Disclosure of information on the ESG-related risks facing financial institutions is widely recognised as a vital tool to promoting market discipline.  It enables stakeholders to assess the risks presented to financial institutions by issues such as climate change, social and governance risks, whilst also allowing stakeholders to review the sustainable finance strategies of financial institutions.  In light of this, governments are increasingly introducing different mandatory ESG-related reporting requirements for financial institutions, such as TCFD-aligned reporting requirements (for further information on TCFD-aligned reporting requirements, please see our previous blog posts here and here).

Adding to the plethora of existing ESG-related reporting requirements, on 24 January 2022, the European Banking Authority (“EBA“) published its final draft implementing technical standards on Pillar 3 disclosures on ESG risks (the “Final Draft ITS“).  The Final Draft ITS sets out mandatory templates, tables and instructions that supplement the EBA’s ‘Pillar 3 package’ prudential reporting requirements (the “Reporting Requirements“), which certain EU-based financial institutions will be required to comply with under the Capital Requirements Regulation (Regulation (EU) No. 575/2013) (the “CRR“).

The Reporting Requirements will include, amongst other things, disclosures on the financial impacts of the physical and transition risks associated with climate change on institutions’ balance sheets.  Physical risks include the impacts of the “physical effects of environmental factors” (e.g. adverse weather events, global warming), whilst transition risks include the impacts of “the transition to an environmentally sustainable economy” (e.g. the effect of new renewable technologies or climate policy changes).  In each case, these risks are assessed in  disclosures by reference to their impact on the exposures to the institution’s counterparties or financial assets.

The EBA hopes that the Reporting Requirements will allow stakeholders to understand how climate change, social and governance risks may exacerbate other risks within financial institutions’ balance sheets and how financial institutions are mitigating those risks.

Which institutions will the Reporting Requirements apply to?

Article 449a of the CRR provides that, from 28 June 2022, the Reporting Requirements will apply to “large institutions which have issued securities that are admitted to trading on a regulated market of any Member State“.  An institution is deemed as “large” if it meets any of the conditions in Article 4(146) of the CRR, namely if:

  1. It is a “Globally Systemically Important Institution“, as defined in Article 131 of the Capital Requirements Directive (the “CRD“);
  2. It is an “Other Systemically Important Institution“, as defined in Article 131 of the CRD;
  3. It is one of the three largest institutions in terms of total value of assets in the Member State in which it is established; and / or
  4. The total value of its assets on an individual basis, or, where applicable, on the basis of its consolidated situation in accordance with the CRR and the CRD, is equal to or greater than €30 billion.

What obligations will these institutions have under the Reporting Requirements?

By virtue of Article 449a of the CRR and Article 98(8) of the CRD, from 28 June 2022, the above institutions will be required to disclose information on ESG risks, including physical and transition risks, as set out in the Final Draft ITS.  This information includes, but is not limited to, the following:

  1. Quantitative information on institutions’ exposures to carbon-intensive activities and assets subject to chronic and acute climate change-related events;
  2. Quantitative information on institutions’ exposures to fossil fuel-based clients, the scope 1, 2 and 3 greenhouse gas emissions the institutions finance, and the institutions’ alignment with 2050 net zero emission goals;
  3. Quantitative information on institutions’ mitigating actions to support their counterparties in the transition to a carbon-neutral economy and in the adaptation to climate change;
  4. Green Asset Ratio (“GAR“) – under Article 8 of the EU Taxonomy Regulation, certain corporates and financial institutions are required to report the proportion of their revenues which are generated from “environmentally sustainable activities”, as classified under the EU Taxonomy Regulation; and
  5. Qualitative information on how institutions are embedding ESG considerations in their governance, business models, strategies and risk management frameworks.

The Final Draft ITS includes a series of disclosure templates and tables that specify more granular information which the above institutions will be required to disclose.  Controversially, Template 4 of the Reporting Requirements requires the disclosure of institutions’ banking book exposures to the top twenty most carbon-intensive companies globally (i.e. those global companies which report the highest volumes of greenhouse gas emissions).

Disclosures will be required on an annual basis for the first year and semi-annually thereinafter.  Institutions will start disclosing from June 2022, which, in practice, means that the first disclosures will take place in 2023 for the disclosure reference date as at the end of December 2022.

How will the Reporting Requirements align with other ESG-related reporting regimes?

The EBA recognises that financial institutions rely on disclosures by corporates to produce their own disclosures.  The Reporting Requirements, when formally adopted by the European Commission, are intended to operate alongside other ESG-related reporting initiatives that apply to both corporates and financial institutions.  These other reporting initiatives include the reporting obligations under Article 8 of the EU Taxonomy Regulation (relating to GAR reporting), the entity level reporting requirements under the EU Sustainable Finance Disclosure Regulation and the forthcoming EU Corporate Sustainability Reporting Directive.  In-scope entities will, therefore, need to ensure compliance and reconciliation of the different reporting regimes.

The UK does not yet have comparable reporting requirements for financial institutions.  However, in its October 2021 “Greening Finance: A Roadmap to Sustainable Investing” policy paper, the UK Government has set out a timeline for potential taxonomy-aligned disclosures for certain UK corporates and financial institutions.  Accordingly, institutions caught by the Reporting Requirements will need to consider the implications of these potential taxonomy-aligned disclosures as they originate and mitigate exposures into their in-scope entities.

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