In April 2022, the European Banking Authority (EBA) published its final draft of Implementing Technical Standards (ITS).
Since then, over 250 regulated banks in the European Union have been mulling over frameworks, systems, and processes to comply with the new regulations. They are expected to become compliant by June 2024, albeit in a phased manner. Banks are focusing on article 449a of the Capital Requirements Regulation (CRR), which mandates disclosure on environmental, social and governance (ESG) risks. It is expected to help capital markets reduce information asymmetry, mitigate environmental risks, and leverage new business opportunities while adapting to climate change.
Banks must quantify transitional and physical risks and provide a window into their business, strategy, governance, and overall risk management. This regulatory approach will foster transparency and accountability in the EU and global sustainable capital markets. It will also inspire independent banking authorities in other jurisdictions to adopt similar measures, which will help markets transition to a low-carbon economy.
Banks are now required to report on the energy efficiency of their real estate assets covered by loans.
Additionally, they are expected to disclose their aggregate exposure to the top 20 most carbon-intensive firms in the world. Next, they will need to report the credit quality of exposures to Nomenclature of Economic Activities (NACE) sectors, emissions, and residual maturity. This will require institutions to establish frameworks, systems, and process to identify and report on Scope 1, 2, and 3 greenhouse gas (GHG) emissions of clients and their counterparties.
Finally, banks will need to disclose their banking books’ Scope 3 emissions with regard to alignment metrics defined by the International Energy Agency (IEA) for the ‘net zero by 2050’ scenario. Recognizing challenges around Scope 3 emissions reporting, the EBA has put in place transitional measures for institutions to begin reporting by June 2024.
Disclosures on physical risks will require banks to identify exposures by NACE sector and geography.
This will include exposure to chronic and acute climate hazards such as heat waves, droughts, floods, hurricanes, and wildfires. These narratives can be supported by incorporating climate data from public databases such as National Oceanic and Atmospheric Administration, PCA Global Drought Risk Platform, and the World Bank’s climate change knowledge portal.