions*. This year is the first in which the institutions under the scope of EBA ITS will have to publish their Pillar 3 Reports with the reference date of 31 December 2022. The ECB has therefore also included in its third review an assessment of how advanced and developed Pillar 3 disclosures are so far.
The review included 103 significant institutions (SIs) and 28 less significant institutions (LSIs). Furthermore, 12 non-EU Global Systemically Important Banks (G-SIBs) were assessed for a benchmarking exercise. The report was based on disclosures with the end of 2021 as a reference date, or later where available. The supervisor focussed on disclosures across some key areas, such as materiality, business model and strategy, governance, risk management, and metrics and targets (which it described in its 2020 Guide).
Key results
Overall, C&E disclosures have improved since the last review. For instance, in 2021, only 36% of the banks considered C&E risks to be material, while in 2022 this number has increased to 86%. However, the acknowledgement of material risks is not sufficient in itself, as it often only refers to basic information, lacking substantiation. Indeed, from the banks that did consider the risks to be material, only 24% of disclosures were considered as adequate** or broadly adequate*** . Also, among the 14% of banks that do not consider the risk to be material, no solid justification was given, or no assessment was conducted. As such, it seems that still a significant number of banks only assesses the impact of C&E risk in a very generic way.
The table above shows that only a third of the institutions have disclosed all of the information set out in Expectations 13.4 and 13.6, and from those, only 6% of banks provide information that is adequate or broadly adequate. Surprisingly, six banks were identified as still having insufficient disclosures for all five categories, whereas seven banks do provide detailed and transparent information. The table also reveals that half of the banks disclose adequate information about how the board oversees C&E risks, with 97% of banks disclosing information on this area. But all in all, financial institutions still have a way to go, and more efforts must be made in order to present more substantial and less generic information.
The report also notes that banks seem ill-prepared to provide information as defined in the EBA ITS on Pillar 3 disclosures, which in some cases is already as of this year (e.g. disclosures on EPC labels on residential and commercial real estate). Furthermore, the graph below also shows that half of the banks report on exposures that are aligned with the EU Taxonomy, although the information provided is still very generic and not meeting expectations. As such, banks need to make ‘substantial efforts’ to be able to comply with the EBA ITS.
The chart on the previous page also clearly highlights discrepancies and inconsistencies in the current level of information being provided by banks. For example, while half of the banks report on exposures that are aligned with the EU Taxonomy (although very generic as we previously noted), only a small minority (around 8%) of the institutions disclose information on EPC labels of their real estate portfolio. This is a clear contrast as in particular banks with a wide mortgage portfolio require information on EPC labels to assess EU Taxonomy alignment, which brings into question whether the information on e.g. EPC labels is not available or just not being transparently reported.
Most LSI not aligned with supervisory expectations
The report included for the first time an overview on C&E disclosures of less significant institutions (LSI). Although most LSIs currently do not fall under the regulatory scope of C&E disclosures, this might change in the future with a reform of the Capital Requirements Regulation (CRR) likely demanding all credit institutions to report the EBA ITS. Nevertheless, National Competent Authorities (NCAs) are entitled to apply the expectations set out in the Guide, proportionate to an institutions’ nature, scale and complexity. The key finding is that there is still a long way to go for these smaller institutions, as results were disappointing (see graph below). For instance, C&E disclosures of around 80% of LSI were assessed as inadequate or somewhat inadequate, with most room for improvement in the area of business model and strategy. The key reason for this poor performance might be related to the scarcer resources that these banks have when compared to larger, and more established institutions. However, the ECB noted that it already observed an improvement among LSIs immediately after the assessment, something it expects to continue as well.
Benchmark exercise between non-EU G-SIBs and EU G-SIBs
In the benchmarking exercise between the EU G-SIBs and non-EU G-SIBs, EU G-SIBs seem to be on a more solid ground. For instance, almost all EU G-SIBs have recognised material exposure to C&E risks, while only slightly more than half of the non-EU G-SIBs consider being materially exposed to C&E risks. Still, both EU G-SIBs and non-EU G-SIBs scarcely substantiate C&E metrics and targets. Furthermore, the report highlights that a majority of all G-SIBs (regardless of the parent entity’s location) continues to lack disclosures on Scope 3 financed emissions. This is despite the fact that most of them have joined the Net Zero banking Alliance (NZBA), implying that they have committed their lending and investment portfolios with net zero emissions by 2050.
Reporting on Scope 3 emissions remains a challengeScope 3 emission reporting seems to be the most challenging for all financial institutions, which should also not come as a surprise as this is rather complex. Scope 3 emissions measure the carbon emissions that stem from bank counterparties, which are the emissions of the companies and households that they lend to. Therefore banks need emission data from their counterparties, which is often not (yet) available. Looking at the sample of 103 SIs, the numbers are disappointing. Half of the banks do not disclose their scope 3 emissions, and from the ones that do, 53% did not substantiate their calculation methodologies and 29% did it, but only partially. The lack of methodologies casts serious doubts on the validity of the numbers, and the 2022 climate stress risk also revealed that the majority of the banks still uses proxies to calculate emissions, which results in a high dispersion of data. Furthermore, when asked about the reference date, some don’t state any date, and others state an outdated one.
For sure, it is not an easy task to calculate scope 3 emissions without having non-financial companies reporting their emissions. But this should become easier as companies under the Non-financial Reporting Directive (NFRD) start to comply with the European Sustainability Reporting Standards (ESRS) from January 2024 onwards. Furthermore, a phase-in period was granted to financial institutions until June 2024, which they should use to explain the methodologies they are developing to measure and estimate their scope 3 emissions and the sources of data they plan to use.
Final remarks
The ECB concludes that banks are still lagging and significant efforts still need to be taken to comply with the EBA ITS Pillar 3 and the C&E risk disclosure reports. This particularly holds for smaller institutions that will need to strengthen their C&E risk disclosures going forward. Transparent and standardized disclosures are the best way to make financial institutions accountable for their decisions, which will also strengthen comparability of data. This, in turn, will prove especially relevant for external stakeholders in their investment decisions. Furthermore, supervisors have been very serious about their expectations going forward and stand ready to take harsher actions if banks do not comply within the imposed deadlines. As Frank Elderson stated in a speech on the 27 March 2023, “we expect all banks under our supervision to be fully aligned with our expectations by the end of 2024 at the latest. After 2024, a limbo of identifying a risk as material but not adequately addressing it will no longer be tolerated.” As such, time is running out.
*With instruments traded in a regulated market in a Member State
**Adequate: the bank discloses relevant C&E risk information and somewhat substantiates that information in line with the Guide
***Broadly adequate: the bank discloses some C&E risk information, but it is either not comprehensive or not sufficiently substantiated