Europe must harmonise its patchwork of transition plan requirements

Transition plan requirements feature in several EU laws under discussion. Policymakers should harmonize these overlapping rules into a single, consistent requirement for all financial institutions to avoid legal uncertainty and free-riding.

Demonstrating their commitment to the new EU climate law, European policymakers are crafting legislation to implement a package of EU laws called the Renewed Sustainable Finance Strategy. This will have a massive impact on the day-to-day operations of all EU businesses and financial institutions.

Pushback from the guardians of business-as-usual

The new sustainable finance strategy may not be able to achieve its primary goal of aligning financial flows with the Paris agreement (analyzed here), but its remaining value to society comes from establishing some crucial prerequisites for sustainable finance.

But when it comes to the game-changing measures within this EU framework, opposition from vested interests is strong and Member-States are often the voice of their national business champions to undermine European ambition.

One of the concepts that should be protected at all costs from pushbacks, is requiring financial institutions to implement a transition plan and evaluate their progress towards sustainability goals. Interestingly, many of the largest European banks and insurers are already part of net-zero alliances, where they have committed to doing exactly that but so far, only on a voluntary basis.

The role of transition plans for financial institutions

The need for mandatory transition plans stems directly from Europe’s commitment to be climate-neutral by 2050. Indeed, for this to become reality, Europe must make sure that all EU businesses and financial institutions prepare rigorous plans to achieve net zero themselves. Including financial institutions is crucial, as they can hinder or facilitate the transition, depending on whether they provide financing to harmful or to sustainable economic activities and whether they use their voting power to prioritise short-term financial gains or advocate for the adoption of sustainability practices (read also our recommendations).

Many of the European legislative packages currently on the table mention transition plan requirements for financial institutions in one way or another: sometimes in the context of obligations of sustainability disclosures (1 disclosure), due diligence duties (2 governance) and financial institutions’ risk management (3 risk).

1 Disclosure: avoiding net-zero washing via transition plans

When it comes to transparency, the upcoming transition plan requirements lodged into various legislative files (see below) are meant to have financial institutions disclose how they will align their business with the EU climate targets.

Disclosure requirements

The Corporate Sustainability Reporting Directive (CSRD) creates an obligation for banks and insurers to report transition plans if they have them. As the Directive deals with reporting there is an area of legal uncertainty as to whether it can create the obligation to have a plan.

The European Sustainability Reporting Standards (ESRS), drafted by the EFRAG, aim to confirm details on the targets to be disclosed in transition plans and the progress made in implementing them. They will be adopted through Delegated Acts mandated by the CSRD.

The Sustainable Finance Disclosure Regulation (SFDR) includes a requirement to disclose and assess alignment with sustainability objectives for banks to the extent they provide investment decision-making (portfolio management). This could be considered to put banks under the scope of the CSRD, but again leaves legal uncertainty as disclosure regulation on where the obligation to adopt and implement alignment objectives comes from.

2 Governance: obligating results on sustainability

When it comes to due diligence in Europe, an upcoming directive is likely to create the obligation for all financial institutions to quantify and reduce their adverse impacts in line with European climate objectives.

Governance requirements

The Corporate Sustainability Due Diligence Directive (CSDDD) sets out the requirement to adopt transition plans. It aims to resolve the legal uncertainty in the CSRD, but it does not reference the CSRD or align the plan with the provisions to be disclosed.

3 Risk: prudential requirements for managing sustainability risk

On risk management, several sets of EU standards and prudential rules are currently under discussion, including the obligation for banks and insurers to disclose their exposures to sustainability risks better as well as to undertake actions to reduce these exposures.

Risk management requirements

The proposal to review the Capital Requirements Directive (CRD) looks to cover sustainability issues for banks, including plans to manage the risks of misalignment with EU sustainability objectives. ECON Committee amendments clarify this obligation and table the requirement for banks to use CSRD-aligned transition plans to help mitigate climate-related financial risks.

The proposal to review the Capital Requirements Regulation (CRR) ensures sustainability risks are also included in the banks´ disclosures. ECON Committee amendments also table the requirement for banks to include their CSRD-aligned transition plans to help mitigate climate-related financial risks in their supervisory reporting and public disclosures.

The proposal to review the Solvency II Directive (SII) looks to cover sustainability issues for insurers. ECON Committee amendments table the requirement for insurers to use CSRD-aligned transition plans to help mitigate climate-related financial risks.

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.

Finance Watch Europe must harmonise its patchwork of transition plan requirements

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

For banks:

Introducing clear transition plan requirements in the CRD and CRR can avoid overlaps and legal uncertainty for banks. It can ensure that all banks are on an equal footing when applying sustainability requirements. The requirement 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.

Amendments under paragraph 14 to Article 76 in the European Parliament report as part of the CRD review achieve this by:

  • Including references to the CSRD to ensure that the same plans can be used to fulfil both CRD and CSRD requirements – CSRD being the foundation for corporate sustainability requirements.
  • Clarifying the application of transition plan requirements for all banks.

Amendments under paragraph 17 to Article 87a in the European Parliament report as part of the CRD review also ensure that the plans are integrated into risk management processes and are properly supervised.

Amendments under paragraphs 176 and 189 to Articles 430 and 449a the European Parliament report as part of the CRR review on reporting and disclosure obligations ensure the consistency link with use of transition plans for risk management purposes in the CRD.

Additional adjustments could provide further legal clarity by:

  • Including a reference to amended Articles 76 and 87a of the CRD in Article 430 of the CRR.
  • Including references to CSDDD to ensure that there is one consistent transition plan requirement for risk management, due diligence and disclosure purposes or a mandate for the European Commission to include a reference at a later stage if needed.
  • Including explicit references to the Article 8 of the Taxonomy Regulation and its  Delegated Act to ensure sustainability targets/KPIs for banks’ on and off-balance sheet exposures are aligned with the Taxonomy.

For insurers

Introducing clear transition plan requirements in Solvency II can avoid overlaps and legal uncertainty for insurers. It can ensure that all insurers are on an equal footing when applying sustainability requirements. It also ensures that transition plan requirements benefit from the strong built-in proportionality principle in Solvency II.

Amendments 455 – 462, 472 & 476 in the ECON Committee as part of the Solvency II Review achieve this by:

  • Including references to the CSRD to ensure that the same plans can be used to fulfil both SII and CSRD requirements (via amendment to SII Art. 44 on risk management) – CSRD being the foundation for corporate sustainability requirements
  • Clarifying the application of transition plan requirements for all insurers
  • Application of the supervisory review process to the transition plans.

Additional adjustments could provide further legal clarity by:

  • Including references to CSDDD to ensure that there is one consistent transition plan requirement for risk management, due diligence and disclosure purposes or a mandate for the European Commission to include a reference at a later stage if needed.
  • Including a reference to Article 29 of SII to explicitly ensure that the proportionality principle is taken into account.
  • Including explicit references to the Article 8 of the Taxonomy Regulation and its  Delegated Act to ensure sustainability targets/KPIs on insurance companies’ underwritings and investments included in the transition plan are aligned with the Taxonomy.