The EBA, the ESMA and the EIOPA released their recommendations on taxonomy KPI for financial institutions

Newsletter

4-minute read

 

Early March, the European Supervisory Authorities (ESAs) — the EBA,  the ESMA and the EIOPA [1]— submitted their advice to the European Commission regarding new KPIs that would measure the alignment of banks, insurance companies, as well as asset managers with the EU Taxonomy. The ESAs’ proposals came as a response to the EU’s request [2] in light of the forthcoming mandatory disclosure requirements, which are to come into force from early 2022.

 

The Article 8 of the EU Taxonomy

Under the Article 8 of the EU Taxonomy Regulation (see our Taxonomy publications), any undertaking, which is subject to an obligation to publish non-financial information under the non-financial reporting directive (NFRD) should include a non-financial statement on “how” and “to what extent” this activity relates to economic activities that qualify as environmentally sustainable under the Taxonomy Regulation. Non-financial activities should disclose the following elements:

 

  1. The proportion of their turnover derived from products or services associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation.

 

  1. The proportion of their capital expenditure (CapEX) and the proportion of their operating expenditure (OpEX) related to assets or processes associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation.
     

However, the Article 8 does not define any specific KPI for financial undertakings. With no available solution at the time of the negotiation, legislators decided to give themselves time to come up with more precise calculation methodologies for financial institutions through a delegated act to be adopted by the end of June 2021. Based on this mandate, the Commission has asked the ESAs to provide advice and proposals on Taxonomy related KPIs and methodologies for the financial sector through a call for advice [3].   

 

The ESA’s recommendations

In order to enhance non-financial disclosure for financial companies, the ESAs recently delivered their remarks and proposed several metrics to the European Commission. If followed, these proposals would require financial institutions to publish their non-financial reporting on an annual basis.

The EBA has made several proposals to measure the Taxonomy alignment of lenders’ banking and trading portfolio, off-balance sheet exposures and advisory fees. The EIOPA advised that insurers should report the ratio of non-life gross premium and investments. Meanwhile, the ESMA recommended  that asset managers report the ratio of total investments that are Taxonomy aligned.

 

The table below summarizes the different key performance indicators proposed per entity:

 

European Banking Authority (EBA)

European Insurance and Occupational Pensions Authority (EIOPA)

European Securities and Markets Authority (ESMA)

Entity

Credit institutions

Insurance companies

Asset Managers

Advice

Green Asset ratio (GAR)

  • The extent to which the financing activities in their banking book [4] are associated with economic activities aligned with the EU Taxonomy

GAR for retail exposures [5]

  • Proportion of loans to households collateralised by residential immovable property or granted for house renovation purposes aligned with the Taxonomy, compared to total loans to households collateralised by residential immovable property or granted for house renovation purposes
  • KPI based on the Energy Performance Certificate (EPC) of the car and their CO2 emissions

Trading KPI

  • In cases the trading portfolio has a more predominant role in the business model of the credit institution, the EBA’s advice is that credit institutions should provide separate, more granular, quantitative information and a specific KPI for their trading book, the Trading KPI which is a ratio of absolute purchases plus absolute sales of taxonomy-aligned securities compared to total absolute purchases plus total absolute sales of eligible securities

 

Understanding insurers potential to invest sustainably

  • Ratio of the insurer’s investments in relation to total investments that are directed at funding, or are associated with, economic activities that qualify as environmentally sustainable

Investments Taxonomy aligned

  • Ratio of investments that are Taxonomy aligned
  • When investee companies are financial undertakings, the relevant KPIs for those undertakings should be used as a proxy for the share of turnover used for non-financial investee companies.

Off-balance-sheet exposures (FinGuar & AuM KPIs)

  • Proportion of taxonomy-aligned financial guarantees backing lending exposures
  • Proportion of taxonomy-aligned assets under management, for guarantee and investee companies subject to NFRD disclosure obligation

Assessing insurers business activities identified as environmentally sustainable

  • Ratio of the non-life “gross premiums written” — in relation to total non-life gross premiums written — corresponding to insurance activities identified as environmentally sustainable in the EU taxonomy.

Fee and commission income (F&C KPI) [6]

  • Part of their services other than lending and asset management associated with economic activities that qualify as environmentally sustainable.

 

 

It is now up to the Commission to propose a delegated act potentially including the advice published by the ESAs. We expect this delegated act to be published in draft form at the end of April or beginning of May, for a 4-week consultation before the final publication.

 

Some concerns about these ratios

A few days after the indicators were published, criticisms were voiced:

  • Firstly, they have been criticized for being too complex to compute owing to a lack of data. Strict deadlines to comply with these new KPI disclosures could be challenging for financial companies, as they will need to obtain their clients’ information prior to disclosing theirs.
     
  • Secondly, the proposed formulas are based on activities, which have been identified as environmentally sustainable in the EU taxonomy. However, this lack of granularity de facto excludes the majority of financial undertaking activities and is likely to generate poor results once computed (with no granularity analysis, neither for significant contribution below the technical screening criteria nor for significant harm to climate objectives).

The drafting of a so-called brown taxonomy (we will comment next month the report from the Sustainable Finance Platform on this matter) could potentially serve as a crucial element in achieving global sustainability goals, inasmuch as it would clearly distinguish projects aimed at reducing emissions from climate-harming activities. This could be particularly interesting for financial institutions, as it would allow them to better distinguish the impact of their investments when creating or diversifying their portfolios. In this light, addition to the Green Asset Ratio (GAR), in the future it might be interesting to monitor a Transition Asset Ratio as well.

 

[1] The three European Supervisory Authorities (ESAs) are the European Banking Authority (EBA), European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pensions Authority (EIOPA)

[2] The Commission’s call for advice on “KPIs and methodology regarding the extent to which activities of undertakings that fall within scope of the Non-Financial Reporting Directive qualify as environmentally sustainable under the Taxonomy Regulation”.

[3] On September 15, 2020 the European Commission invites the ESAs to develop advice determining KPIs and associated methodology that undertakings  subject to the Non-Financial Reporting Directive (NFRD) should use to disclose information (Call for advice)

[4] Banking books include loans and advances, debt securities and equity instruments.

[5] Particularly the mortgage portfolio, house renovation loans and part of the credit consumption portfolio (motor vehicle loans) as they can be assessed under the relevant taxonomy screening criteria for the  objective of climate change mitigation based on the information provided by the energy performance certificate of the underlying asset (immovable property or car).

[6] Proportion of the institution’s fee and commission income from corporates subject to NFRD disclosure  obligations, derived from products or services other than lending associated with taxonomy-aligned economic activities that contribute to the environmental objective of climate change mitigation, climate change adaptation or other environmental objectives, compared to total fees and commissions from corporates subject to NFRD disclosure obligations from products or services other than lending.