By Rudi Lang, Partner, Member of the Group Executive Board and Virginie Mennesson, Head of Regulatory Affairs, Mazars
The performance of banks on sustainability has come under increasing scrutiny from society.
This trend must be understood in the context of a worldwide mobilisation to tackle climate risks and ESG (environmental, social and corporate governance) issues, with individual countries taking decisive actions. The United States’ Biden-Harris Administration has announced a new target to achieve a 50-52-percent reduction from 2005 levels in economy-wide net greenhouse-gas pollution by 20301. Meanwhile, the UK Government has set into law a target to reduce emissions by 78 percent by 2035 compared to 1990 levels—a feat that would bring the United Kingdom more than three-quarters of the way to achieving net-zero emissions by 20502.
The international response to COVID-19 has further oriented public policy towards sustainability. As an example, the European Commission’s (EC’s) rescue package was positioned as an opportunity to “address the damage caused by the pandemic and invest in a green, digital, social and more resilient EU”3.
Mazars’ benchmarking study explores whether banks are playing their parts in this common effort through adjustments to their product ranges, financing activities and risk-management processes.
Mazars’ benchmarking study explores whether banks are playing their parts in this common effort through adjustments to their product ranges, financing activities and risk-management processes—and whether these changes are reflected in their public disclosures and sustainability targets. The sample includes 37 banks across the Americas, Asia and Europe, allowing for a global view of industry practice.
The report concludes that banks’ sustainability practices are improving. UK and French institutions are leading the way—these banks have developed governance structures, strategies and responsible product offerings that aim to support long-term sustainable finance targets. North American banks follow closely; they performed well in most of the areas assessed, in particular ESG disclosures and responsible product offerings.
In the rest of the world, banks still need to improve the integration of ESG risks in their risk-management frameworks and increase their capabilities to measure the risks they face. However, African and South American banks demonstrated good progress on culture and governance, while Asia-Pacific banks performed particularly well with respect to their responsible product offerings.
The results show that banks now view sustainability as a strategic issue, with 68 percent of the sampled banks setting climate-finance objectives. The majority of these banks (54 percent) set targets based on financing volumes rather than setting targets meant to address the real impacts of this financing (e.g., net-zero emissions from financing by 2050).
However, the findings indicate this will likely change in the coming years. For instance, 51 percent of the banks assessed are piloting the Paris Agreement Capital Transition Assessment Tool (PACTA) methodology to measure the alignment of their financial portfolios with various climate scenarios and the Paris Agreement. This will help banks to steer their financing in line with these objectives4.
The uptake of the PACTA can be expected to increase as governments encourage its use. For instance, in Norway, the government will provide financial institutions with free access to the tool5.
To effectively reorient capital towards sustainability, measuring the emissions financed will be key. The fact that only 11 percent of banks disclosed their emissions financed is a testament to ongoing difficulties in measuring Scope 3 emissions, although tools are being developed to address this challenge. One initiative, the Partnership for Carbon Accounting Financials (PCAF), is introducing methodologies to measure emissions financed across asset classes, such as listed equity, corporate bonds and business loans6.
Finally, banks are evaluating their financial risks from climate change. This is a challenging task due to the lack of supporting data, tools and methodologies, and only 22 percent of banks provided quantitative information on the materiality of the climate risks they faced. However, banks are beginning to assess these risks, and 38 percent had already conducted climate-related scenario analyses.
The development of new scenario-analysis tools on the market, such as those assessing companies’ preparedness for the transition to a low-carbon economy, should accelerate this trend—as should the growing number of regulators mandating scenario analysis as a means to measure climate risk. For example, in the next two years, both the Bank of England7 and the ECB8 will have conducted climate-related stress-testing exercises.
The impact of regulation
Regulatory requirements are a driving force behind sustainability in banking. As such, market practice should evolve as regulators enhance their rules on disclosure and risk management and develop green taxonomies.
Global ESG regulation is most developed in the area of disclosures. In 2020, the UK Government published an indicative roadmap to mandate disclosures aligned with guidelines from the Task Force on Climate-related Financial Disclosures (TCFD) across the economy by 20259. In Europe, the Sustainable Finance Disclosure Regulation (SFDR) will require enhanced reporting from financial institutions on the management of their sustainability footprints, the impacts of ESG risks on their returns and financial products marketed as “sustainable”10. At a global level, convergence work between the IIRC (International Integrated Reporting Council), GRI (Global Reporting Initiative) and SASB (Sustainability Accounting Standards Board) reporting frameworks, as well as the potential creation of a global sustainability standard by the IFRS (International Financial Reporting Standards) Foundation, should help to improve the comparability of sustainability disclosures across geographies—although it may be a while before this materialises in banks’ reporting11.
New regulations are also being introduced for ESG risk management. In the UK, the PRA (Prudential Regulation Authority) expects firms to have fully embedded their approaches to managing climate-related financial risks by the end of 2021, with requirements across governance, risk-management and disclosure arrangements12. The ECB (European Central Bank) now expects banks to understand the impacts of climate and environmental risks on prudential risks and put in place adequate governance structures, business strategies, risk-management arrangements and reporting frameworks to deal with these. It has asked significant banks to submit implementation plans on how they will comply with these expectations by May 2021. In 2022, it will conduct a full supervisory review of banks’ practices and take concrete follow-up measures as needed13.
Beyond Europe, the Australian Prudential Regulation Authority (APRA) has published a consultation on managing the financial risks of climate change, which is designed to assist banks in managing climate-related risks and opportunities as part of their existing risk-management and governance frameworks14.
Regulators are also seeking to improve and harmonise the understanding of which activities and assets can be considered “green”. In the European Union (EU), the Taxonomy Regulation will require banks to disclose the alignment of their revenues, capital expenditures and financial portfolios with thresholds defined in the EU taxonomy for sustainable activities. Reporting requirements on climate-related objectives will be applicable from January 1, 2022, and requirements on other environmental objectives will apply from January 1, 202315.
Further afield, on March 21, 2021, the People’s Bank of China (PBOC) announced that China was working with the European Union to adopt a common green taxonomy later this year, a move that could spark a convergence in the disclosure practices of banks in these two geographies16. Meanwhile, the South African government is looking to develop its own Green Finance Taxonomy, with support from the IFC (International Finance Corporation), South Africa’s National Business Initiative (NBI) and Carbon Trust17. These initiatives should help reach a common understanding globally of green activities and assets and are promising developments.
In Europe, French and UK banks have taken leading positions when it comes to sustainability practices. Most have developed governance structures, strategies and responsible product offerings that aim to support the long-term sustainable-finance targets set.
Further progress is needed from all European banks (including UK and France) on climate-scenario analysis, ESG risk management and disclosures. However, we expect market practice to evolve as regulators such as the ECB and Banque de France increase their focus in these areas.
North American banks performed well in most of the areas assessed, notably in their responsible product offerings and on ESG disclosures, where they outperformed French and UK banks on average. However, further progress is needed when it comes to embedding ESG risks within their overall risk-management frameworks.
African and South American banks achieved good scores on culture and governance but underperformed relative to other geographies on their risk management and responsible product offerings.
Asia-Pacific banks evidenced room for improvement in their sustainability strategies, ESG risk management and disclosures, although there are significant discrepancies in practices within the region. On a positive note, these banks performed particularly well with respect to their responsible product offerings.
Future developments on the horizon
The study captures banks’ performance across a broad range of ESG dimensions, but the results reflect a tendency among banks to focus on climate change.
The study captures banks’ performances across a broad range of ESG dimensions, but the results reflect a tendency among banks to focus on climate change. However, we should start seeing future reporting evidence initiatives on social risks as well as other environmental areas.
Ahead of this year’s UN Biodiversity Conference (CBD COP 15), it is likely that biodiversity risks will become more prominent across multiple areas of assessment. On disclosures, we may see growing adoption of reporting aligned with recommendations from the Taskforce on Nature-related Financial Disclosures18, an initiative backed by the United Nations Environment Programme Finance Initiative (UNEP FI) and the World Wide Fund for Nature (WWF), among others.
As we learn more about the risks that biodiversity issues can pose to financial stability, it is equally likely that banks will begin to reflect this in their risk-management practices. In April 2021, the NGFS (Network of Central Banks and Supervisors for Greening the Financial System) and International Network for Sustainable Financial Policy Insights, Research and Exchange (INSPIRE) announced the launch of the joint Study Group on ‘Biodiversity and Financial Stability’19, an initiative that is likely to spark progress in this area.
1 The White House: FACT SHEET: President Biden Sets 2030 Greenhouse Gas Pollution Reduction Target Aimed at Creating Good-Paying Union Jobs and Securing U.S. Leadership on Clean Energy Technologies, April 22, 2021. (https://www.whitehouse.gov/briefing-room/statements-releases/2021/04/22/fact-sheet-president-biden-sets-2030-greenhouse-gas-pollution-reduction-target-aimed-at-creating-good-paying-union-jobs-and-securing-u-s-leadership-on-clean-energy-technologies/)
2 GOV.UK: UK enshrines new target in law to slash emissions by 78% by 2035, April 20, 2021.(https://www.gov.uk/government/news/uk-enshrines-new-target-in-law-to-slash-emissions-by-78-by-2035)
3 European Parliament: Covid-19: the EU plan for the economic recovery, December 17, 2020. (https://www.europarl.europa.eu/news/en/headlines/priorities/eu-s-long-term-budget/20200513STO79012/covid-19-the-eu-plan-for-the-economic-recovery)
4 2° Investing Initiative (2DII): 2° Investing Initiative launches PACTA for Banks, a first-of-its-kind climate scenario analysis toolkit, September 15, 2020. (https://2degrees-investing.org/pacta-for-banks/)
5 Bloomberg Quint: “Banks in Norway Offered Free Climate-Risk Tool by Government,” Frances Schwartzkopff, April 14, 2021. (https://www.bloombergquint.com/onweb/banks-in-norway-offered-free-climate-risk-tool-by-government)
6 Partnership for Carbon Accounting Financials (PCAF): The Partnership for Carbon Accounting Financials (PCAF) launches first global standard to measure and report financed emissions, November 18, 2020. (https://carbonaccountingfinancials.com/newsitem/the-partnership-for-carbon-accounting-financials-pcaf-launches-first-global-standard-to-measure-and-report-financed-emissions)
7 Bank of England: Update on the Bank’s approach to the Climate Biennial Exploratory Scenario in selected areas, December 16, 2020. (https://www.bankofengland.co.uk/-/media/boe/files/stress-testing/2020/update-on-the-banks-approach-to-the-climate-biennial-exploratory-scenario.pdf?la=en&hash=B864270BA6D35453A7700990B1DEE809FB8B29A1)
8 European Central Bank, Banking Supervision: ECB publishes final guide on climate-related and environmental risks for banks, November 27, 2020 (https://www.bankingsupervision.europa.eu/press/pr/date/2020/html/ssm.pr201127~5642b6e68d.en.html)
9 HM Treasury: A Roadmap towards mandatory climate-related disclosures, November 2020. (https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/933783/FINAL_TCFD_ROADMAP.pdf)
10 Eur-Lex: Document 32019R2088. (https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32019R2088)
11 IFRS: Sustainability Reporting. (https://www.ifrs.org/projects/work-plan/sustainability-reporting/)
12 Bank of England Prudential Regulation Authority: Managing climate-related financial risk – thematic feedback from the PRA’s review of firms’ Supervisory Statement 3/19 (SS3/19) plans and clarification of expectations, July 1, 2020. (https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2020/managing-the-financial-risks-from-climate-change.pdf?la=en&hash=A6B4DD1BE45B2762900F54B2F5BF2F99FA448424)
13 European Central Bank Banking Supervision: ECB publishes final guide on climate-related and environmental risks for banks, November 27, 2020. (https://www.bankingsupervision.europa.eu/press/pr/date/2020/html/ssm.pr201127~5642b6e68d.en.html)
14 APRA: APRA releases guidance on managing the financial risks of climate change, April 22, 2021. (https://www.apra.gov.au/news-and-publications/apra-releases-guidance-on-managing-financial-risks-of-climate-change)
15 Eur-Lex: Document 3202R0852. (https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32020R0852)
16 Lexology: China and EU to Collaborate on Green Investment Standards, Latham and Watkins, April 12, 2021. (https://www.lexology.com/library/detail.aspx?g=9031e27b-bc47-4210-b8e5-c48878773309)
17 Marrakech Pledge: Fostering Green Capital Markets in Africa: South Africa Green Finance Taxonomy Project, January 29, 2021.(http://marrakechpledge.com/news/south-africa-green-finance-taxonomy-project/)
18 TNFD: Bringing together a Taskforce on Nature-related Financial Disclosures: Who We Are. (https://tnfd.info/who-we-are/)
19 NGFS: NGFS and INSPIRE launch a joint research project on ‘Biodiversity and Financial Stability’, April 6, 2021. (https://www.ngfs.net/en/communique-de-presse/ngfs-and-inspire-launch-joint-research-project-biodiversity-and-financial-stability)
ABOUT THE AUTHORS
Virginie Mennesson is Head of Regulatory Affairs for Mazars in the United Kingdom. She started her career at the Financial Services Authority and was seconded to the Cabinet Office during the financial crisis to coordinate the policy response on financial services within Whitehall. She also previously worked in compliance for Barclays and BNP Paribas.