An Overview of the EBA’s Final Draft ESG Disclosure Requirements and Takeaways for US Financial Institutions

The European Banking Authority (EBA) has published its final draft implementing technical standards on disclosures on Environmental, Social and Governance (ESG) risks. The standards put forward comparable disclosures and key performance indicators, including a green asset ratio (GAR) and a banking book taxonomy alignment ratio (BTAR), as a tool to show how institutions are embedding sustainability considerations in their risk management, business models, and strategy and their pathway toward the Paris Agreement goals.¹ The EBA has also set out the disclosure timelines, granular templates, tables, and instructions in an effort to ensure enhanced consistency, comparability, and meaningfulness of these disclosures by institutions.

Although the EBA’s new ESG disclosure requirements have their legal basis in EU law and are addressed to financial institutions with securities traded on a regulated market of an EU member state, their publication will be of interest to US, UK and other non-EU financial institutions as they provide an indication of the potential direction of US and UK regulators' expectations on ESG disclosures. They also may become a key driver of ESG undertakings and reporting requirements for issuers and borrowers in the bond and syndicated loan markets.

The focus of the disclosures is on:

• banks’ financial activities and vulnerabilities;
• how they are mitigating ESG risks, both physical and transitional; and
• how they are supporting their customers and counterparties in the adaptation process.

These disclosure requirements will be applicable from June 2022. The first disclosure reference date will be 31 December 2022 (or other relevant year-end disclosure date). Therefore, the first disclosure will be during the early months of 2023 and cover all of 2022. After that, the financial institution must make these disclosures on a semi-annual basis (June and December reference dates). The EBA is, however, proposing a phased approach to implementation, with a transition period for certain disclosures for which data collection will be the most challenging. The final implementation deadline will be June 2024.

The draft implementing technical standards set out comparable quantitative disclosures on:

• Climate risks: how climate change may exacerbate other risks within banks’ balance sheets including information on exposures toward carbon-related assets and assets subject to chronic and acute climate change events;
• Mitigating actions: quantitative disclosures on institutions’ mitigating actions supporting their counterparties in the transition to a carbon-neutral economy and in the adaptation to climate change; and
• Green Asset Ratio and Banking Book Taxonomy Alignment Ratio: key performance indicators (KPIs) on institutions’ asset-financing activities that are environmentally sustainable according to the European Union taxonomy, such as those consistent with the European Green Deal and the Paris Agreement goals.

The GAR and the BTAR are based on the EU taxonomy and are Paris-aligned ratios that can be used to identify whether banks are financing sustainable activities, such as those consistent with the Paris Agreement goals. They show the proportion of assets that are environmentally sustainable and contribute substantially to the objectives of climate change mitigation or climate change adaptation or that enable other activities to contribute.

The EBA is also asking institutions to provide qualitative information on how they are embedding ESG considerations in their governance, business model, strategy, and risk management framework.

Although on the face of it, these look like onerous reporting requirements, in an effort not to overburden institutions with information gathering required to meet their reporting obligations, the EBA asserts that it has deliberately designed the KPIs on taxonomy alignment disclosure requirements so they match the data and timelines that large corporates under the Non-Financial Reporting Directive are already required to produce under EU regulations.

For the time being, the EBA is focused on consistency of ESG disclosure by institutions. Importantly, there are currently no minimum ratio requirements. Any minimum requirements could be interpreted as forcing institutions to make substantive decisions on what types of entities they may lend to, which already is a politically divisive issue in the US. However, it is conceivable that once the disclosure requirements are bedded down, minimum ratio requirements will be a logical next step, at least in Europe.

US financial institutions may find the EBA’s new disclosure requirements helpful as they respond to large institutional investors’ drive for increased disclosure and prepare for the US Securities and Exchange Commission’s (SEC’s) proposed rules on mandatory ESG disclosures (expected in the coming months). The requirements may also prove instructive to help anticipate the US banking agencies’ expectations for managing climate-related risk. As we have previously written (here), (here) and (here), the SEC’s proposed rules and the US banking agency expectations are likely to draw from existing disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures (TCFD) framework. It is also entirely possible that the SEC and banking agencies may take a qualitative approach and not issue overly prescriptive disclosure requirements or risk management expectations, leaving many US financial institutions asking what they should be measuring and disclosing with respect to climate-related risk. The EBA disclosure requirements provide some KPIs for consideration. For example, EU financial institutions will be required to disclose: (i) the gross carrying amount of loans and advances, debt securities, and equity instruments provided to non-financial companies in defined sectors that highly contribute to climate change and to companies in carbon-related sectors (other than such investments in the institution’s held-for-trading or held-for-sale portfolios); (ii) loans collateralized by commercial and residential real estate and the energy efficiency of such collateral; (iii) financed GHG emissions, i.e., scope 1, 2, and 3 emissions of the institution’s counterparties, and the distance of those emissions to a Paris-aligned net-zero scenario; and (iv) exposure in banking book to the top 20 carbon-intensive firms globally. Even if the US regulators do not require that this level of detail be disclosed in the near future, the EBA disclosure requirements are nonetheless helpful in guiding US financial institutions on how they can appropriately address and disclose their climate-related risks.

For further information, please contact one of the authors or any other member of Arnold & Porter’s ESG Team.

Arnold & Porter’s Corporate & Finance, Environmental Practice, Financial Services, and Securities groups continue to monitor climate-related and other ESG developments in the financial services sector and to develop best practices for the firm’s financial institution clients. If financial institutions or other companies are seeking advice on how to incorporate ESG factors—including climate-related consideration—into their business strategy, risk management, or disclosure processes, please contact any author of this Advisory, or your regular Arnold & Porter contact.

© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.