Following the Action Plan on Sustainable Growth (2018) set by the European Commission, regulatory pressure to embed sustainability and ESG in business practices and reporting has increased considerably. The plan aims at reorienting capital flows towards a more sustainable economy, mainstreaming sustainability into risk management and fostering transparency and long-term planning.
In this line, the EU Taxonomy (2020) creates a necessary common green playground for credit agencies, investors, banks, and companies. The taxonomy is a classification system defining which economic activities are sustainable or not. Economic activities must contribute to one of six environmental objectives: climate change mitigation, climate change adaptation, sustainable use of water resources, transition to a circular economy, pollution prevention and protection of biodiversity and ecosystems.
For Financial Institutions, regulators recommend integrating ESG in the business strategies, governance and risk management. EBA has published binding standards for reporting ESG under Pillar 3 (2021) with detailed templates and standards.
These binding standards require institutions to disclose ESG information on 3 different aspects: climate risk, mitigating actions and KPIs. On climate risk, banks need to report the exposure to sectors contributing to climate change as well as the physical risk (risk exposure subject to extreme weather events). As for the mitigating actions, they have to disclose the actions taken to support counterparties in the transition to a carbon neutral economy or to adapt to climate change.
Finally, institutions are required to report two KPIs, the Green Asset Ratio (GAR) and the Banking Book Taxonomy Alignment Ratio. GAR represents the percentage of total exposures to taxonomy aligned activities.
ESG: The Experian Approach
An effective way to supervise and manage ESG on a portfolio of clients is to use ESG ratings. Not only lenders or investment companies have an interest in such ratings, but also any companies trying to show their strengths in ESG management, among others. Experian provides an end-to-end solution combining data, analytics and platforms to measure and monitor the ESG impact. The solution is particularly suited for measuring credit risk with stress test scenarios in banks, but it may serve any other company willing to comply with EU regulations.
Our ESG ratings are based on data coming from multiple sources: companies’ self-assessment, transactional data, web data, company data. Models need to cater for specific companies’ needs and regulation in different jurisdictions, especially in the case of financial institutions. Experian builds bespoke models in combination with data made available by the clients. Last, but not least, weather scenarios and information are integrated into our models to yield ESG rating. Solutions may be offered as batch data or a live service through API.