Sustainable finance reporting and the EU taxonomy

Neil Sandle at Alveo outlines the steps banks must take to ensure compliance with the EU taxonomy for sustainable activities

 

The EU taxonomy serves as a crucial element in the EU’s sustainable finance framework and a critical tool for market transparency. It establishes a system that sets benchmarks for economic operations that support the 2050 net zero emissions target, alongside other environmental objectives.

 

The classification outlines eco-friendly business endeavours, such as forestry and solar energy generation, to meet the ambitions of the European Green Deal. However, from 2024, EU-based financial institutions such as banks are obligated to disclose their financial backing of companies and initiatives, with a push towards fostering lending that meets the EU taxonomy’s criteria for sustainability.

 

If a bank’s loan book is heavily weighted towards new fossil fuel exploration, such as oil or coal, it would be rated poorly against EU Taxonomy benchmarks. Conversely, a bank providing substantial financing to a variety of wind or solar energy projects would receive a much more favourable score.

 

The challenge facing banks

The introduction of the EU taxonomy is challenging for banks. If they are lending to large multinationals, the information provision is typically fairly straightforward. These firms will have comprehensive ESG reporting in place, with data gathered and supplied by their investor relations, or sustainability departments.

 

However, the vast majority of borrowers, about 95% or more, are small to medium-sized enterprises. These entities have limited ESG reporting experience and often simply lack the data. Although the EU’s Corporate Sustainability Reporting Directive will require more companies to disclose ESG information, a large group of SMEs will remain below the reporting threshold and in any case it will take time for businesses to report on their environmental performance, and disclosing their ESG credentials will be a new exercise.

 

Banks must also address where funds are applied in some cases. This is not always a ‘black and white’ issue. An oil company may be investing in wind power through a subsidiary for example. Some money lent to it may be for unspecified general purposes but some may be in the form of a specific purpose loan or project finance to the wind power subsidiary and therefore contribute to a higher EU taxonomy score.

 

The way forward

To overcome obstacles in meeting EU taxonomy requirements, banks must gather data from ESG providers, rating agencies, chambers of commerce and other companies. Data from MSCI for example, a leading provider of critical decision support tools and services for the global investment community, has a strong focus on ESG and climate products. Trucost, now part of Standard & Poors Global, and Truvalue Labs, part of FactSet, also act as data and analytics engines.

 

In terms of smaller businesses, banks are also likely to need data coming in from Chambers of Commerce or collected directly. The benefit for banks is not just that they can complete accurate reporting but a lot of these companies will most likely also need funding to bring about their own green transition. Other data sets could be benchmarks from specialty providers for certain segments of the loan book such as manufacturing, shipping or agriculture.

 

Banks can enable accurate reporting and build stronger relationships with a data-driven approach, enabling them to offer new loans that support green initiatives. If the bank can, for example, build positive engagement with their corporate banking clients, it can then start a dialogue with them on sustainability issues. Rather than a regulatory reporting exercise, it’s relationship building, and, given the growing importance of ESG measurements to organisations worldwide, an increasingly important aspect.  

 

Collaboration among banks may also play a role, with clients’ permission, to share or pool basic data. There are currently various initiatives taking place in various countries to facilitate that data sharing.  Many banks will inevitably take an extended period of time to get all this reporting in order because their data landscape may be quite scattered. Even within a single bank, there may be multiple banking systems and they may have different systems in place in different countries. Aggregating all this will be a massive task for corporate banking.

 

Over the longer term, data sharing will become still more prevalent. Individuals will increasingly be able, and want to, move their business from bank to bank. Some corporates will follow suit but they will also want to be able to control who they share information with.

 

Reporting will be necessary for some of the larger corporates. Under the terms of the Corporate Sustainability Reporting Directive (CSRD), an increasing number of EU firms will have to report on their sustainability credentials and make some of their data public but while a lot of the smaller companies will not have to report under this regulation, their bank is likely to want to know more about their sustainability data in order to decide whether to lend more to them.

 

The role of ESG data management

Impeccable data management systems will be essential to navigating a complex ESG environment. For banks aiming to both comply and leverage sustainable finance opportunities, a robust, data-centric approach is indispensable.

 

Ensuring ESG data quality is an ongoing concern. Comprehensive ESG data management should ensure data consistency for various use cases. Though challenges abound, especially concerning data quality, solutions are emerging. Data management solutions and Data-as-a-Service offerings are now assisting firms in capturing the ESG data they need, with capabilities for quality checks, data enrichment, and seamless integration, integrating ESG data into overall market and reference data management.

 

An approach that acquires, integrates and validates ESG data is needed, and it should offer easy data discoverability, efficient integration into user workflows, and capabilities like cross-referencing taxonomies, data derivation, and historical scenario analysis.

 

The rapid regulatory emphasis on fostering a sustainable economy presents both a challenge and an opportunity. The immediate focus should be on determining an effective operating model, designing a target data system, and ensuring a customised implementation approach.

 

Data-as-a-Service is the ESG answer

A Data-as-a-Service model is ideally suited to the end-to-end support that ESG data management needs. In-house capabilities bring value, but the difficulties surrounding ESG data collection, validation and integration might require input from third-party solution providers.

 

Data-as-a-Service may provide the optimal route. Leveraging holistic solutions and external knowledge can improve the efficiency and accuracy of ESG data management, allowing banks to remain in-step with the landscape of sustainable finance.

 

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Neil Sandle is Head of Product Management at Alveo

 

Main image courtesy of iStockPhoto.com