Climate change and increased public awareness, a growing demand for sustainable financial products, upcoming regulatory changes and the financing gap to achieve the global climate target call for a holistic approach to sustainable finance. This requires financial institutions to consider sustainability aspects in their strategy, value chain and IT landscape.

Sustainable Finance

Regulatory initiatives accelerate the need for action

The EU Action Plan for Sustainable Growth, which provides for changes to existing regulations (e.g. MiFID II, UCITSD, AIFMD) as well as new regulations (e.g. disclosure regulation, EU taxonomy), sustainability as an integral part of the future product and service offering of financial service providers. The effects will be felt both on the manufacturers of financial products and on the sales side in retail and corporate banking and in business with institutional customers.

Sustainable value chain

Product creation, sales processes, product consulting and reporting are affected by the new or adapted regulations. The steadily increasing interest of investors in sustainable financial products therefore inevitably requires the holistic integration of ESG aspects into the value chain. Furthermore, corresponding changes should also be reflected in the corporate culture.

In accordance with regulatory requirements, sustainability factors and associated risks must be integrated into the investment advisory and investment processes: in particular, the sustainability preferences of the client must be considered. In addition, producers of financial products must include sustainability information as part of the target market definition.

Extended disclosure requirements

The regulation on sustainability-related disclosure requirements in the financial services sector adopted in December 2019 is to be applied as of March 2021. In order to be able to make an investment decision according to sustainability preferences, the investor needs access to a variety of additional information.

 In particular, the following must be considered:

  • Publication of own sustainability-related corporate information
  • Consolidated evaluation of sustainability risks arising from the product portfolio
  • Integration of sustainability factors in pre-contractual information and periodic reports

Much of the information to be published is based on the EU taxonomy - the framework for determining the sustainability (classification) of economic activities.

The taxonomy is the central element of the European Sustainable Finance Regulation.

In addition to the classification of sustainable economic activities, the taxonomy initiates further disclosure requirements under the Non-Financial Reporting Directive from 2022.

Sustainable Finance

Climate-related risks require a robust risk management framework

Climate-related risks are increasingly attracting the attention of various financial and non-financial stakeholders, including banks and (re)insurance companies, businesses, as well as standard-setters, regulators, and policymakers.

Since 2019, various authorities have articulated their expectations for dealing with climate-related risks affecting the European banking sector. The ECB identified climate-related risks as one of the key risks for the banking sector and included these risks in its risk maps for 2019 and 2020. And the EBA published its work plan on sustainable financing, which integrates ESG (environmental, social, governance) factors into risk management and supervision.

In addition, the Network for Greening the Financial System (NGFS) published a call for action recommending the integration of climate-related risks into supervision. The integration of climate-related risks into regulatory stress testing is addressed in discussion papers of the EBA and the Bank of England. Furthermore, various national supervisory authorities, e.g., the PRA in the UK, BaFin in Germany, and the FMA in Austria, have recently expressed their expectations and provided financial institutions with guidelines for the management of ESG and climate risks.

In Switzerland, FINMA published a risk monitor for the first time in December 2019 that identified climate risks as risks that could affect the Swiss financial center in the long term. FINMA indicated that it would refine its analysis of climate risks in the balance sheets of financial institutions and develop improved disclosure approaches. Finally, climate change's financial risks are also one of the European Securities and Markets Authority's main priorities, and it addressed these risks in its Sustainable Finance Strategy.

Despite the clear expectation that climate-related risks will be discussed at the board level and be robustly managed at every major financial institution, our discussions with banks and the ECB's preliminary findings show that while awareness of these risks is increasing, much more needs to be done.

Further changes are expected as regulatory requirements increase and customer expectations shift towards investment in modern "green" technologies and away from "brown" carbon-intensive industries. However, the direct impact of climate-related risks on an individual financial institution and the need for action depends on the specific characteristics of the institution, such as its business model, business and risk strategy, risk appetite, products offered, and geographical footprint.

What should you focus on first?

With the first wave of regulations coming in 2021, there is a short-term need for action in this area. At the same time, extended risk management requirements must be implemented step by step.

ESG

The fields of action should also fit into an overall ESG strategy in the context of an institution's objectives. A detailed assessment of the portfolio (e.g., regional footprint, sectors, products) is key to a holistic view of the extent of exposure to climate-related risks (now and in the coming years). Examples include ESG risk management and a framework, including the definition of key terms related to climate change risks (e.g., physical and transition risks and defining "green" and "brown" investments). Also, governance aspects, including the definition of roles and responsibilities and organizational structure, need to be considered.

BearingPoint successfully supports banks and financial service providers in Germany, Austria, and Switzerland in various aspects of sustainable finance.

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