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Over the past decades, banks significantly increased their efforts to implement adequate frameworks for managing interest rate risk in the banking book (IRRBB). These efforts typically focus
Find out moreOn 24 January 2022, the European Banking Authority (EBA) published its final draft Implementing Technical Standards (ITS) on Pillar 3 (P3) disclosures on Environmental, Social and Governance (ESG) risks. This publication fits nicely into the ‘horizon priority’ of the EBA to provide tools to banks to measure and manage ESG-related risks. In this article we present a brief overview of the way the ITS have been developed, what qualitative and quantitative disclosures are required, what timelines and transitional measures apply – and where the largest challenges arise.
In an earlier report2, the EBA defined ESG-related risks as “the risks of any negative financial impact on the institution stemming from the current or prospective impacts of ESG factors on its counterparties or invested assets”. Hence, the focus is not on the direct impact of ESG factors on the institution, but on the indirect impact through the exposure of counterparties and invested assets to ESG-related risks. The EBA report also provides examples for typical ESG-related factors.
While the ITS have been streamlined and simplified compared to the consultation paper published in March 2021, there are plenty of challenges remaining for banks to implement these standards.
The EBA has been mandated to develop the ITS on P3 disclosures on ESG risks in Article 434a of the Capital Requirements Regulation (CRR). The EBA has opted for a sequential approach, with an initial focus on climate change-related risks. This is further narrowed down by only considering the banking book. The short maturity and fast revolving positions in the trading book are out of scope for now. The scope of the ITS will be extended to included other environmental risks (like loss of biodiversity), and social and governance risks, in later stages.
In the development of the ITS, the EBA has strived for alignment with several other regulations and initiatives on climate-related disclosures that apply to banks. The most notable ones are listed below (and in Figure 1):
Figure 1 – Overview of related regulations and initiatives considered in the development of the ITS
Compared to the consultation paper for the ITS, several changes have been made to the required templates. Some templates have been combined (e.g., templates #1 and #2 from the consultation paper have been combined into template #1 of the final draft ITS) and several templates have been reorganized and trimmed down (e.g., the requirement to report exposures to top EU or top national polluters has been removed).
The ITS on P3 disclosure on ESG risks introduce ten templates on quantitative disclosures. These can be grouped in four templates on transition risks, one on physical risks, and five on mitigating actions:
An overview of the templates for quantitative disclosures in presented in Figure 2.
Qualitative disclosures
In the ITS on P3 disclosures on ESG risks, three tables are included for qualitative disclosures. The EBA has aligned these tables with their Report on Management and Supervision of ESG risks11. The three tables are set up for qualitative information on environmental, social, and governance risks, respectively. For each of these topics, banks need to address three aspects: on business strategy and processes, governance, and risk management. An overview of the required disclosures is presented in Figure 3.
Figure 3 – Overview of qualitative ESG disclosures (based on templates & section 2.3.2 of the EBA ITS on P3 disclosures on ESG risks)
The ITS on P3 disclosure on ESG risks become effective per 30 June 2022 for large institutions that have securities traded on a regulated market of an EU member state. A semi-annual disclosure is required, but the first disclosure is annual. Consequently, based on 31 December 2022 data, the first reporting will take place in the first quarter of 2023.
The EBA has introduced a number of transitional measures. These can be summarized as follows:
The EBA has further indicated in the ITS that they will conduct a review of the ITS’s requirements during 2024. They may then also extend the ITS with other environmental risks (other than the climate change-related risks in the current version). The EU Taxonomy is expected to cover a broader range of environmental risks by the end of 2022. Sometime after 2024, it is expected that the EBA will further extend the ITS by including disclosure requirements on social and governance risks.
An overview of the main timelines and transitional measures is presented in Figure 4.
Figure 4 – Overview of the main timelines and transitional measures for the ESG disclosures
Society, and consequently banks too, are increasingly facing risks stemming from changes in our climate. In recent years, supervisory authorities have stepped up by introducing more and more guidance and regulation to create transparency about climate change risk, and more broadly ESG risks. The publication of the ITS on P3 disclosures on ESG risks by the EBA marks an important milestone. It offers banks the opportunity to disseminate a constructive and positive role in the transition to a sustainable economy.
Nonetheless, implementing the disclosure requirements will be a challenge. Developing detailed assessments of the physical risks to which their asset portfolio is exposed and to estimate the scope 3 emissions of their clients and counterparties (‘financed emissions’) will not be straightforward. For their largest counterparties, banks will be able to profit from the NFRD disclosure obligations, but especially in Europe a bank’s portfolio typically has many exposures to small- and medium-sized enterprises. Meeting the disclosure requirements introduced by the EBA will require timely and intensive discussions with a substantial part of the bank’s counterparties.
Banks also need to provide detailed information on how ESG risks are reflected in the bank’s strategy and governance and incorporated in the risk management framework. With our extensive knowledge on market risk, credit risk, liquidity risk, and business risk, Zanders is well equipped to support banks with integrating the identification, measurement, and management of climate change-related risks into existing risk frameworks. For more information, please contact Pieter Klaassen or Sjoerd Blijlevens via +31 88 991 02 00.
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