On 21 April 2023, the European Central Bank (the “ECB”) published its third assessment report on the progress banks have made on disclosing climate-related and environmental risks as set out in the ECB’s November 2020 guide.
In the latest report (which follows its second assessment report in March 2022, see our previous blog post), the ECB has found a significant increase in the amount of basic information banks have disclosed across categories – but notes that the quality of disclosure is often insufficient and most institutions “still need to make significant efforts to transparently disclose their exposure to C&E risks and further substantiate the disclosure of the practices they have put in place to mitigate C&E risk”. The overriding view is that at this point in time “external stakeholders are not given sufficient information on how banks could be affected by C&E risks, how they monitor these risks, which scenarios have been used, and how their business strategies have been amended following their findings.”
The report also comments on in-scope Banks’ preparedness to disclose information under the EBA ITS on Pillar 3 disclosures on ESG risks (the EBA ITS) – the observation being that most institutions are “largely unprepared”. The first disclosure year for ESG information is 2023 (and those in scope will be required to disclose information with a reference date of December 2022) and as such Banks will need to make “substantial efforts” to disclose the necessary ESG risk information.
Where are improvements needed?
In considering the adequacy of banks’ alignment with expectation, in this year’s assessment the ECB assessed the existence, substance and soundness of disclosure practices against 5 categories: (i) materiality assessment; (ii) business model and strategy; (iii) governance; (iv) risk management; and (v) metrics and targets.
Overall, when it comes to the existence of C&E disclosures, the ECB notes that clear progress has been made, and evidence of good practices in many areas can be seen.
However when looking at the adequacy of disclosures made, the water becomes muddier, and the ECB outline their expectation that banks make more effort to substantiate (in adequate detail) the disclosure of the practices, structures and methodologies they have put in place to mitigate C&E risk.
An assessment of the 5 categories shows that whilst banks are now disclosing more meaningful C&E risk information pertaining to governance and risk management, disclosures in the business model and metrics and targets categories requires work – in the case of the latter, in almost half of Banks, disclosures are practically absent (and where disclosures do exist, not one institution is, as yet, publicly disclosing metrics and targets that are deemed adequate). Moreover, the ECBs findings indicate that 74% of banks share insufficient information on how, or more specifically, how much their portfolios will be affected by C&E risks.
In Chapter 3 of the report, the ECB shares observations and examples of good practice for each category, to serve as an illustration that could help institutions as they seek to align their own disclosures of C&E risks against supervisory expectations.
Benchmarking Banks’ progress against non-EU counterparts
For the first time, the ECB has compared the climate and environmental risk disclosures of the EU based Global Systemically Important Banks (“G-SIBs”), against their non-EU based counterparts. The results suggest a step in the right direction in that “while EU-based G-SIBs are not fully aligned with supervisory expectations, they generally outperform their global peers in all assessment categories”.
What’s next for banks?
Banks have been informed of their ECB supervisors’ findings via individual feedback letters. They are expected to further advance their C&E risk disclosures and to ensure that they comprehensively convey their risk profile and disclose information that is material. In particular, the ECB expects banks to take decisive action to address the shortcomings set out in the feedback letter in their disclosures. Banks have furthermore been asked to inform the ECB on how they intend to address the identified shortcomings in their forthcoming disclosures.
The EBA also expects Banks to update them on their ongoing and planned preparatory actions to comply with the EBA ITS. In the second half of 2023, the ECB will proceed to review whether eligible banks meet the new standards. Failure to comply with these standards will constitute a breach of the Capital Requirements Regulation (EU) No. 575/2013 and will result in supervisory action.
The EBA note that in the context of increasing public commitments to net zero, further supervisory investigations will target the soundness of Bank’s disclosures and how these align with internal practices.
You can read the ECB Report here.
The related ECB press release can be found here.