ESG Financial Institutions & regulation update

NZBA publishes supporting notes to the Guidelines for Climate Target Setting
In May, the Net-Zero Banking Alliance (NZBA) published supporting notes to clarify several aspects of the Guidelines for Climate Target Setting for Banks (version 2) which were adopted by NZBA members in March 2024. The supporting notes address, among other things, variations in methodological and technical approaches to setting climate targets. They also clarify considerations regarding the materiality of different emission types and sources, outline different scenario types that banks may encounter, define the scope of financial activities and sectors that should be included in target setting processes, and provide reporting expectations.

ESMA publishes position paper on EU capital markets
On 22 May, the European Securities and Markets Authority (ESMA) published a position paper entitled ‘Building more effective and attractive capital markets in the EU’. The paper sets out 20 recommendations to strengthen EU capital markets and met the needs of European citizens and businesses. ESMA's recommendations for a well-functioning capital market focus on three dimensions: citizens, businesses and the EU regulatory and supervisory framework. One of the recommendations is to promote EU capital markets as a hub for green finance, which should include efforts to simplify sustainability disclosures, including through the use of sustainability labels and categories where appropriate.

NGFS publishes report on sustainable and responsible investment in central bank portfolio management
On 16 May, the Network for Greening the Financial System (NGFS) published a report with ten non-binding recommendations on sustainable and responsible investment (SRI) in central bank portfolio management. These recommendations outline how central banks can further integrate sustainability considerations into their investment practices without losing sight of the effectiveness of their approach. The first four recommendations focus on integrating sustainability considerations into governance. Recommendations five and six relate to the assessment of exposure to sustainability factors. Recommendations seven and eight deal with the implementation of SRI policies, and recommendations nine and ten with reporting practices and the evaluation process.

ESMA guidelines on fund names using ESG or sustainability terms
On 14 May, the ESMA published guidelines outlining the circumstances under which fund names using ESG or sustainability-related terms may be considered unfair, unclear, or misleading. The guidelines also clarify what investors may expect in terms of policies, practices and features of funds that meet sustainability standards. The guidelines will apply to UCITS and AIFs, EuVECA, EuSEF, and ELTIF, and money market funds. The guidelines will apply three months after their publication on the ESMA website, and immediately for newly created funds.

AFM publishes two reports on SFDR compliance
On 14 May, the Dutch Authority for Financial Markets (AFM) published two reports assessing financial institutions’ adherence to the SFDR and their incorporation of sustainability considerations into product oversight and governance (POG) procedures and suitability assessments. The first report covers the use of templates in line with the Level 1 SFDR-requirements. The AFM expects all financial institutions to comply with these SFDR provisions. Insufficient compliance efforts will be addressed through regulatory action. In addition, further granularity is required in both the use and completion of these templates. The second report focuses on the POG and suitability standards within investment firms. While steps have been taken to integrate sustainability into policies and products, there is still room for enhancement, particularly in explaining sustainability preferences in a way that is understandable for clients. Investment firms are encouraged not only to incorporate sustainability considerations into their POG policies, but also to review their product offerings accordingly to avoid potential mismatches. Both reports offer guidance and illustrative examples.

ECB blog by Frank Elderson: "2024 is a crucial year for banks to make decisive progress in becoming more resilient to C&E risks"
On 8 May, the ECB published a blog post by its board member Frank Elderson. The blog outlines good and ‘bad’ practices in banks' materiality assessments and identifying climate-related risks. It also discusses the way forward for the ECB's expectations on the management of climate and environmental (C&E) risks. "By the end of this year, we expect all banks under our supervision to be fully aligned with all our supervisory expectations on the sound management of C&E risks", says Elderson.

ECB updates climate-related indicators
On 18 April, the European Central Bank (ECB) updated its climate-related indicators, providing systemic insights, both into how financial markets are tackling the green transition and how financial institutions may be affected by climate change. The modifications relate to green bonds and banks' credit portfolios. For green bonds, the indicator now distinguishes between self-declared sustainable bonds and those that have undergone a second external assessment in order to provide more information to investors. For banks' loan portfolios, the updated version allows the data to be analysed as a consistent time series. In addition to these changes, the ECB has introduced the Collateral Adjusted Exposure at Risk (CEAR) indicator, which aims to quantify potential losses in financial terms and to allow comparison across different exposures. The ECB published also a paper about climate-related indicators, outlining the methodology, underlying data, and findings in three areas: sustainable finance, carbon emissions, and physical risk, respectively.

NZAOA releases new edition of Target-Setting Protocol
On 18 April, the Net-Zero Asset Owner Alliance (NZAOA) published the fourth edition of its Target-Setting Protocol, accompanied by a background document. The Protocol now covers all private asset classes, and the majority of all major asset classes. It requires members to set targets for the period 2025-2030 aiming for a 40-60% reduction by 2030 compared to 2019 on a comply-or-explain basis. The NZAOA also launched a pilot project to assess the climate impact of sovereign debt using the ASCOR database.

NGFS publishes transition plan package
On 17 April, the Network for Greening the Financial System (NGFS) published the report 'Connecting transition plans: financial and non-financial firms'. The report explores the relationship between financial institutions and the transition plans of their clients and counterparties. It is published alongside two other reports: Tailoring transition plans: considerations for EMDEs and Credible transition plans: the micro-prudential perspective. The reports provide complementary perspectives on related topics and help to establish further foundational understanding of the relevance of transition planning and plans for micro-prudential authorities.

BCBS publishes discussion paper on climate scenario analysis and risk management
On 16 April, the Basel Committee on Banking Supervision (BCBS) published a discussion paper on how climate scenario analysis (CSA) can be used in practice to strengthen the management and supervision of climate-related financial risks. In 2022, the BCBS published the Principles for the effective management and supervision of climate-related financial risks to encourage banks and supervisors to use CSA to assess the resilience of business models and strategies to a range of climate-related pathways and determine the impact on their overall risk profile. However, differences in the scope, features and approaches of CSA exercises across jurisdictions and banks limit the harmonisation of supervisory expectations and the comparability of results. The BCSB is therefore seeking stakeholder feedback, which may lead to complementary work to strengthen bank regulation, supervision and practices worldwide with a view to enhancing financial stability. Feedback can be submitted until 15 July.

UNEP FI launches resources to support banks with CSRD implementation
On 4 April, the United Nations Environment Programme Finance Initiative (UNEP FI) released a UNEP FI - PRB / ESRS Interoperability Package. It aims to assist banks in leveraging the alignment between the Corporate Sustainability Reporting Directive (CSRD) and the Principles for Responsible Banking (PRB) by using the UNEP FI Holistic Impact Methodology. The package includes a user guide, topic and data point mappings, and a conversion tool to extract relevant data points from the UNEP FI Portfolio Impact Analysis Tool for Banks (Version 3) for CSRD reporting.

EIOPA launches consultation on natural catastrophe risk reassessments under Solvency II
On 3 April, the European Insurance and Occupational Pensions Authority (EIOPA) launched a consultation on the reassessment of natural catastrophe risks in the standard formula under Solvency II, as to better capture the risks posed by certain perils. New risk factors have been proposed for 25 perils/regions across five perils (flood, hail, earthquake, windstorm, subsidence). Additionally, EIOPA has proposed to extend the standard formula to countries with natural catastrophe risks not previously covered, such as flood exposure in the Netherlands. EIOPA is also monitoring emerging perils (beyond the five included in the standard formula) across Europe that could have a significant impact on the region’s insurance sector, including wildfire, coastal flooding, and drought. The consultation period ends on 20 June.

ESMA consults on possible changes to the regulatory framework for credit rating agencies
On 2 April, the European Securities and Markets Authority (ESMA) launched a consultation on proposed amendments to Commission Delegated Regulation (EU) No 447/2012 and to Annex I of the Credit Rating Agencies Regulation (CRAR). The proposals aim to ensure a better incorporation of ESG factors into credit rating methodologies and subsequent disclosure to the public, and to enhance transparency and credibility of the credit rating process. In particular, they aim to (i) ensure that the relevance of ESG factors within credit rating methodologies is systematically documented; (ii) enhance disclosure on the relevance of ESG factors in credit ratings and rating outlooks; and (iii) provide a more robust and transparent credit rating process through the consistent application of credit rating methodologies. The consultation closes on 21 June.

ESMA launches consultation on rules for 'external reviewers' of EU green bonds
On 26 March, the European Securities and Markets Authority (ESMA) launched a consultation on Draft Regulatory Technical Standards (RTS) relating to the registration and supervision of external reviewers under the EU Green Bond Regulation (EuGB). ESMA's proposals aim to clarify the criteria used for assessing an application for registration by an external reviewer, to standardise registration requirements and to contribute to the development of a level playing field through lower entry costs for applicants. ESMA will consider the feedback received in this consultation and will submit the draft RTS to the EC by 21 December 2024.

ECB publishes study ‘Business as usual: bank climate commitments, lending, and engagement’
On 22 March, the European Central Bank (ECB) published a study on the impact of voluntary climate commitments by banks on their lending activity and on the climate impact of borrowing firms. Overall, the results cast doubt on the efficacy of voluntary climate commitments for reducing financed emissions, whether through divestment or engagement. Making a commitment leads to an increase in a lender's ESG rating. Lenders reduce credit in sectors they have identified as high priority for decarbonisation. However, climate-aligned banks do not change their lending or loan pricing differentially compared to banks without climate commitments, suggesting that they are not actively divesting. Climate-aligned lenders do not divest more than 2.6% from firms in targeted sectors. Corporate borrowers are no more likely to set climate targets after their lender sets a climate target, casting doubt on active engagement by lenders.

EIOPA publishes factsheet on taxonomy alignment of occupational pension funds' investments
On 14 March, the European Insurance and Occupational Pensions Authority (EIOPA) published a factsheet summarising the sustainable characteristics of investments made by occupational pension funds based in the European Economic Area (EEA). The factsheet shows that 4.5% of the investments issued by EEA-based funds were aligned with the EU Taxonomy, with a further 26.1% eligible for alignment with sustainable criteria. A breakdown shows that 9% of corporate bonds were Taxonomy-aligned (42% eligible) and 1% of equities were Taxonomy-aligned (15% eligible).

NZBA publishes second version of the Guidelines for Climate Target Setting for Banks
On 13 March, the members of the UN-convened Net-Zero Banking Alliance (NZBA) adopted a new version of the Guidelines for Climate Target Setting for Banks. The guidelines demonstrate a continued commitment to achieving net-zero by 2050 or sooner, and to setting intermediate 2030 targets that are consistent with the latest science, using low or no overshoot 1,5 degrees scenarios, and covering all or a substantial majority of nine carbon-intensive sectors. For the first time, the scope of the targets will be extended beyond lending and investment activities to include banks' capital markets activities.

ECB publishes study ‘Greening the economy: how public-guaranteed loans influence firm-level resource allocation’
On 13 March, the ECB published a study on the reasons why banks' continue to support fossil fuel-based firms. It examines the role of public guaranteed loans (PGLs) in redirecting resources towards greener economic activities, thereby facilitating the climate transition process. The study has three main findings: (i) European banks perceive lending to green companies as riskier than to their brown counterparts (green transition risk); (ii) European banks have strategically leveraged PGLs to channel resources towards environmentally sustainable activities during the COVID-19 pandemic, thereby increasing the proportion of green loans in their portfolios and partially shifting the inherent ‘green transition risk’ to European governments and citizens; and (iii) a preference by banks for awarding PGLs to financially robust green firms rather than less profitable, highly indebted green firms, which could pose significant challenges for green businesses in need of financial support during the COVID-19 crisis.

DNB publishes analysis of financial institutions' climate plans
On 8 March, De Nederlandsche Bank (DNB) published a report analysing the climate action plans of around 50 banks, insurers, pension funds and asset managers. The analysis shows that financial institutions have developed strategies to achieve their (self-imposed) climate targets. However, these strategies often lack specificity and a clear link to the targets. The institutions also provide little insight into which functions within the organisation are responsible for implementing the plans. DNB emphasises the importance of actually implementing the action plans in order to avoid reputational risks, and the importance of a common reporting format and a digital environment for storing and monitoring the plans.

EIOPA publishes paper on demand-side aspects of the protection gap
On 29 February, EIOPA published a revised version of its paper on addressing natural catastrophe protection gaps. The paper examines the underlying causes of the protection gaps from a demand-side perspective and identifies options to address mainly the demand factors. Some of the main ‘solutions’ mentioned to limit the gaps are: (i) increasing risk awareness and coverage, for example through digital tools that can more easily present the risks to which consumers are exposed; (ii) improving consumer understanding and product comparability; (iii) streamlining the consumer journey during the purchasing process; and (iv) reducing insurance premiums by requiring risk mitigation measures to limit insurers’ exposure to risk and incentivising consumers to purchase natural catastrophe coverage.

AFM: Major listed companies are on the right track with transparency on 2030 climate targets, road to 2050 remains vague
On 7 February, the Dutch Authority for the Financial Markets (AFM) published the report Transparent net zero targets require courage, which shows that large public interest entities (PIEs) are moving in the right direction towards substantiating their climate targets up to 2030 in their annual reports. Around half of the companies analysed disclose the scope of emission data and targets, as well as how this data is generated, in a clear and transparent manner. However, the path to 2025 remains blurred and can be improved. For example, the reliability of sustainability information tends to fall short of financial information, which is partly due to limited access to data and uncertainties about the data, particularly for scope 3. In-depth interviews show that relevant internal knowledge on net-zero targets is not always included in management reports. The AFM expects transparent disclosure on uncertainties and challenges, requiring courage on the part of companies. The AFM will provide recommendations, good practices and self-assessments to support such disclosures.

AFM survey: around half of retail investors pay attention to sustainability
On 6 February, the AFM published the results of its research under 711 retail investors (Consumentenmonitor Beleggers). The results show that around half of private investors sometimes or (almost) always consider the sustainability of their investments. Retail investors mainly look at the name of the investment product. However, another AFM survey shows that the name of a product or fund is often not a reliable indicator of its sustainability content. The regulator also stated that it plans to investigate how market participants communicate about sustainability and whether investment firms integrate sustainability as required.

ESMA publishes first TRV Risk Monitor
On 31 January, ESMA published its first Report on Trends, Risks and Vulnerabilities 2024, outlining the key risk drivers currently facing financial markets. While overall markets have remained ‘remarkably resilient’ in the second half of 2023, ESMA notes that, after several years of uninterrupted growth, the uptake of ESG investing and the growth of ESG markets have leveled off in recent quarters. This is evidenced by (i) slower growth in the ESG bond market; (ii) accelerating outflows from SFDR Article 8 funds; and (iii) for the first time, net outflows from Article 9 funds. The report also highlights the improved availability of ESG data and the decline in the price of EU and UK emission allowances.

ECB expands work on climate change
On 30 January, the European Central Bank (ECB) published its climate and nature plan for 2024 and 2025, demonstrating its increased focus on climate change. Three focus areas will guide the ECB’s work on climate and nature in 2024 and 2025: (i) navigating the transition to a green economy; (ii) addressing the increasing physical impacts of climate change; and (iii) advancing work on nature loss and degradation. The work planned in these focus areas will complement the ECB's current climate-related activities in its ongoing tasks, including monetary policy and banking supervision.