Banks must disclose ESG risks, rule EU finance ministers

Major banking package also revives ‘green’ and ‘brown’ capital requirements debate

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ESG for the European banking sector took a big leap forward yesterday, as the Economic and Financial Affairs Council (ECOFIN) backed plans for mandatory ESG risk disclosure within three years.
The proposals are part of the broader and long-awaited EU Banking Package, which was first put forward by the European Commission in 2016 to address banking risk on the back of the financial crisis. The package has two main pillars: capital and liquidity requirements, and EU rules on banking recovery and resolution.
The first pillar includes some potentially game-changing climate and sustainability components, which were among those that this week got the thumbs up from ECOFIN (the committee comprising finance and economics ministers from all EU members states). Led by European Parliament, the package proposals were updated earlier this year to include additional disclosure requirements for ESG risks.
The approved amendments have also breathed life back into the fading discussion around the need for a ‘green supporting factor’ or a ‘brown penalising factor’ for EU banks. The green supporting factor, in which banks have lower capital requirements for eligible ‘green’ lending, was identified by the European Commission last year as one of its top priorities within its Action Plan on sustainable finance.
However, it faced major backlash from central banks, investors, civil society and politicians. The main argument was that capital requirements should be linked solely to risk correlations, not policy objectives, but there are also fears that incentivising banks to invest in green projects could create ‘bubbles’, and crowd out long-term institutional investors without such financial incentives. It has since gone very quiet as a topic of discussion under the EU’s Action Plan on sustainable finance.
The ‘brown penalising factor’ was more-or-less ruled out by the Commission, which said earlier this year that it didn’t want to punish investors in the sustainability debate, and didn’t have plans for create definitions for ‘brown’ assets.Included in the proposals endorsed yesterday, though, is the requirement – via the Capital Requirement Directive and Capital Requirement Regulation – for the European Banking Authority (EBA) to publish a report on potential green and brown factors. These were among other proposals relating to other supporting factors, such as SMEs and infrastructure projects.
Another EBA report was proposed on the potential inclusion of ESG risks in the review and evaluation performed by financial regulators. Both reports would have to be produced within two years.
All three proposals – mandatory ESG disclosure for banks and the two mandates for EBA reports – were supported by the ECOFIN Council yesterday, meaning they now have hefty political weight behind them. They are expected to be signed off by the end of the year. European Parliament and Council will then be asked to formerly adopt the regulation next year.
WWF praised the development, saying that, so far, “banks have not properly been disclosing climate-related risks, not are such risks adequately monitored by financial regulators”.
“The ECOFIN Council decision on these two EBA reports is an important and necessary step to assess the financial risks posed by climate-related and other ESG impacts, notably the risk of stranded assets,” said Sebastien Godinot, an Economist at WWF’s European Policy Office, adding that the “mandatory disclosure of climate and ESG-related risks for banks is another impact advancement”.
“WWF recommends that these measures now be reflected in the European Supervisory Authorities package currently under discussion,” the NGO said in a statement, with Godinot claiming: “It is critical that ESAs develop climate scenario analysis to assess the impact of climate and ESG risks on the financial stability of institutional in the short, medium and long term”.