Banking has traditionally been a stable, slow-to-change industry. As linchpins of the global economic system, banks must consider a wide range of highly interconnected stakeholders in any actions they take. Moves in one area can create ripple effects throughout the economy. Historically, this critical role banks play has meant that adjustments to their ways of doing business have tended to be measured and incremental. Climate change is significantly altering this status quo. Banks have responded rapidly to the financial risks and opportunities associated with climate change, paving the way for a “new normal” in which climate strategy and disclosures are an embedded part of banks’ standard operating procedures. Today, banking institutions are at the forefront of climate strategy and disclosure, driven by both their fiduciary duty to report on the risks associated with their businesses and their obligation to comply with an increasingly stringent regulatory environment.
This post will cover climate disclosures in banking, including net zero commitments, corporate sustainability regulations, regulatory requirements for sustainable investment products, the risks of greenwashing and related enforcement actions, and sustainability-related prudential regulations affecting the banking sector.
Global Net Zero Commitments
Net zero is no longer just a talking point. According to BlackRock, by 2021, almost 90% of the world economy and over half of the financial institutions had committed to net zero pledges. Governments' motivations for pursuing net zero emissions are multi-faceted, but the logic for investors is simple. As BlackRock CEO’s Larry Fink wrote in his 2022 CEO letter, “We focus on sustainability not because we're environmentalists, but because we are capitalists and fiduciaries to our clients.” Institutional investors care about sustainability because they care about returns. This has led investors to demand both emissions reduction targets and reliable disclosure.
Banking has traditionally been a stable, slow-to-change industry. As linchpins of the global economic system, banks must consider a wide range of highly interconnected stakeholders in any actions they take. Moves in one area can create ripple effects throughout the economy. Historically, this critical role banks play has meant that adjustments to their ways of doing business have tended to be measured and incremental. Climate change is significantly altering this status quo. Banks have responded rapidly to the financial risks and opportunities associated with climate change, paving the way for a “new normal” in which climate strategy and disclosures are an embedded part of banks’ standard operating procedures. Today, banking institutions are at the forefront of climate strategy and disclosure, driven by both their fiduciary duty to report on the risks associated with their businesses and their obligation to comply with an increasingly stringent regulatory environment.
This post will cover climate disclosures in banking, including net zero commitments, corporate sustainability regulations, regulatory requirements for sustainable investment products, the risks of greenwashing and related enforcement actions, and sustainability-related prudential regulations affecting the banking sector.
Two related alliances are helping guide the banking industry’s path to net zero. The Glasgow Financial Alliance for Net Zero (GFANZ) operates as an umbrella group, representing over 550 financial institutions across over 50 jurisdictions committed to net zero by 2050. Within GFANZ sits the Net-Zero Banking Alliance (NZBA), which specifically coordinates among banks. NZBA currently represents over 40% of global banking assets. These two entities help support the global banking industry’s pledges to move towards a net zero future.
Regulatory Requirements and Standards for Banks as Corporations
While net zero commitments have generally been voluntary, an increasing share of the banking industry will likely be subject to mandatory corporate climate disclosure rules in the near future. These rules apply broadly to corporate entities and are not specific to the banking sector, though the emissions profiles of banks may be more complicated than other entities due to the extent of banks’ financed emissions. We’ll focus here on the three corporate regulations likely to be most relevant to the banking sector: (1) the SEC's proposed Corporate Climate Disclosure Rule, (2) the EU’s Corporate Sustainability Reporting Directive (CSRD), and (3) the International Sustainability Standards Board (ISSB)’s global standard.
SEC’s Proposed Corporate Climate Disclosure Rule
In March of 2022, the SEC published proposed rules governing climate disclosure for public companies reporting in the US. Many banks are public reporting companies that would be subject to the rules. The proposal would require public companies to report scopes 1 and 2 greenhouse gas (GHG) emissions in their Form 10-K annual filings and in registration statements to register public securities offerings. Larger companies would also have to disclose scope 3 emissions if those emissions are financially material or if the companies have set targets including scope 3 emissions. Alongside those quantitative metrics, public companies would also need to disclose their companies’ climate-related governance structures, strategies for managing climate-related risk, and specific climate-related impacts on the company’s financial condition. Assurance requirements for scopes 1 and 2 emissions would phase in over time. (These rules are expected to be finalized in H1 2023. Persefoni has been covering updates to the SEC proposal in real-time here.)
EU’s Corporate Sustainability Reporting Directive (CSRD)
The CSRD, approved by the European Council in November 2022, is the EU’s core corporate climate disclosure rule. The CSRD applies to all large companies in the EU, companies listed on EU-regulated markets, and certain non-EU companies with branches or subsidiaries in the EU. Compliance with CSRD is expected to require reporting on GHG emissions, including scope 3 emissions*. For financial institutions, this would include financed emissions, which can be reported based on the Partnership for Carbon Accounting Financials (PCAF) standards. The first companies subject to CSRD would be required to report on the fiscal year 2024. Like the SEC’s Corporate Climate Rule proposal, the CSRD is phasing in assurance requirements over time.
*Based on the current draft reporting standards, subject to finalization by the European Commission in June. Listed SMEs will be subject to proportionate standards issued for consultation this summer and finalized next year.
International Sustainability Standards Board (ISSB)
The ISSB is a body within the International Financial Reporting Standards (IFRS) Foundation that aims to create high-quality, globally useful sustainability standards that allow stakeholders to all “speak the same language.” Critically, the ISSB itself is not a regulatory body with any binding authority. Instead, its standards are suggestions and frameworks that alliances and jurisdictions can consider adopting as they create their own requirements. The ISSB has 2 proposed standards: (1) IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and (2) IFRS S2 Climate-related Disclosures. S1 is an overarching framework that broadly considers “sustainability” factors, whereas S2 is distinctly climate-focused (e.g., reporting scopes 1, 2 & 3 GHG emissions). Final S1 and S2 standards are expected to be issued by the end of June 2023 and be formally effective for use as of January 1, 2024. (For more details, see Persefoni’s full primer on the ISSB here).
Though the precise details vary among these regulatory schemes and standards, they all build off of a common set of foundational frameworks: (1) the Task Force on Climate-Related Financial Disclosures (TCFD) and (2) the Greenhouse Gas Protocol. Together, these two frameworks help ensure that companies conduct carbon accounting and disclose their climate-related financial risks and opportunities thoroughly and comparably throughout the world. The emergence of the ISSB, in particular, demonstrates the growing consensus that in a world in which organizations operate multi-nationally, capital crosses borders freely, and climate change is global, consistent reporting frameworks will be critical to help investors make informed decisions and support corporations in compliance.
Regulatory Requirements for Banks Offering “Sustainable” Investment Products
In addition to the sustainability regulations banks face as corporate entities, they are also subject to a special class of sustainability regulation specifically targeted at institutions offering financial products that are marketed as “green” or “sustainable.” We’ll focus here on three regulations likely to be widely applicable to the banking sector: (1) the SEC’s ESG Funds proposal, (2) the SEC’s proposed amendments to the Names Rule, and (3) the EU’s Sustainable Finance Disclosure Regulation (SFDR).
SEC’s ESG Funds proposal
The SEC proposed its ESG Funds rule in May 2022. The proposal would create additional ESG disclosure requirements for fund registration statements, fund annual reports, and investment advisor brochures. The proposal would define three types of funds, each of which would have to adhere to a different disclosure level, based on the stated focus of the fund.
In addition, any fund with an environmental focus would also be required to report greenhouse gas emissions, including the fund’s carbon footprint and the portfolio's weighted average carbon intensity. A fund would be exempted from this carbon footprint requirement if the fund explicitly states that it doesn’t consider emissions data. (Persefoni has been covering updates to the SEC proposals in real-time here.)
SEC’s proposed amendment to the Names Rule
The SEC’s proposed amendment to the Names Rule, also released in May 2022, targets greenwashing in financial products. The proposed amendment would mandate that any fund with a name that suggests an ESG or sustainability-focused approach (e.g., the inclusion of “green” or “ESG” in the name of the fund) would be required to allocate at least 80% of assets to investments consistent with the name of the fund. The fund would need to maintain documentation indicating how it classifies investments as consistent or inconsistent with the fund's name. Integration funds (which consider ESG factors but do not give them any more weight than other factors) would be generally prohibited from using “ESG” terminology in their names. (Persefoni has been covering updates to the SEC proposals in real-time here.)
Sustainable Finance Disclosure Regulation (SFDR)
The SFDR is a broad regulation affecting EU-based financial advisers (FAs) and financial market participants (FMPs), as well as investment managers and advisers outside the EU that market products to EU clients. The SFDR classifies investment products into one of three groups, each of which has a different disclosure requirement:
(For more details, see Persefoni’s full primer on the SFDR here.)
Alongside these American & EU regulations, multiple other jurisdictions, including the UK, Japan, and Singapore have released plans to regulate “sustainable” investment products. These regulations and the associated disclosure requirements aim to ensure that investors across the globe understand the nature of the financial products available to them and exactly how “sustainable” those products truly are.
Risk of Greenwashing
The risk of greenwashing has risen commensurately with the increase in consumer and investor interest in sustainable products. Greenwashing is the act of presenting false or misleading claims about an entity’s sustainability credentials, allowing that entity to receive undue benefits from consumers & investors. In recent years, global watchdogs have shown they are serious about pursuing claims against companies allegedly engaging in greenwashing.
Lawsuits by non-profits and investor groups are proliferating. Within the U.S., private plaintiffs have pursued greenwashing cases against a wide range of corporations, including Oatly (an alternative milk company), Vale S. A. (a Brazilian mining company), and Exxon. In the EU, banks, in particular, have been on the receiving end of claims. ClientEarth, a legal-focused non-profit, sued the Belgian National Bank in 2021 over the bank’s purchase of bonds from heavy-emitting corporations. In Germany, a consumer group filed lawsuits against DekaBank and Deutsche Bank’s DWS asset management group over greenwashing claims. Though the outcomes of these cases may vary, it’s clear that banks should expect to continue to receive intense scrutiny over their ESG claims from potential litigants.
Regulatory bodies have also taken a number of enforcement actions to hold companies accountable for greenwashing. The SEC has established a Climate and ESG Task Force within the Division of Enforcement to “proactively identify ESG-related misconduct.” In 2022 alone, this group announced six enforcement actions, including against Goldman Sachs Wealth Management ($4M fine) and BNY Mellon ($1.5M fine) for failing to establish policies and/or comply with their policies to support marketed ESG claims. In the UK, the Advertising Standards Agency cited HSBC for greenwashing in its advertising campaign, admonishing the bank to “ensure that future marketing communications featuring environmental claims were adequately qualified and did not omit material information about its contribution to carbon dioxide and greenhouse gas emissions.” And in one of the most dramatic examples of enforcement seen to date, in Germany, prosecutors raided the offices of Deutsche Bank and DWS Asset Management over greenwashing allegations.
The risks associated with greenwashing are tangible. A wide-ranging group of stakeholders - including regulators, non-profits, and investors - are intent on ensuring that when companies make public ESG statements, they have the requisite policies, procedures, and data to back them up. Companies unable to substantiate their sustainability claims risk not only “name and shame” campaigns, but also substantial fines and escalating legal action.
Prudential Regulation
In addition to the regulations discussed so far, which primarily aim to protect investors and consumers in their interactions with individual firms, governments are also beginning to adopt regulations to safeguard against the systemic financial risk posed by climate change. This prudential regulation aims to equip the financial system with the strategies, processes, and resources necessary to deal with physical risks and transition risks associated with climate change. Extreme weather events, evolving legal requirements, and shifting consumer behavior will create a complicated set of factors for lenders to consider. Central banks are determined to ensure that their banking sectors will be well-prepared for the journey ahead.
In the U.S., the Federal Reserve has announced that the nation’s six largest banks will be participating in a pilot climate scenario analysis. In presenting its rationale for the exercise, the Fed has explained its “narrow, but important, responsibilities regarding climate-related financial risks – to ensure that banks understand and manage their material risks, including the financial risks from climate change.” As part of this climate scenario analysis, these six banks will consider the impacts of multiple climate-related scenarios, including one that reflects achieving net zero greenhouse gas emissions by 2050. The Fed intends to share aggregated learnings from the exercise, though details on the performance of the individual banks (Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo) will remain confidential. In addition to this real-world exercise, the Fed has also published research considering whether banks should be required to carry additional capital reserves to account for potential climate-related losses. While preliminary, this publication indicates the seriousness with which the Fed treats the potential systemic risks of climate change.
Outside of the U.S., prudential regulators have also been active in setting new standards. In January 2022, the European Banking Authority (EBA) published its final draft of “Pillar 3” disclosure guidelines to help guide financial institutions in their ESG reporting. These guidelines build on the Task Force on Climate-related Financial Disclosure (TCFD) recommendations, tailoring them to the banking sector. They include banking-specific metrics such as a Green Asset Ratio, which describes how banks should measure the proportion of assets they have invested sustainably. In June 2022, the Basel Committee on Banking Supervision (BCBS), an international standards body for banking, published a set of general principles for banks and prudential supervisors to help guide them in their respective approaches to climate-related financial risks. The 18 principles released by the BCBS cover various topics, including corporate governance, internal controls, risk and capital adequacy assessments, and reporting. By releasing this high-level guidance document, the BCBS continues the trend of international standards setters creating frameworks that can help ensure regulatory alignment across the world. Building off of that momentum, in March 2023 the Canadian Office of the Superintendent of Financial Institutions (OSFI) released Guideline B-15: Climate Risk Management, which includes risk management expectations as well as a requirement to report on Scope 3 financed emissions. Across the globe, regulators are showing a keen interest in creating strong regulations to ensure the stability of their banking sectors in the face of climate change.
Addressing the Complex Landscape of Climate Disclosure Regulations with Confidence
The banking sector has historically been subject to some of the strictest regulations in the global economy, and climate disclosure is no exception. Banks are bound by corporate climate disclosure regulation, ESG investment product disclosure regulation, and prudential regulation. Multinationals need to consider the potentially varying details of disclosure requirements in each jurisdiction in which they operate. Enforcement in this area is already substantial and poised to grow.
However, in the face of these challenges, three factors can give banks confidence in their ability to comply. First, international standards setters, including the ISSB and the BCBS, are developing frameworks to drive global regulatory harmony. Second, the growing scope of corporate climate disclosure rules will help ensure that the data banks need on portfolio companies and borrowers is available and reliable. Third, technology solutions, such as carbon accounting platforms, enable thorough, auditable, and repeatable processes that streamline reporting. Though the compliance landscape is undeniably complex, an ecosystem of organizations and tools exists today to help banks follow disclosure requirements.
Learn more about how Persefoni’s carbon accounting platform can help banks meet compliance obligations.
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