Banks and Taxonomy data: where are we?

Since January 2023, the pressure was on for banks as they had to report not just on the eligibility of their activities but also on the alignment with the EU Taxonomy criteria for the two climate-related objectives (mitigation and adaptation).

This meant banks needed to disclose how much of their activities were compliant with the technical screening criteria set out in the Taxonomy for these objectives. Then, as of January 2024, reporting requirements were expanded to cover the remaining four environmental objectives of the EU Taxonomy Regulation:

• Sustainable use and protection of water and marine resources;
• Transition to a circular economy;
• Pollution prevention and control;
• Protection and restoration of biodiversity and ecosystems.

2025 and beyond

It’s important to consider the Corporate Sustainability Reporting Directive (CSRD) implementation timeline. With the introduction of the CSRD, reporting will expand in both scope and granularity. The CSRD applies from 2024 for companies already subject to the Non-Financial Reporting Directive (NFRD).

It means that in 2025, large companies not previously subject to the NFRD will begin reporting for FY 2024 and in 2026, small and medium-sized enterprises (SMEs) that are publicly listed will need to start reporting for FY 2025.

Banks must make sure they report on these specific key indicators related to EU Taxonomy alignment:

• Taxonomy-eligible and aligned assets: The proportion of their assets that align with the Taxonomy’s sustainability criteria.
• Key Performance Indicators (KPIs): Banks must disclose KPIs such as the Green Asset Ratio (GAR), which indicates the proportion of their loans, bonds, and other investments aligned with the EU Taxonomy.
• Disclosures on Risk and Opportunities: How Taxonomy-related activities impact the bank’s risk profile and opportunities.

The EU will continue to position the Taxonomy as a key player in directing capital towards activities that support the climate and environmental goals. But this is no mean feat and banks must make sure they adhere to the rules: These include:

1. Regulatory Compliance

As highlighted above, banks must disclose the environmental sustainability of their positions, particularly under SFDR and NFRD. Access to accurate EU Taxonomy data is crucial to meeting these reporting obligations. Non-compliance can lead to reputational damage, regulatory penalties, and loss of investor confidence.

Banks must also ensure they gather sufficient data on their portfolios to comply with these requirements –a very complex exercise.

In addition, with new disclosures comes the additional risk of being accused of greenwashing but, proper use of Taxonomy data helps banks  to be transparent about which investments truly align with EU Taxonomy criteria, ultimately protecting them from reputational and legal risks.

2. Risk Management and Capital Allocation

EU Taxonomy data provides insight into the environmental risks associated with various economic activities.

This helps banks integrate environmental and climate-related risks into their broader risk management frameworksimproving their ability to manage credit risk and exposure to environmentally harmful sectors.

Banks can then use this data to direct capital towards sustainable activities. As investors and clients demand more sustainable finance options, banks that efficiently incorporate EU Taxonomy data will be better positioned to allocate resources toward green projects and benefit from the growing green bond market.

3. Strategic Alignment with Sustainable Finance

Banks must increasingly align their strategies with sustainability objectives, including decarbonization goals. EU Taxonomy data helps identify sectors and companies that are already aligned or transitioning to sustainability, which can inform lending and investment strategies.

Access to Taxonomy-aligned data enables banks to develop and offer sustainable financial products like green bonds, loans, or sustainability-linked financing. This can be a competitive differentiator as demand for these products grows.

4. Impact on Cost of Capital

Eventually, EU regulators may use EU Taxonomy compliance to adjust the capital requirements of banks.

Doing this could mean that activities aligned with the Taxonomy may receive favourable risk-weighting, reducing capital requirements for green lending, while non-compliant activities may see increased costs.

As a result, banks that demonstrate a strong commitment to sustainable finance by providing clear, transparent EU Taxonomy data should attract ESG-conscious investors thus leading to potentially lower cost of capital

5. Competitive Advantage

Banks that are early adopters and are proficient in handling EU Taxonomy data will put themselves in a better position than of their counterparts who do not.

They will be seen as leaders in sustainable finance, which can enhance their reputation and attract a growing segment of environmentally conscious clients and investors.

As investors increasingly demand transparency on sustainability, banks that can provide clear, comprehensive, and Taxonomy-compliant disclosures will be more attractive partners.

In summary, the implications of obtaining EU Taxonomy data for banks are extremely broad, affecting regulatory compliance, risk management, operational processes, strategic direction, and financial performance.

The ability to handle and integrate this data effectively will be crucial for banks to remain competitive and compliant in an evolving financial landscape that increasingly prioritizes sustainability.

 

This article first appeared on Retain Banker International