The terms Environmental, Social and Governance (ESG) are no longer just buzzwords. The regulations and laws coming into force require concrete action on environmental, sustainability and social issues. In this article, we provide an overview of the topic for banks with relevant requirements, entry points and implementation options in reporting. In addition to the implementation effort, ESG also offers financial institutions support in positioning and decision-making for management and the boards.


Background

The subject of Environmental, Social and Governance (ESG) is becoming increasingly relevant from a regulatory perspective and demands concrete action by banks. In principle, ESG criteria, i.e. standards for the environment, social issues and corporate governance, serve as a guide for assessing the sustainability performance of companies. They increasingly influence the decision-making of investors, customers and regulators. Banks that engage with ESG can strengthen the trust of their customers, better manage their risks and promote long-term sustainability. Regulatory authorities see ESG as important and increasingly require the disclosure of ESG data. ESG is therefore relevant for us as a software manufacturer, too.  We are a supplier to the financial industry and banks that are required to report and disclose. Things get interesting in everyday life when those responsible contact us to implement the regulations in their IT systems. Our software is used at the interface with customers, accordingly the data used for reporting or disclosure is also there. We therefore discuss specific processes and possible implementations with our customers. In this article we give an overview of these topics.

Sustainability requirements relevant for banks

There is a lot to consider when think about sustainability requirements for banks. The issues range from climate targets at EU level to each individual bank management. Various legislative levels apply. Fundamentally, we see the following requirements as currently relevant for implementation for banks:

  • The Corporate Sustainability Reporting Directive (CSRD), the previously introduced Non-Financial Reporting Directive (NFRD) and the additional European Sustainability Reporting Standards (ESRS) oblige enterprises to publish information on the sustainability of their business activities. CSRD, NFRD and ESRS include statements on environmental, social and employee issues, respect for human rights, fighting corruption and bribery, and diversity in the supervisory boards/management. The information must be published in the annual report and be available in a machine-readable format. The reporting requirements apply to financial years beginning on or after January 1, 2024 for public-interest entities with more than 500 employees; from January 1, 2025 for all other large companies in accounting terms, and from January 1, 2026 for capital market-oriented SMEs, unless they take the option of delaying until 2028.
  • The Sustainable Finance Disclosure Regulation (SFDR) leads to transparency for investors in terms of sustainability. The SFDR requires financial market participants and financial advisors to disclose information on sustainability indicators and principal adverse impacts (PAI) at product level. Under additional requirements applicable since February 20, 2023, financial market participants and financial advisors must disclose the exposure of their portfolios to gas and nuclear energy-related activities, in accordance with the Taxonomy Regulation.The Sustainable Finance Disclosure Regulation (SFDR) leads to transparency for investors in terms of sustainability. The SFDR requires financial market participants and financial advisors to disclose information on sustainability indicators and principal adverse impacts (PAI) at product level. Under additional requirements applicable since February 20, 2023, financial market participants and financial advisors must disclose the exposure of their portfolios to gas and nuclear energy-related activities, in accordance with the Taxonomy Regulation.
  • The ESMA guidelines on the MiFID II suitability requirements, which include the query of sustainability preferences, match this. This means that since August 2, 2022, advisors must document and take into account the sustainability preferences of their clients when providing investment advice and selling insurance-based investment products.
  • Article 8 of the EU Taxonomy Regulation requires financial market participants to disclose certain information when offering financial products that are declared as “environmentally sustainable” in the taxonomy. Companies that are required to provide non-financial reporting must state how their activities are linked to environmentally sustainable economic activities. This is an EU regulation but the exact details and implementation requirements vary depending on national regulations.
  • The EBA Prudential Disclosures pursuant to Article 449a of the Capital Requirements Regulation (CRR) include the disclosure of ESG risks and risk-reducing measures. These include, for example, information on lending to environmentally harmful industries or measures to promote sustainable financing. The adoption of CRR III and IV, which include the “full disclosure” of information but also the implementation of the Basel capital requirements (“Basel IV”), will follow shortly.

From the ESG strategy to implementation in the systems

A person responsible for this aspect must consider what the ESG strategy really aims at. The sustainability requirements for banks outlined above provide a clear picture of what the legislators and regulators want to see and when. Clearly, there is much more than that behind the subject of ESG that should be reported. For instance, social banking, which includes supporting social entrepreneurs, promoting local communities, and reducing internal and external inequality. Most banks and their employees want to meet regulatory and legal requirements, but also to position themselves as a brand, product provider, and employer. This means going beyond the requirements and voluntarily committing to act on some or all relevant aspects of ESG. This positioning requires a target image of what is to be achieved. This target image may be now more wishful thinking than reality. Reporting is already structured so that most banks provide information on ESG in their annual reports. In some cases, information on the mandatory categories must be provided to the financial services supervisory authority. This is where the ESG strategy determines how the target image is to be implemented in the future. Our discussions with the banks concerned show that not all information provided to authorities and regulators has to be complete, but at least the categories.

Reporting of these target figures as intended in the future requires a suitable database. This can be sourced externally or internally. Purchases from external data providers such as MCSI or Bloomberg are always popular. If these specific product providers are selected, they can also make statements about sustainability at product level, which can then easily be aggregated into the portfolio. The portfolio risks are another option for external data suppliers. Especially as regards the assessment of physical uncertainties or environmental risks in the lending business, these data can help to update the assessment without relying on input from the borrowers. Banks often choose that in order to minimize the acquisition of data from customers. This keeps processes efficient, especially in terms of processing times, and does not place unnecessary burdens on customers. The situation is different with data that can only come from customers. An example is currently the energy efficiency and emissions of real estate, which are included in project energy certificates. The public accessibility of such data may change in the future. In addition, there are already several providers for business customers who can furnish the data on supplier networks and their assessment of the sustainability of the supply chain, or enable the invitation of new suppliers. However, internal data are also usually relevant for reporting. These data in particular are important for the CSRD. They must come from internal departments and must be systematically acquired. All of the data categories must be implemented in the IT systems and data sets.

Conclusion

The implementation of ESG is very positive. The interactions between the bank and bank customers and within the bank are becoming more sustainable and transparent. The ESG strategy is visionary and implementation (especially with customers and in the IT system) is not easy. However, this is the same with any other aspect of strategy implementation. Regardless of where the data come from, they must be integrated into the processes and data sets. This enables using the data in decision-making. These decisions should (in our view too) be made in the banks and by their decision-makers rather than by the legislators and regulators. We find it positive in our discussions that the corporate sector is a lot further ahead than the private customer sector as there is greater leverage for change there. If transparency rises, conclusions can also be drawn from it, both in the business strategy and with customers, but also with employees.

If we have not mentioned requirements that apply to you, please contact us directly or comment under the article on LinkedIn https://www.linkedin.com/pulse/esg-banken-vom-green-deal-zu-datenquellen-f%25C3%25BCrs-reporting-uniquare-dsrkf/?trackingId=wFxe8h51TKSYqwp9wLVw3Q%3D%3D. We are also open to discussing new requirements and their impact on you.

#ESG #Banken #Regulatorik #Nachhaltigkeit #CSRD #NFRD #ESRS #SFDR #CRR


Please, note: The basic version of this article and the images were created using AI (GPT-4 and DALL-E-3).