UniCredit - ESG regulatory compass for banks and corporates

Massimo Catizone - Global Head of ESG Advisory, UniCredit / Cosmin Creanga - Sustainable Finance Senior Policy Advisor, UniCredit, 27 Feb 2023 - 09:50
Those that were involved in the initial discussions around how regulators should facilitate the advancement of macro European environmental policies will remember that a number of options have been considered over the years including, but not limited to, preferential regulatory treatment for green assets. 

We have always looked at preferential regulatory treatment driven solely by chromatic factors with some decree of skepticism. 

It is acknowledged that preferential regulatory treatment is certainly an enticing perspective. However, it should be recognized that such an approach would hardly be consistent with a macro prudential framework where capital requirements are driven by risk. Unfortunately, as of today, a fully satisfactory, statistically relevant data set that could justify preferential regulatory treatment for green assets is not yet available. The IT investments made by a number of financial intermediaries will eventually enable the market to produce data series justifying a more favorable treatment for green assets. Not a preferential treatment, but a treatment justified based on empirical evidence with respect to performance and risk.  

Against this backdrop, it should not come as a surprise that the recently proposed revisions to Basel III standards come into place with a tint of “green” and confirmed two of the main priorities of the EU Commission: the integration of risks deriving from climate change in banks overall risk assessment and the need to harmonize European legislation governing the journey to carbon neutrality scheduled for completion by 2050. 

As usual, the Commission proposal was subject to intense discussions in Parliament and within the Council. The outcome of such discussions are the three amendments summarized below. 

Let us consider them in turn.

First. The discussions on the implementation of brown penalties (also known as brown penalising factors) which, if implemented would result in a higher risk weight for carbon intensive sectors and the Parliament has agreed to leave it for the European Banking Authority (EBA) to assess a potential implementation of risk discounts/add-ons for climate change vulnerable assets and activities. It is possible that discussions on this topic will be revived in the future, although if the measures described below will be implemented, brown penalties may become redundant.  

Second. The merits of providing the competent supervisory authorities with the discretion to apply business restrictions to banks taking excessive risks have also been considered. At the time of writing, what constitutes excessive risk remains uncertain. Again, it would be for EBA to cast some light on the concept of excessive risk. The nature and magnitude of the impact on banks’ activities of any restriction is expected to vary on a case-by-case basis. There is the possibility that the final legislation will allow regulators to apply a combination of business restrictions and additional capital charges. This matter remains under discussion. Increased and more stringent supervision may be expected, should supervisors be given the power to, 1) require banks’ boards to approve and review (annually) their business strategy for alignment with EU policy objectives (i.e. Net Zero Strategy), 2) perform a periodical assessment of a bank’s strategy in the context of the Supervisory Review and Evaluation Process.  

Third. Competent supervisory authorities may be entitled to set a Systemic Risk Buffer to mitigate climate change risks and preserve financial stability and protect the real economy. While the ratio behind this proposal can be understood, it is absolutely paramount that any double counting with risk discounts/add-ons for climate change vulnerable assets and activities is avoided.

Going forward, we will also be watching the fixed income space closely where the debate on EU Green Bond Standard remains very lively and continues to impinge on disclosure requirements and allocation of funds. With respect to disclosure, the current prevailing position within the Parliament favours a disclosure consistent with the relevant provisions of the EU Green Bond Standards for all bonds marketed as “Sustainable” in the EU market. In the quest to reach a final agreement, on February 28th, the Parliament backed down and agreed to introduce only voluntary disclosure requirements for issuers of other sustainable bonds. If implemented in its previous formulation, this provision would have, most likely and unintentionally, result in issuers having to report both under EU GBS and under ICMA (if the bonds were used under the ICMA rules). Moreover, with respect to allocation of funds, the Parliament was taking a fairly intransigent stance and was proposing that 100% of the issuance proceeds are deployed according to the EU Taxonomy. The general consensus in the market is that a flexibility pocket, if allowed, would not compromise the integrity of the framework and investor protection and therefore it should be favourably regarded. The market driven position eventually gained traction and the agreement reached allows, for those sectors not yet covered by the EU Taxonomy, a flexibility pocket of 15%.

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