How to get your "green ratios" – banks and the EU taxonomy
In recent years, banks have been at the center of multiple legislative initiatives on sustainability reporting - and the pace is still ongoing. Some of the most comprehensive measures to date are introduced with the EU taxonomy. The Non-Financial Reporting Directive (NFRD) made as an obligation for banks to start reporting their Green Asset Ratio (GAR).
The taxonomy is intended to help investors, banks, and other financial institutions understand their investments' environmental impacts and identify opportunities for supporting sustainable development. It consists of a set of technical screening criteria that define what constitutes a "sustainable economic activity," as well as a classification system for different sectors and subsectors of the economy.
For banks, the taxonomy can be used to identify and promote sustainable finance products, such as green mortgages or loans for energy-efficient building renovations. It can also help banks meet their regulatory requirements for disclosing their activities' environmental impacts and integrating sustainability into their risk management processes.
What is GAR, and what does it mean for banks?
GAR (green asset ratio) is a green fraction of their "sustainable loans" proportion, meeting the EU taxonomy criteria compared to most balance-sheet banking book assets.
In reality, calculating Green Asset Ratio for EU taxonomy will be easy. Based on loans to large, publicly listed companies that themselves are required to disclose their scores, banks would need to collect the scores from the reports.
Due to the limited scope of GAR for banks, The European Banking Authority puts forward requirements on reporting on the entire banking book, which is mandatory for Pillar 3 banks. The metric for disclosure is called the Banking book Taxonomy Alignment Ratio (BTAR), which in contrast to GAR, is based on all loans, the entire banking book.
What about BTAR? What should banks keep in mind when dealing with it?
BTAR is a whole different game than GAR for european banks and will require them to roll up their sleeves and get to work. In response to this game-changer requirement, the European Banking Federation (EBF) formulated guidelines for banks on practically approaching this, based on input from a range of large European banks.
EBF states that the new requirement means that banks will have to base BTAR on loans to both NFRD and Non-NFRD companies, which then includes both EU SMEs and Non-EU clients. When calculating the score of loans, the EBF says banks should:
- "Proactively collect data"
on exposure whenever possible;
- Be cautious with estimates
e.g., estimates that are based on NACE codes;
- Use the "main activity" approach for SMEs
meaning that an SME score can be based on its performance in their main EU taxonomy activity;
- Seek information on all the activities of large companies
also for large Non-EU clients;
So, what now?
The lack of data in ESG means that basing EU taxonomy scoring of loans purely on outside-in evaluations, using proxy data and estimates will not provide accurate results - and is, in fact, not even allowed. Such data can, however, be used for additional context when reporting; EBF specifies:
"Given that estimates and proxies are not allowed for the mandatory reporting under Article 8 of the Taxonomy Regulation, banks can leverage such voluntary disclosures based on estimates and proxies to contextualize their mandatory reporting."
Thus, banks need to use the data they have on their clients or proactively collect data if they cannot determine their scores based on their existing data. In reality, only some banks will have data that may help them assess their clients' taxonomy scores beyond the rough indication that NACE codes may provide.
The EBF says self-assessment forms may do the job when collecting the data from clients: "Banks may consider collecting the necessary information through questionnaires and self-assessment forms." These may "be tailored to the clients."
What are the best practices for banks regarding the EU taxonomy?
We compiled a list of recommendations that are based on the EU taxonomy legislation from Brussels, the new requirements to come from the European Banking Authority, and the guidelines provided by the European Banking Federation:
Determine which loans may qualify for the EU taxonomy based on existing customer data
such as NACE code or other industry information, and that have a fair likelihood of a significant score (10%+)
→ This gets you a subset of all your loans to avoid bothering most of your clients with data requests.
Provide most clients with a simplified "main activity" focused self-assessment form
distributed on a website via e-mail and taking no more than 10-15 minutes to complete
→ This gives you an appropriately precise score for most of your loans.
Provide large clients with a self-assessment form that collects data on multiple of their activities
and if necessary, have your customer managers complete the forms or help your clients with it.
→ This gets you higher accuracy scores for the remaining large clients, significantly affecting the bank's score.
And, of course, the EU taxonomy is in continuous development, so make sure that the framework you use gets updated so that clients provide you with the correct data and get the right results.
Taking advantage of green asset calculations
One potential adverse effect of the green asset ratio for banks is that some may be motivated to manipulate their reported green assets to improve their ratios' optical performance. This could involve shifting assets between different regulatory jurisdictions to take advantage of more favorable green reporting standards or storing non-green assets in jurisdictions with more favorable standards to improve the appearance of the green asset ratio for European banks.
While these practices may allow banks to present themselves as more environmentally sustainable than they are, they could ultimately undermine the integrity and effectiveness of the green asset ratio for European taxonomy as a measure of sustainability. By artificially inflating the reported value of green assets, banks may be able to mislead investors and other stakeholders about the true sustainability of their operations and investments.
Furthermore, these practices could negatively affect the transition to a low-carbon, climate-resilient economy. Banks can deflect pressure to adopt more ambitious green policies and practices by presenting a distorted picture of their sustainability efforts. This could slow the pace of transition and undermine efforts to address the urgent challenges posed by climate change and environmental degradation. On the other hand, EU taxonomy reporting for companies is quite different.
Celsia is here to help
Questions? We love discussing the EU taxonomy reporting for banks. Feel free to reach out (or ask us whether we have a solution in line with the three recommended steps above - spoiler alert: we do!)
Find our pricing for EU taxonomy assessment here.
The green asset ratio is a financial measure used to assess the sustainability of a company or investment portfolio. It is calculated by dividing the total value of a company's or portfolio's environmentally friendly assets by the total value of all of its assets.
Green assets are those that are deemed to have a positive environmental impact, such as renewable energy projects, sustainable agriculture, and eco-friendly products. The higher the green asset ratio, the greater the proportion of a company's or portfolio's assets that are dedicated to environmentally friendly initiatives.
Investors may use the green asset ratio as a way to assess the sustainability of a company or investment portfolio and to make informed decisions about where to allocate their capital. Companies with a high green asset ratio may be seen as more socially responsible and may be more attractive to investors who prioritize environmental and social concerns.
In the context of a bank, taxonomy reporting can affect the entire value chain in several ways:
- Investment decisions: By classifying financial assets according to their ESG characteristics, banks can make more informed investment decisions that align with their sustainability goals.
- Risk management: Understanding the ESG characteristics of financial assets can help banks identify and mitigate risks associated with certain investments.
- Stakeholder engagement: Taxonomy reporting can help banks communicate their sustainability efforts to stakeholders, such as customers, investors, and regulators.
- Business strategy: By considering the sustainability impact of their investments, banks can align their business strategy with their sustainability goals and potentially attract more sustainable-minded customers.
Overall, taxonomy reporting can help banks better understand and manage the sustainability impact of their investments, which can in turn support the bank's overall business objectives.
When dealing with the BTAR, banks should keep several considerations in mind:
- Disclosure requirements: The BTAR is a disclosure requirement for banks operating in the European Union. Banks should ensure that they are accurately reporting their BTAR in accordance with the relevant regulations.
- Data quality: Accurate and reliable data is crucial for calculating the BTAR. Banks should have robust processes in place for collecting and verifying the data used to calculate the BTAR.
- Sustainability objectives: The BTAR can be used as a way for banks to assess their progress towards their sustainability objectives and identify areas for improvement.
- Stakeholder engagement: Banks should consider the BTAR when communicating their sustainability efforts to stakeholders, such as customers, investors, and regulators.
Overall, banks should ensure that they are accurately reporting their BTAR and using it as a tool to support their sustainability objectives.
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