Risking overlap in requirements
The variety of contexts and legal languages in which these requirements are written in law fails to provide legal clarity on transition plans for banks and insurers: it could create legal complexity and administrative burden that could kill the original ambition.
Consistency between the different requirements is needed to ensure that financial institutions do not have to prepare different versions of transition plans for the different purposes of risk management, due diligence and sustainability reporting.
Risking an unlevel playing field
Ensuring the application of the transition plan requirements to all European banks and insurers would create a level playing field, promoting virtuous behaviours. Today, 122 world leading banks who are members of the Net Zero Banking Alliance (NZBA) and 29 insurers who are members of the Net Zero Insurance Alliance (NZIA) have committed to implement and disclose transition pathways, sustainability targets and annual progress (see here and here). They also commit to integrating sustainability risks into their risk management frameworks. This places them under the scope of CSRD and aligns them with the proposed CSDDD, Solvency II and CRD requirements. For these virtuous financial institutions, an ambitious EU legislation on transition planning will codify the commitments, but not overburden them by adding any new requirements.
On the other hand, as it stands NZBA and NZIA members risk being the only institutions compliant with the European Climate Law. Other banks and insurers could avoid sustainability requirements in the short term, free-riding on the active work of the NZBA and NZIA to mitigate climate risk and implement the transition. This creates an unlevel playing field of sustainability requirements, potentially even initiating a race to the bottom.
An absence of ambitious transition planning requirements would also risk erasing any efforts by compliant banks and insurers, through increased climate risk and in particular transition risk to which all institutions are exposed through the interconnectedness of institutions and systemic risk.
The concerns outlined above are supported by the conclusions of the ECB thematic review of banks on climate-related and environmental risks (report of November 2022).
In the same report, the ECB also recognised the role of transition plans, along with targeted client engagement, as a risk management tool to enhance the resilience of the banks’ business models (This is likely to be true for insurers as well). However, despite being integrated into institutions’ organisational frameworks, transition planning policies and commitments were found not to be supported by intermediate targets or were “set such that there is negligible immediate impact on the institution’s exposure profile”. This also pleads for stronger requirements to level the playing field and better protect banks.
Solution: One requirement at EU level
Introducing clear transition plan requirements in the CRD, CRR and Solvency II for banks and insurers can prevent overlaps with disclosures and due diligence requirements, thus reducing legal uncertainties. It can ensure that all institutions are on an equal footing when applying sustainability requirements. These will necessarily take into account the nature, scale and complexity of transition risks inherent in the business model of the respective institution, in line with the principles embedded in the legislative framework.
Now is the perfect opportunity to turn transition plan requirements into a catalyst for change. We should not allow vested interests to burden the “sustainable finance strategy” with unnecessary complexity or to push for a total lack of requirements. Let’s act now and pave the way for a greener, more sustainable financial future.
Paul Fox, Pablo Grandjean, Nikolas Geirnaert