Europe’s banks warn of hidden credit risk in sudden ESG retreat

COPENHAGEN – The European Banking Federation (EBF) is warning that the sheer scale of a proposed rollback of the bloc’s environmental, social and governance (ESG) rules will make it harder for lenders to analyse credit risk.

Banks in Europe have been waiting for years for their clients to start providing hundreds of data points under new ESG reporting rules.

But as the European Union now looks set to dramatically water down planned regulations, banks fear they will be left without the necessary tools to conduct proper credit risk analyses, according to the EBF, whose members include BNP Paribas, UniCredit and Deutsche Bank.

The EBF’s warning comes as the European Commission prepares to unveil its long-awaited omnibus proposal on Feb 26.

The EU’s executive arm is proposing that key ESG rules, including the Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive, be scaled back so that 85 per cent of the companies originally intended to be in scope will no longer be required to comply, Bloomberg reported earlier this week.

Ms Denisa Avermaete, the EBF’s senior policy adviser for sustainable finance, said the EU now appears to be winding back reporting requirements to a level that will be even weaker than before the bloc started working on the current ESG framework.  

For banks, fewer reporting requirements for their clients “will introduce complexity and a need for bilateral engagement, as banks will always need certain key data that is necessary for sound business and risk management”, she said in an interview.  

And while companies across Europe may now be facing a reduced mandatory ESG reporting burden, the proposed watering down of regulations “will not reduce the operational burden” since banks will have to make their own demands, Ms Avermaete said.

CSRD, which is being phased in through the end of the decade, was intended to require thousands of companies to use standardised templates to report hundreds of ESG metrics.

But after intense pressure to simplify Europe’s regulatory framework, officials in Brussels look set to take a knife to the bloc’s once prized ESG agenda.

The commission’s proposal “could be bad news for the financial industry”, said Ms Eva-Maria Segur Cabanac, global lead sustainability partner for the financial institutions group at Baker McKenzie.

“They would have had reliable data audited by an external auditor on a very large set of their clients,” she said.

“Now, they’re not getting that.”

Banks will, of course, continue to ask for sustainability data, Ms Cabanac said.

“There is a financial risk associated with not transforming, not decarbonising, et cetera.”

Germany and France, the EU’s two biggest economies, led the call for the rollback, citing the threat to European competitiveness.

The US has also voiced displeasure at the design of Europe’s ESG rules, which force non-EU companies targeting the EU to comply.

US Commerce Secretary Howard Lutnick told Republican senators in January he is prepared to use “trade tools” in retaliation if the EU does not rein in its ESG framework.

The European Banking Authority (EBA), which is the bloc’s main watchdog for lenders, said in a report on Feb 24 that banks are currently struggling to gather information on parameters such as how customers’ exposure to environmental risks like flooding may affect their ability to pay off a loan.

That is as the European Central Bank warns lenders it is ready to impose fines if they do not adequately address environmental and social risks lurking in their portfolios.  

The EBA is “very closely” monitoring the discussions around CSRD, which had been expected to address such data gaps, said Ms Dorota Wojnar, the EBA’s head of ESG risks.  

Ms Wojnar said the EBA is now hoping that the basic data points that banks need “will remain available”, despite the expected rollback. But part of the challenge for banks is that “we do not necessarily know which exact data points will be the ones that are the most useful”, she said.

Ms Avermaete said the EBF would be willing to back a reduction in the number of data points that companies are required to report.

But the prospect of having a dramatically reduced universe of companies in scope remains problematic, she said. BLOOMBERG