ESMA and the EBA advise on KPIs for transparency on institutions’ environmentally sustainable activities, and the EBA consults on prudential disclosures of ESG risks under the CRR.

By Nicola Higgs, Suzana Sava-Montanari, and Axel Schiemann

On 26 February 2021, both the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) issued guidance on Article 8 of the EU Taxonomy Regulation. Firms in scope of the EU Taxonomy Regulation now have all the relevant guidance to start planning their disclosures on how and to what extent their activities are associated with economic activities that qualify as environmentally sustainable under the EU Taxonomy Regulation.

The guidance elaborates on the Key Performance Indicators (KPIs) that institutions should disclose, the scope and methodology for the calculation of those KPIs, and the qualitative information that institutions should provide.

The main KPI proposed is the Green Asset Ratio (GAR), which identifies institutions’ asset financing activities that are environmentally sustainable according to the EU Taxonomy Regulation, including activities consistent with the goals of the European Green Deal and the Paris Agreement. Information on the GAR is supplemented by other KPIs that provide information on the taxonomy-alignment of institutions’ services other than lending and investing. The EBA has integrated proportionality measures that should facilitate institutions’ disclosures, including transitional periods where disclosures in terms of estimates and proxies are allowed.

The EU Taxonomy Regulation takes effect on the following dates:

  • 1 January 2022 (with disclosure reference date end 2021): for the environmental objectives of climate change mitigation and climate change adaptation
  • 1 January 2023 (with disclosure reference date end 2022): other environmental objectives (sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; the protection and restoration of biodiversity and ecosystems)

ESG Risk Disclosures Under CRR

The EBA is consulting on prudential disclosures of ESG risks under Article 449a of the Capital Requirements Regulation (CRR) as part of the Pillar 3 reporting framework, currently designed for  disclosure of regulatory capital and risk exposures. The proposals are intended to allow investors and stakeholders to compare the sustainability performance of institutions, with a spotlight on their financial activities and vulnerabilities, and how they are mitigating ESG risks, including information on how they are supporting their customers and counterparties in the adaptation process. The Pillar 3 disclosures work in parallel to Article 8 of the EU Taxonomy Regulation and the EBA advice under Article 8 of the EU Taxonomy Regulation should therefore be read in conjunction with this consultation paper.

The EBA is proposing a sequential approach for the implementation of prudential ESG disclosures. This approach falls in line with the deadlines that the European Commission has planned for the EU Taxonomy Regulation, which by the end of 2022 covers only the screening criteria related to the environmental objectives of climate change mitigation and climate change adaptation. Once the taxonomy screening criteria is extended to cover other environmental objectives, the EBA will then extend the draft Pillar 3 ESG implementing technical standards (ITS) to implement quantitative disclosures on other environmental risks and objectives. By the end of 2021, the Commission will report on whether to extend the scope of the taxonomy to social risks and to environmentally harmful and neutral activities, an extension that the EBA would very much support, as it would provide additional and relevant tools to institutions. If the taxonomy is extended to cover environmentally harmful and neutral activities, the EBA will revise the quantitative information proposed in the draft ITS in order to align it with the taxonomy definitions and classification criteria.

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The Pillar 3 disclosures will be required from 28 June 2022 (for CRR firms) and 26 December 2022 (for IDD Class 2 firms). Transitional arrangements are in place as follows:

  • June 2024: disclosures on institutions’ scope 3 emissions

Rationale: Institutions will need to collect information on CO2 emissions from their counterparties and develop methodologies to estimate their scope 3 emissions. During the transitional period, institutions will explain the methodologies they are developing to measure and estimate their scope 3 emissions and the sources of data they plan to use. Institutions that are already estimating this information should start disclosing it, using estimates and ranges.

  • June 2024: disclosure of the GAR on stock of assets for those exposures towards retail and corporates not subject to the Non-Financial Reporting Directive (NFRD) disclosure obligation

Rationale: The data collection process should be easier and faster in the case of counterparties that are subject to NFRD disclosure obligations, as they will start disclosing relevant information for the 2021 financial year from January 2022 under Article 8 of the EU Taxonomy Regulation. It will be more burdensome for counterparties not subject to the NFRD — in that case, information will be collected on a bilateral basis. The transition date is aligned with the deadlines included in the EBA Guidelines on loan origination and monitoring.

Firms in scope of the EU regulations have a number of different overlapping entity level ESG disclosures to make.