Banks need to step up efforts on climate and environmental risk disclosures

Mon 11 Apr 2022

In March 2022, the European Central Bank (ECB) published its second snapshot of climate-related and environmental risk disclosure levels among significant institutions under its direct supervision. In line with the results of the first snapshot published in November 2020 – regarded as the baseline measurement – none of the institutions in scope for this second review met the minimum level of disclosures set out in the ‘ECB Guide on climate-related and environmental risks.’  The results demonstrate that efforts are still required by banks to disclose exposures to climate-related and environmental risks transparently. Indeed, 45% of the disclosures were even assessed as insufficient from both content and substantiation perspectives. Individual feedback has been shared with the institutions, and climate-related and environmental risk disclosures will continue to feature prominently in the ECB’s supervision to assess how banks have addressed ECB feedback.

The ECB has planned a number of supervisory activities for 2022 and will assess banks’ preparedness to manage climate-related and environmental risks by conducting full reviews, including deep dives on how climate-related and environmental risks are incorporated into their strategy, governance and risk management. The ECB is expected to gradually integrate climate-related and environmental risks into its methodology for the Supervisory Review and Evaluation Process (SREP), which will influence Pillar 2 capital requirements, as well as its on-site inspection methodology.

What the ECB’s snapshot reveals

The key observations made by the ECB in their report are as follows:

• With regard to the transparency of the materiality of risks and methodologies, one-third of institutions do not yet transparently disclose that they are materially exposed to climate-related and environmental risks in line with their internal materiality assessments.
• Institutions still scarcely substantiate their climate-related and environmental metrics and targets, for instance in terms of their commitment to align with Paris Agreement objectives: only about one in five institutions disclose the methodologies, definitions and criteria for all of the figures, metrics and targets reported as material. Conversely, more than one-third of institutions do not disclose these aspects at all.
• The content remains sparse and heterogeneous across the board. Some banks publish dedicated climate-related and environmental risk reports with extensive qualitative and quantitative information. In contrast, other banks report on climate-related risks only to a marginal extent or solely in the context of corporate sustainability, with inherent confusion between the impact of the banks’ operations and that of the activities it finances.

The current report demonstrates that banks’ recent disclosures are insufficient to meet future regulatory disclosure requirements. Indeed, in the context of the upcoming Corporate Sustainability Reporting Directive (CSRD) and Implementing Technical Standards on ESG Pillar III disclosures by the European Banking Authority (EBA ITS), banks subject to these rules will have to disclose specific metrics showing the extent to which their assets are aligned with the EU Taxonomy and specific transition alignment metrics.

Standards created to improve disclosures

The EBA ITS, which are based on existing initiatives such as the Taskforce on Climate-related Financial Disclosures (TCFD) recommendations, non-binding guidelines on climate change reporting and the EU taxonomy, include:

1. Tables for qualitative disclosures on environmental, social and governance risks
2. Templates with quantitative disclosures on climate change transition risk
3. A template with quantitative disclosures on climate change physical risk
4. Templates with quantitative information and key performance indicators (KPIs) on climate change mitigating measures, including the Green Asset Ratio (GAR) on Taxonomy aligned activities according to Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment (Taxonomy Regulation), extended information on Taxonomy alignment of exposures in the banking book and other mitigating actions.

By creating these standards, the EBA tries to make it more straightforward for firms to develop the necessary risk management, process, policy, and strategy changes to incorporate ESG and sustainability.  These standards will also make it easier for authorities and stakeholders to assess ESG risks and sustainability strategies while creating market discipline.

Banks must now use these standards and take decisive action to increase their preparedness to ensure that their disclosures comprehensively convey their risk profile and disclose material information to meet requirements.