Regulatory overview and classification of Pillar III disclosures in the European sustainable finance regulation

In the center of the regulation of sustainable finance stands the taxonomy regulation. It presents a detailed classification system for all sectors in the financial system. The aim is to promote investment in environmentally sustainable activities and to give other regulations a reference, such as the Non-financial Reporting Directive (NFRD) / Corporate Sustainability Reporting Directive (CSRD), Sustainable Finance Disclosure Regulation (SFDR), and the Capital Requirements Regulation's Pillar III Disclosure on ESG (Environmental, Social, Governance) Risks. The SFDR and the NFRD are applicable for financial market participants and for large companies. The NFRD will evolve to the CSRD starting from 2023. The implementing technical standards (ITS) on Pillar III disclosure on ESG risks is applicable for most large banks in the European Union.

In March 2021, the EBA launched a public consultation on draft implementing technical standards (ITS) on Pillar III Disclosures on ESG risks. The final draft ITS were submitted to the European Commission for adoption in January 2022.

What are the Pillar III disclosures on ESG risks?

Disclosure of prudential information on ESG risks: the first disclosure of ESG risks will be annual but from 2023 it will be semi-annual. The ITS will be applicable from June 2022 with the first reference date on December 31, 2022. In this regulation, the EBA will follow a sequential approach and will be in line with taxonomy and other initiatives.

What information must be disclosed?

Climate change and other environmental risks, including transition and physical risks (disclosure of “green taxonomy” aligned and carbon-intensive exposures). In addition, social and governance risks are considered.

Qualitative and quantitative templates

The ESG disclosure report consists of three qualitative tables and ten quantitative templates. The qualitative part is divided into business strategy and processes, governance, and risk management. Banks shall disclose to the public how they adjust their business strategy and how they may assign responsibility of management for sustainability goals. Regarding risk management, banks are obliged to report the processes to identify and monitor risk-sensitive sectors and exposures. The methodology of stress tests and scenario analysis concerning these ESG risks must also be disclosed.

The climate-change related disclosures are separated into the different type of risks. Within this disclosure, there is a differentiation between transition risk, physical risk, and mitigation risks. Transition risk can occur when moving towards a less polluting and greener economy. The second type of risk, physical risk, results from events caused by climate change, e.g., the extreme rainfall and flooding in Germany in 2021. Mitigation risk is the process of planning for disasters and having a way to lessen negative impacts of climate change.

We have developed an ESG reporting module for our proven software solution Abacus360 Banking. The ESG module targets financial institutions that must comply with the new standard ESG risks disclosure reporting obligation from EBA from 2022 on.

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