stability monitoring purposes, the supervisory authorities and regulators are
continually integrating ESG risks into Capital Markets supervisory requirements.
A financial sector risk assessment of potential impacts due to climate risk has
become one of the major priorities for regulators. In March 2021 the European Banking Authority (EBA) published a proposal on how banks should
disclose their activities in an EU-Taxonomy compliant manner. As a result, the
authority requires banks to determine the Green Asset Ratio (GAR), which indicates
the “green” proportion of a portfolio. The final rules are due to come into
force in 2022. Banks will then be required to start with GAR related disclosures.
Since the timetable is tight, banks are now encouraged to take action and to start
their preparations in order to integrate the taxonomy-compliant information into
their system & data infrastructure. Quantitative indicators like the GAR
capture both risk and opportunities, and allow for a comparison between
portfolios. Therefore, banks are advised to participate in supervisory driven pilot exercises since this is expected to
give them a competitive advantage. In addition, it will help them to influence
the final outcome.
The EU Commission
mandated EBA to identify Key Performance Indicators
(KPIs) and methodologies for the disclosure of taxonomy-compliant activities to
be used by those banks subject to the EU Non-Financial Reporting Directive
(NFRD). These are all EU credit institutions, insurers and non-financial
companies with more than 500 employees and listed securities on a regulated
market of an EU member state. What followed is a proposal by the EBA in March
2021, according to which banks and investment firms are to determine and
disclose (among other things) the "Green Asset Ratio" (GAR) in future. The GAR is part of the so-called
"Green Deal" of the EU.
The GAR is not a
stand-alone ratio. Rather, it is a set of three GARs - the "GAR
Stock", the "GAR Flow" and finally the "Non-EU GAR".
There are also four accompanying KPIs that provide information on the taxonomy
compliance of the trading book, financial guarantees, assets under management
and fee income generated by services other than lending and asset management.
The EBA identifies
the GAR Stock indicator as the most important KPI. This indicator provides
information on the taxonomy compliance of a bank's assets as of a specific
reporting date. This backward-looking information is to be complemented by the
GAR flow indicator, which provides a more dynamic disclosure on green funding
trends. Non-EU financing, on the other hand, is to be recorded under the non-EU
GAR. Compliance with the latter indicator can be done on a
"best-effort" basis. In addition, banks are expected to disclose
their forward-looking objectives and strategy in relation to climate risk. This is to provide information on how banks
are managing climate change-related transition risks and opportunities.
On 21 May 2021,
the EBA published a GAR estimate of around seven to eight per cent for EU
medium to large corporate exposures across a sample of 26 large banks (EBA/2021/Rep/11).
These low GARs are no surprise. Due to the taxonomy, low GARs are still to be
expected initially. Most of the companies and real estates for which banks
provide financing are not yet compliant with the EU taxonomy. The draft
delegated regulation on the implementation of GARs presented by the Commission
in May 2021 could even result in initial ratios that are still below the EBA's
estimates. These estimates assumed that the green classification of a
relatively small proportion of banks' exposures of a limited subset of
taxonomy-eligible assets would be in line with its own GAR proposals of
February 2021. In contrast, the Commission proposes to match taxonomy-compliant
assets with a broader range of exposures. As expected, this would result in a
drop in ratios. Under the draft regulation, derivatives,
trading book securities, interbank loans and loans to industries not covered by
the EU taxonomy must be included in the denominator of the GAR calculation.
This would lead to lower ratios for banks whose activities are less covered by
the EU taxonomy (as capital markets business).
2. GAR and internal risk management
In the past, when
bank supervisors tested newly developed supervisory initiatives in pre-studies,
it has always turned out that the associated and legally binding requirement to
do so did not take long. This applies especially
to supervisory indicators and ratios. With the development of the GAR and the
first corresponding disclosure exercises, the banking sector could face the
As things stand,
the GAR is (still) in its infancy. In the long run, however, it remains to be
seen in what form the ratio will find its way into European banking supervision
law. Is the GAR an exercise that will be discarded because financial markets players
are not (yet) ready for the determination, analysis & control of the
indicator? Could the GAR become mandatory "exclusively" in the form
of disclosure requirements? Or will the GAR also have an impact on the capital
adequacy of assets in the future? The answers to these questions will primarily
have major implications for the bank´s risk managers "of tomorrow".
It is already
clear today that overall bank management is changing significantly. In times of
pressure on earnings and margins, it is more essential than ever to understand
revenue and cost drivers in detail in order to be able to take the right next
steps from a strategic and operational perspective. Obviously, bank supervisors
have recognised the need to acknowledge "green" activities of the financial
sector as an important driver of the future with an impact on revenues and
A closer look at
the initiatives that regulators have developed, published and tested in a very
short period of time under the guise of "ESG" leads to one central conclusion
in this context: in the long run, the banking industry will have to integrate
the topic of "green activities" not only in its marketing strategy,
but also in its overall risk management. The revised CRR/CRD package contains a
mandate addressed to the EBA (Art. 98; point 8 of the CRD), on the basis of
which the European supervisory authority is mandated to develop appropriate
criteria as well as stress testing processes and scenarios to be applied by
banking institutions for the purpose of assessing the impact of ESG risks. This
includes the assessment of the impact of adverse environmental developments on
the financial position. Furthermore, the methods should also include
quantitative and qualitative risk control mechanisms that are expected to be
used in bank control and risk management. The relevance of the GAR for bank
management should be obvious at this point at the latest.
that bank supervisors are paying a great deal of attention to the topic of
"green" activities is provided by the initiation of so-called
"pilot exercises" at an early stage. The focus of these pilot
exercises is to test the banks' ability to identify, classify, evaluate and
efficiently manage their own portfolios using the EU taxonomy. Furthermore, the
exercises aim to determine how existing and newly developed approaches/tools
for the classification of climate risks are performing and to what extent the
institutions are already in a position to sufficiently identify and manage
indicators such as the GAR and to master the challenges in connection with
"taxonomy-compliant" data requirements.
While this is
currently still a supervisory exercise under the direction of the supervisory
authorities, it could become a binding regulation in three to five years, which
is how long it takes to implement a new regulatory requirement. Against this
background, it is even more important to use the insights gained from the
"pilot exercises" to support the transition efforts of the banks. The
transition aims at the willingness to invest in companies that are not yet
sustainable and to actively support them on their way to sustainability.
Besides the taxonomy-compliant data requirements, this is sometimes one of the
most significant challenges.
integration of GAR into the overall risk management becomes mandatory, banks
are encouraged to deal with the challenges at an early stage. The establishment
of an internal GAR culture and infrastructure is indispensable for efficient
GAR management. To this end, a process-related reorganisation is necessary in
some areas. Above all, the data requirements and information needed to
determine GAR are new in nature and need to be analysed and connected. As
expected, there will be data and information bottlenecks for some activities
and counterparties. For example, when classification according to taxonomy
requirements is not possible. In these cases, solutions are needed that can be
used to fill data gaps, e.g. through "data sourcing" or
examination of the "mechanics" of the ratio represents another
essential field of action, as the GAR may have to be evaluated within the
framework of risk-bearing capacity (ICAAP or ILAAP). Furthermore, early
consideration of the functioning of the ratio is indispensable when it comes to
modelling adverse scenarios and simulations, which are also an integral part of
the normative perspective. However, stress tests and modelling can only be
developed meaningfully if risk managers and bank controllers have a sufficient
picture of which parameters affect the ratio and in what form
(positive/negative). Thus, it will also be essential for the market units to
understand which of their activities and counterparties trigger a "good
degree of green" for the ratio and which do not, or to what extent the
earmarking of financing can trigger an influence on the amount of the ratio.
3. GAR and implications in the context of
concept of market discipline within the banking sector stems from Pillar III of
the regulations developed by the Basel Committee on Banking Supervision.
Primarily, the market discipline regulation requires banks to disclose
predefined prudential information and ratios, especially on regulatory capital.
This is intended to provide market participants with a comprehensive insight
into the risk exposure as well as the capital base of an individual bank in order
to strengthen self-regulatory market forces.
The banking sector will thus be "disciplined" through the
requirements by market participants to provide information that is conducive to
day-to-day business with investors or other stakeholders.
What this means in
concrete terms for the disclosure of the GAR, in its role as a central “green” indicator
developed by the EBA, and what the supervisory authorities see as the timetable
for mandatory disclosure, is explained in more detail below.
from banking experts assume that the disclosure of a GAR could increase,
especially for capital market-oriented banks. Market observations make it clear
that the zeitgeist of potential clients, capital providers and other
stakeholders has shifted drastically in the direction of sustainable and
ecological claims. Furthermore, the banking sector is subject to implementation
pressure in terms of policy and regulatory initiatives on these issues. GARs
are expected to contribute to the preference for "greener" financing
over "brown" financing in the future. There is also a risk that
institutions will come under refinancing pressure if investors with high
sustainability requirements withdraw deposits from banks that report too low
ratios. In this context, there is also a potential interaction with the SFDR,
Since March 2021,
the SFDR obliges all investment managers to declare/disclose whether their
funds/products promote environmental or social characteristics (so-called Art.
8 funds) and whether their funds/products target sustainable investments
(so-called Art. 9 funds). In turn, the SFDR is expected to lead to a surge in
demand from asset managers for investments that meet sustainable criteria. In
this respect, GARs and SFDRs could complement each other. For example, it is
conceivable that the debt instruments of banks will be excluded or included in
ESG-labelled funds. This creates a direct link to reputational risk.
In connection with
the GAR disclosure under banking supervision law, the first fields of action
are already foreseeable: the EBA envisages in principle that the GAR will not
only be disclosed in the sense of quantitative quota values, but that
qualitative information on the indicator will also be published, which should
benefit the overall understanding of the markets:
contextual KPI information, e.g. balance sheet items and activities considered
within the indicators, details on data sources and data gaps, use of proxies,
estimates and other approximation parameters;
on the evolution of taxonomy-aligned activities over time, taking into account
different types of drivers;
of taxonomy integration within the banking strategy, including objectives,
product design, processes and engagement with clients and counterparties;
that are not subject to the disclosure requirement of “held for trading”
balance sheet items must additionally disclose qualitative information on the
alignment of the trading portfolio with the taxonomy (e.g. composition,
observed trends, targets and internal policies);
information disclosing a better picture of the institution's strategy in
relation to the financing of sustainable activities.
The final rules,
announced by the European Commission on 6 July, are due to come into force in
2022. Banks will be required to make limited disclosures in 2022. The full set
of KPIs will not have to be disclosed until 2024. The timetable is tight. Banks
need the time to integrate the taxonomy-compliant information they require from
large listed companies. These will not start publishing this information until
early 2022 under the EU's Non-Financial Reporting Directive (NFRD). Only such
information published by NFRD companies will be included in the numerator of
the GAR when it is introduced. Loans that do not fall within the scope of the
NFRD - such as SME loans - are not part of the GAR.
exposures to non-NFRD entities that publish the required data for GARs will be
integrated from 2025, subject to EU Commission approval. Banks will not be
required to publish KPIs that take into account their trading books or
commissions and fees for commercial services other than the provision of
financing until 2026.
order to comply with the EBA's disclosure proposals, institutions must first
collect detailed information on their loan and securities portfolios in order
to be able to harmonise balance sheet items with the classification
requirements of the EU taxonomy.
Subsequently, there will be a need for reassessments
- especially for those companies with high greenhouse gas emissions - and
disclose them accordingly.
When the EBA
prepared its report (EBA/2021/Rep/03), the supervisory authority prepared in
parallel the draft ITS on ESG risk disclosure in the sense of Article 449a CRR.
According to the EBA, the parallel development of both documents was considered
necessary to ensure consistency in definitions and methodologies. If GAR
disclosure requirements were to be included in the ESG Pillar III - ITS in accordance
with Art. 8 of the EU Taxonomy, this would have certain implications. Firstly,
the templates would have to fully comply with the information required under
Art. 8 and furthermore, the GAR information should only be provided when the
delegated act on the taxonomy for financial undertakings becomes applicable.
Furthermore, in this case, the transition periods to be determined by the EBA
in the context of the draft ITS would have to be aligned for certain groups of
risk exposures, in particular those of non-financial undertakings.
recommendation, banks should already prepare for the GAR disclosure
requirements. The results from the first supervisory bank surveys on the
biggest impacts in connection with the implementation of the GAR further
confirm this. The EBA asked a selection of banks and associations where they
expected the biggest cost drivers of the implementation. Seven out of a total
of ten large banks from five jurisdictions took part in the survey. According
to the survey, the most significant cost drivers are seen in the following
fields of action:
and research efforts in connection with data requirements, including the
personnel resources to be deployed for this purpose,
of staff to understand new GAR requirements,
of the IT framework
European Banking Authority also received feedback from the banks surveyed that
initial attempts had been made to actively integrate sustainability aspects
into business models (e.g. through multi-year business transformation
initiatives, participation in supervisory impact studies such as those
conducted by the EBA, or also partly through in-house developed methods for
measuring climate risks). Although at a very early stage, only one of the banks
reports that a KPI has already been implemented, which in parts follows the
requirements of the EU taxonomy. In addition, initial staff training on sustainability
issues and the integration of these into the "Client Relationship
Management" (CRM) are said to have taken place. The EBA received feedback
from the smaller banking institutions that the processes for integrating ESG
issues into the strategy or risk management have not yet started.
The process of
integrating climate risks into financial stability supervision has started.
Quantifying the potential impact of climate risks on the banking sector has
become a priority for regulators. This is reflected not only in the GAR, which
has received particular attention through initial disclosure testing, but also
in the taxonomy to which the GARs refer. In any case, the GAR is to be
welcomed, because the ratio illuminates a previously unconsidered area in a standardised
and comparable manner. However, it still seems too early to assess whether the
ratio can contribute to making environmental data on loans and investments of
EU banks comparable. It is important here that banks do not
"greenwash" their relevant balance sheet items for the determination,
measurement and reporting of the GAR in order to achieve better results.
Against this background, the EBA plans to supervise the first disclosure
according to taxonomy classification and, if necessary, to sharpen existing
requirements based on these observations. Here is where banks are encouraged to
participate in supervisory driven pilot test exercises since this will give
them a competitive advantage and will help to influence the final outcome.
As long as the
comparability is not yet given, it also remains to be seen to what extent
stakeholders are convinced of the quality of the GAR and include it in their
decisions. The estimates made so far by institutions and the first attempts to
determine the GAR show that there are significant differences in the ratios.
Both regulators and the banking sector have a lot of work ahead of them. The
development of a uniform playing field as well as uniform data definitions and
methods are essential here. Furthermore, the first critical voices are
currently discussing that the GAR could possibly have disadvantages for the
European banking market if the foreign banking sector refrains from introducing
development of the ESG risk framework is one of the EBA's priorities for the
coming year. Here is an excerpt:
– ESG: provide tools to measure and manage risks
will monitor the effective implementation of ESG disclosure standards in 2022
of key ESG metrics, such as the Green Asset ratio and gradually expand the
scope of disclosure reflecting the development of the EU taxonomy and data
the publication of the EBA report on ESG risk management and supervision, and
the technical standards for ESG disclosure, the EBA will continue investigating
these risks, to inform risk assessment and policy making, and ultimately
incorporate ESG risks into the risk management and supervision part of the
Single Rulebook. As advised by the ACP, the EBA will pay particular attention
to the specificities of SNCIs during this process to ensure proportionality is
will implement ESG considerations into its policy development via ESG impact
assessments and will progress in incorporating ESG risks into its risk analysis
and stress testing. The EBA will prepare a report for consultation on a
potential prudential treatment of assets associated with environmental and/or
social objectives. The EBA will also continue to participate in global,
European and national initiatives in this regard, such as the Platform on
Sustainable Finance and Network for Greening the Financial System also as
strongly encouraged by the EBA’s ACP.
the Renewed Sustainable Finance Strategy of the Commission (expected to be
published in 2021), the EBA envisages additional mandates to incorporate
sustainability into financial services and improve ESG risk management. Based
on the Commission’s consultation on the Renewed Sustainable Finance Strategy,
areas where potential mandates might be directed to the EBA include green
securitisation, green bonds, ESG risk management tools and ESG reporting
 In its most recent report, the EBA
called for ten-year plans for dealing with climate risks to be drawn up:
Management and Supervision of ESG Risks for Credit Institutions and Investment
Fanos Adams has over 7 years of consulting experience. She combines risk management expertise with a distinct Capital Markets focus and a profound knowledge of the European banking domain & supervisory initiatives and regulations.
HANS JOACHIM LEFELD
ESG Consulting Partner
Hans Joachim Lefeld is Partner in LPA´s Frankfurt-based consulting team.
He has over 20 years of end2end regulatory reporting expertise and is LPA´s
responsible ESG Consulting Partner.
Christian Behm is partner in LPA´s Frankfurt-based risk consulting
team. He has over 15 years of experience in executing regulatory required risk
assessments under the so-called supervisory normative risk perspective.
NICKY MARCO HEBER
ESG Campaign Lead
Nicky Heber has over 10 years of consulting experience in the European
Capital Markets sector, ranging from banks to clearing houses and asset
He is LPA´s ESG
campaign lead for our international banking clients and partners.