The role of sustainable finance is increasingly taking centre stage as the EU, and other jurisdictions, attempt to address the climate crisis and meet ambitious regulatory targets. It plays a key role in delivering on EU policy objectives under the European Green New Deal, which sets the blueprint for a new economic model in response to the climate emergency and to achieve reductions in emissions in the EU by at least 55% by 2030 (from 1990 levels). In Ireland, policy objectives are equally ambitious with the Climate Act committing to achieving a 51% reduction in emissions from 2021 to 2030, and to achieving net-zero emissions no later than 2050.

Critical role of banks in supporting the transition
Banks now play a vital role in supporting the climate objectives, given their direct relationships with customers in the real economy. They incentivise clients with attractive products such as sustainability-linked loans and reduced rates for mortgaged properties with improved energy performances. Sustainable finance products can engage and empower clients to make more sustainable choices and it is in the interest of banks to support clients to reduce their exposure to climate-related risk such as high energy costs or increasing carbon pricing. Banks are also actively involved in financing renewable energy projects and projects to support natural capital. The issuance of green bonds support climate mitigation or adaptation projects, including reducing emissions, protecting ecosystems, and promoting renewable energy, energy efficiency, and clean transport.

In order to support EU and national climate objectives and achieve their own decarbonising objectives, banks also have their own individual NetZero transition plans. To achieve best practice and access expert guidance, many participate in collaborative initiatives, such as NetZero Banking Alliance, GFANZ, the UNEP and the UN Responsible Banking Principles. The two pillar banks in Ireland have also signed up to strict science-based targets, under the Science Based Targets initiative (SBTi), which validates banks’ greenhouse gas (GHG) emission targets.
In Ireland, we have an added advantage with the presence of leading global banks, which provides for informed dialogue and the sharing of expert experience on areas such as green bonds issuance and ESG integration. This is very beneficial for the essential collaboration between banks, businesses and national authorities in informing climate policy and in financing critical infrastructure required for climate adaptation.

Emerging legislative challenges for financial institutions
A key principle underpinning climate policy is to shift capital to support economic activities that contribute to a greener world. The EU has interpreted this via its evolving and complex Sustainable Finance Framework for financial institutions, which introduced significant new classifying, transparency, and reporting requirements, as well as new tools to enhance the “usability” of the new framework for financial institutions.

This legislative regime is ambitious and urgent, requiring financial institutions to come to terms with new terminology and new skillsets, while investing resources in sustainability across many divisions, particularly risk, client relationship management and financial reporting.

The supervisory mandate on climate risk has been particularly significant with the most substantial interventions coming through the ECB Guidance on Climate and Environment-related risk 2020, which requires that banks must understand the impact of climate-related and environmental risks on the business environment in which they operate in the short, medium and long term and to conduct stress testing; and the EBA’s extensive Sustainable Finance Mandate which requires banks to integrate climate-related risk into their strategies, business models and risk management frameworks.

However, given that the legislative regime is in its relative infancy, along with the large volume and complexity of inter-related and novel requirements, it is inevitable that a number of challenges have arisen that will need to be addressed in order to progress in this area. Some of the key challenges include:

- EBA Pillar 3 requirements are technical standards aimed at ensuring stakeholders are well-informed about institutions’ ESG exposures, risks and strategies. The standards have introduced tools to show how institutions are embedding sustainability considerations in their risk management, business models and strategy with comparable disclosures and KPIs including a green asset ratio (GAR) and a banking book taxonomy alignment ratio (BTAR). However, some of these standards are currently incompatible with other existing regulation. For example, one tool requires banks to report on the performance of their building collateral using Energy Performance Certificates but in Ireland, banks are not permitted to use this data. BPFI is working with members and government to seek changes to current regulations that prevent access for financial institutions to the database of Building Energy Ratings held by the Sustainable Energy Authority of Ireland.
- The Green Asset Ratio (GAR) is being used as an indicator of what proportion of a bank’s assets is ‘green’, i.e. aligned with the EU Taxonomy¹. However, this may not adequately represent a bank’s progress in making its portfolios more sustainable, as major parts of the economy financed by banks are not aligned with the taxonomy. In fact, the European Banking Federation estimates that only about 30% of all economic activities in the EU are tracked and financing of economic activities outside of the EU is excluded. The European Commission has indicated it will review the effectiveness of the GAR in 2024.
- Corporate Sustainability Reporting Directive (CSRD) entered into force in January 2023. This new directive modernises and strengthens the rules concerning the social and environmental information that companies have to report. A broader set of large companies, as well as listed SMEs, are now required to report on sustainability. However, there are also emerging global reporting standards under the International Sustainability Standards Board (ISSB). Global banks operating in the EU are concerned with ensuring that the new reporting requirements of the Corporate Sustainability Reporting Directive (CSRD) are aligned with the global standards and ongoing dialogue between these regulatory bodies is essential to reduce misalignment and ensure an efficient reporting process.
- SME reporting standards: In order to fulfil their reporting requirements under the new regimes, banks will rely on clients to provide data on their ESG-related activity. This is a challenge for smaller companies who may lack resources and information to provide the data. BPFI and our members welcome the proposed voluntary reporting standard for SMEs currently under consultation by the European Financial Reporting Advisory Group, which will be designed to be a simple reporting tool to assist non-listed SMEs, which are not subject to reporting obligations under the CSRD, to respond to requests for sustainability information for example, where a non-listed SME forms part of the value chain of an in-scope entity.

As the implementation challenges of the emerging legislation are worked through, the reality is that, given the essential role of banks in providing transition finance, it will mean that uneven sustainability reporting is inevitable in the near term. As lenders finance urgent, sustainable decarbonisation, some sectors will take longer than others to reduce emissions or, indeed may temporarily increase emissions in the first instance. A simple example is the financing of a wind farm which may include funding for concrete in order to establish the farm. To attain a long-term reduction of emissions in the real economy, banks must finance not only climate solutions but also companies in greenhouse gas (GHG) intensive sectors in parallel with credible plans to decarbonise.

In order to ensure that the implementation of the new regulatory regime for sustainable finance is effective and scalable, it is essential that European and national authorities work with the banking sector to resolve challenges in a practical and speedy manner.

Government-led incentives needed to scale change
In both the EU and Ireland, significant progress has been made to integrate climate targets into legislative regimes, with banks proactively working to fulfil the expectations of supervisors and align with government policy on climate action. In 2017, Banking & Payments Federation Ireland (BPFI) established a Sustainable Finance Forum, incorporating members from across the international banking, retail banking sectors and non-banks. Since then, the prioritisation of climate and environment within member institutions has been remarkable, with an internal shift driven by sustainable finance legislation, particularly the EU’s Sustainable Finance Framework, and bolstered by individual initiatives within some of the banks to prepare their own organisations to better support clients and demonstrate their green credentials to investors and clients alike.

However, in order to scale to the level of change required and meet the ambitious targets that have been set out, government policy must incentivise consumers and businesses to act by creating market conditions that encourage and support private sector action.

Indeed, the latest IMF report noted that Ireland will likely miss its emission reduction targets of 51% by 2030 and pointed to options for government action that includes reduction or removal of implicit fossil fuel subsidies, expanded and higher carbon taxation and sectoral rebates.

The current European Union Parliament and Council that introduced the Green New Deal is set to change in June 2024, and we are facing a level of political uncertainty ahead. The focus of sustainable finance is also moving beyond climate to wider environmental issues, including water and marine, pollution, biodiversity and the circular economy, and to social issues. The industry will be monitoring the situation closely and will require policy certainty to ensure we can continue to integrate new climate and environmental rules and support clients to decarbonise.