Banks are increasingly reporting on their future contribution towards sustainability. The most common public commitment is their ambition to redirect capital flows towards sustainable investments as part of the lending business. This is where the green asset ratio comes into place as it shows how green banks’ portfolios are.
But what happens if a bank gives a commitment and reports a zero percent green asset ratio within the non-financial reporting? Well, that simply means there’s no contribution and that clients and investors will for sure start to challenge the commitment in public. Since you don’t want that to happen, you better get ready for it —right now.
In this blog, we aim to help you in your reporting journey by sharing and walking you through the key considerations when it comes to the Green Asset Ratio.
Ready, set… and here’s the timeline
For the first time, banks across Europe are publishing their taxonomy eligibility ratios in accordance with the Taxonomy Regulation —if you need a refresher on the EU taxonomy for sustainable finance, with a special focus on banking, we’ve got you covered in our previous blog. From 1 January 2024, the reporting obligation for taxonomy alignment will follow.
The data used for the so-called green asset ratio (GAR) might be employed in the future as a steering impulse for CO2 reduction, among other things. However, due to different data collection methods, it’s currently difficult to compare. One reason for this is that banks are still facing challenges in terms of data availability.
In addition, today, small and medium-sized enterprises (SMEs) are exempt from the taxonomy regulation, removing an incentive to finance renewable energies. As for the data’s external audit, the collection methods need to be standardised to ensure its quality and comparability. However, this can be expected in the near future —to be more precise, at the earliest by 2025 for 2024 data.
A look into the regulatory requirements
From the beginning of 2022, banks are obliged to report on their portfolio’s taxonomy eligibility, and from 1 January 2024 —as of 31 December 2023 actually— the reporting obligation on taxonomy compliance will follow.
In the context of the EU taxonomy regulation’s gradual introduction, the first step in the taxonomy compliance’s examination is merely to determine the proportion of the bank’s financing activities that are covered by the regulation. For this purpose, the classification of the NACE codes is to be applied —to clarify, NACE codes are the standard European nomenclature of productive economic activities.
The verification of the significant contribution of the company’s activities to one of the two environmental objectives of the taxonomy —that is, climate change mitigation and climate change adaptation— based on the technical screening criteria as well as the « do no significant harm » criteria for four other EU environmental objectives will only be due in the context of taxonomy compliance from 2024.
Side, but relevant, note: these four environmental objectives —that are yet to come— are sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and protection and restoration of biodiversity and ecosystems.
For this, compliance with the minimum social safeguards laid down in the taxonomy must be ensured. A further delegated act is expected to come into force at the end of 2023. It will stipulate the technical screening criteria for the other four objectives and thus prompt companies to make further disclosures.
Across Europe, banks are currently publishing ratios regarding their portfolios’ taxonomy eligibility in accordance with Article 10 (EU) 2021/2178. We have observed that banks tend to interpret its text differently. As a result, different analysis and calculation methods were applied this year and the results partly differ and, hence, can’t be compared.
How taxonomy reporting affects the entire value chain of a bank
From the front office to the back office to controlling, the processes within a bank must be rethought and adapted in light of the taxonomy regulation. To meet the reporting requirements for taxonomy alignment, additional information must be requested from the customer besides the collection of market data.
Alongside the need for the structured collection of this data, employees must also be fully trained in Environmental, Social and Governance (ESG) regulation and understand the regulatory requirements, especially when it comes to client interaction and data collection.
Moreover, the credit department’s back office has to check the additional data, and the controlling department has to do the subsequent calculation of the alignment. The data for taxonomy reporting also flows through the IT system.
Here, new data fields as well as recording and processing options must be created to record and process the sustainability data. In addition, it’s important to define clear responsibilities and to anchor the topic in the bank’s governance to meet the reporting requirements in terms of scope and quality.
Then, the communication or investor relations department usually carries out the publication of the taxonomy key figures. Both the communication challenge and banks’ disclosure obligations shouldn’t be underestimated if the published ESG data is to be correctly understood and interpreted by the market and the public.
The challenges in data availability
There’s no questioning that the taxonomy’s reporting requirements are complex. The taxonomy compliance ratios to be published next year will, in particular, pose major challenges for banks, as the data required for this isn’t largely available yet.
With regard to providing market data, banks are faced with the challenge that they can’t currently make comprehensive use of the companies’ taxonomy reports, as these have themselves disclosed their corresponding ratios for the first time.
To make matters worse, some of the EU requirements aren’t specific enough and leave room for interpretation. Also, the delimitation of companies that fall under the EU directive on non-financial reporting is challenging for banks and leads to different approaches. In addition, the EU Commission prohibits the use of estimates for mandatory reporting. Ratios based on estimates, among other things, can be included in voluntary, but separate reporting.
Hence, this year’s mandatory reporting by banks largely includes taxonomy-eligible loans to large corporations and mortgage loans to households —for which banks collect their own data. Corporate securities and debt securities will only be included next year. From 2023 onwards, banks’ taxonomy ratios are expected to increase as they will be able to access the taxonomy ratios of the companies in which they are invested.
The issue of different survey methods
The taxonomy eligibility ratios published so far by 18 German banks range from zero to 35 percent. Different survey methods were used. Some banks included their entire assets in the denominator and thus arrived at 100 percent with taxonomy-eligible and non-taxonomy-eligible ratios, while others included only a part of their portfolio in the denominator because, for example, the data for the securities wasn’t yet available for the mandatory reporting.
In addition, some Key Performance Indicators (KPIs) were published in aggregate and/or duplications weren’t adjusted for. As we mentioned before, the methods must be standardised to ensure data quality and comparability for the external audit. To achieve this, the EU must provide further tangible guidance.
A warning on false incentives
Financial companies must also report the ratio of non-taxonomy-eligible assets in their portfolio. The current exemption of SMEs from the taxonomy regulation originally derived from the good intention of giving smaller companies more time to implement additional reporting obligations.
The problem with this, however, is that it creates incentives that contradict the regulation’s aim to channel financial flows into sustainable economic activities. This is because wind power and photovoltaic projects are often implemented by smaller companies.
Thus, financial institutions that lend to smaller wind power and photovoltaic project developers can’t include these loans yet in the taxonomy quota, whereas banks that have large nuclear or gas companies in their portfolios can declare them as taxonomy-compliant from 2023 onwards.
This removes an incentive to finance renewable energies. As long as SMEs are exempt from mandatory reporting, banks could include their loans to smaller companies in voluntary reporting so that they are visible to external stakeholders.
A real steering effect will only come with the disclosure of taxonomy compliance ratios next year. This is because portfolio managers can use this data to drive their investments’ sustainability level.
To further increase the data’s informative value, it would make sense to extend the taxonomy to other sectors, such as aircraft in the transport sector. Therefore, banks should see the Green Asset Ratio as an opportunity and use it as a management tool to reduce CO2 emissions in their portfolios.
What we think
Currently, financial institutions are facing some implementation challenges —the availability of data, clear allocation of responsibilities for the data collection process within the bank, and the technical implementation by IT are particular challenges that need to be addressed as early as possible.
It’s necessary to understand that the entire value chain of the bank is affected. In the future, those responsible for customers must be able to collect the necessary data from their clients. The data flow will go through the entire bank and then at the end banks will report the Green Asset Ratio in the non-financial statement.