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Taxonomy

What is the Green Asset Ratio and what will it mean for banks?

The EU Taxonomy already mandates banks to disclose the proportion of their total assets of exposures to EU Taxonomy-eligible economic activities. However, with the Green Asset Ratio (GAR) disclosures due in January 2024 for the financial year 2023, banks will need to step it up a notch.

Louis de Wergifosse

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In January 2024, EU banks will have to disclose their Green Asset Ratio (GAR) for the financial year 2023. This means that banks will need to provide quantifiable evidence that demonstrates the extent to which the activities they finance meet what the EU Taxonomy defines as sustainable. 

Thus far, banks’ climate ambitions and commitments have mainly consisted of redirecting capital towards green investments or reducing their long-term investments in fossil fuels. The GAR will bring a new element to these commitments, as it will provide a more transparent screenshot of a bank’s portfolio and its level of sustainability. Therefore, any discrepancies between climate goals and commitments, with what actually happens in practice, will be identified and tracked more quickly and clearly.

What is the Green Asset Ratio?

According to the EU Taxonomy Disclosures Delegated Act, the GAR refers to the proportion of a credit institution’s assets that finance and are invested in EU Taxonomy-aligned economic activities as a proportion of the total covered assets. If you need a refresher on EU Taxonomy eligibility and alignment and how these are calculated check out our blogs on these topics.

In other words, the GAR is a ratio showing EU Taxonomy-aligned financial assets as a percentage of lenders' banking books. The main hurdles that come with calculating the GAR are twofold:  on the one hand, it can be tricky to understand which assets must or must not be included and on the other hand,  it can be time-consuming to collect data on the assets and whether they are EU Taxonomy-aligned or not.

These issues can be tackled as follows: 

Issue one: Understanding the assets

First, the bank needs to separate the financial assets from the on-balance (debt and equity assets and liabilities) and the off-balance sheet (Financial guarantees, Assets under Management).

Second, the exposures to central governments, central banks and supranational issuers need to be excluded from the calculation of the numerator and denominator of the GAR, as well as the assets held for trading (which will also be subject to their own disclosure, i.e the trading book KPI). For the first, the reason for excluding them is that no guidelines have yet been disclosed on how to assess the EU Taxonomy alignment of such large-scope entities. Assets held for trading are also excluded as they are acquired mainly with the purpose of selling and/or repurchasing in the near term, which is less compatible with the nature of EU Taxonomy-aligned investments. In addition, the bank will have to disclose its Trading Book KPI by 2026 (see delegated Regulation (EU) 2021/2178).

Finally, some assets are excluded from the numerator but integrated in the denominator, including exposures to undertakings that are not under the NFRD, derivatives, on-demand interbank loans, cash and cash-related assets as well as “other assets” (e.g. goodwill, commodities etc…). These could be considered as 100% not eligible.

Assets that are considered in the numerator of the GAR include loans and advances, debt securities, equity holdings and repossessed collaterals. For those loans where the use of proceeds is unknown (general-purpose loans), the turnover and CapEx alignment of the loan will be the same as the emitting asset. In the case that a loan where the use of proceeds is known (specific-purpose loans) the EU Taxonomy-alignment data needed is provided by the counterparty of the project or activities to which the proceeds will be applied.

Credit institutions must disclose GARs at an aggregated level over all exposures, as well as its breakdowns by environmental objective, type of underlying positions, such as loan and advance or equity, and by type of counterparty, for example, non-financial corporates or insurance undertakings.

In addition, the GAR must be disaggregated between its stock positions, previously existing positions, and its flow positions, new loans and advances or other positions because these are included on the on-balance sheet during the reporting exercise

Issue two: Gathering the right data

The second issue is related to data availability. As mentioned, only undertakings that are under the scope of NFRD and, consequently, which need to disclose their EU Taxonomy alignment in 2024 must be included in the GAR numerator. This data should therefore be publicly available. However, many observers stress that corporates are not ready to calculate their EU Taxonomy-alignment due to various reasons (inadequacy of accounting system, insufficiently granular data, lack of understanding of the regulation) (see for example the reports from EBF and UNEP-FI: Testing the application of the EU Taxonomy to core banking products and Practical approaches to applying the EU Taxonomy to bank lending) and consequently, scores could be very low, remain hidden or even unpublished. In addition, for loans contracted for households (e.g. mortgage, renovation, car loans) or repossessed by real estate, the bank will need to screen the assets itself. This task can be substantial as banks can have a significant number of such loans and the criteria for these activities is often country-specific.

How to prepare and make the best out of the GAR disclosure?

Due to the limited scope of the GAR numerator and the lack of readiness of non-financial undertakings, banks’ GAR scores are expected to be low at the start. In May 2021, in its first EU-wide pilot exercise on climate risk, the EBA estimated an average GAR of 7.9% for a sample of 29 EU banks. As a result, the relevance of the GAR comparison between banks will be limited at first but will increase as more undertakings are included in the scope. 

To enable banks to measure their GAR better, they may include an additional section with information that outlines their score if they were to include non-NFRD undertakings in their GAR numerator under certain conditions, the undertakings should: 

  • not contradict or misrepresent the mandatory information.
  • not be given more prominence than the mandatory disclosures.
  • include supporting details setting out the basis for voluntary disclosures.
  • include details on methods used for their preparation, with a clear explanation of how this differs from mandatory reporting.

The GAR including non-NFRD undertakings is also the definition of the Banking Book Taxonomy Alignment Ratio (BTAR), which banks will be required to disclose under the EBA Pillar III Disclosures on ESG Risks as of June 2024 (still subject to the adoption process of the European Commission). For more information on this mandatory disclosure framework, please refer to our blog article on the topic.

Given that non-NFRD undertakings are not mandated to calculate their EU Taxonomy alignment, proxies can be used for them when no other information is available (but never for the GAR!). However, even among proxy providers, limited data exists for Small & Medium Enterprises (SMEs).

Given all the challenges mentioned, the EBF and UNEP-FI  gathered a group of 24 banks and 12 banking associations to test and discuss the application of the EU Taxonomy to banks’ lending products. The report generated a set of steps to help to apply the EU Taxonomy to core banking products: 

  • Step 1: As far as possible, define the use of proceeds of the loan or credit facility.
  • Step 2: When the use of proceeds is not specified, classify exposure on the basis of clients’ business activities.
  • Step 3: Decide into which EU Taxonomy category the transaction, activity or company falls - Mitigation, Adaptation, Enabling, Transitioning, etc.
  • Step 4: Require clients to disclose the necessary information to meet Technical Screening Criteria (TSC) and MSS.
  • Step 5: TSC for Substantial Contribution should be strictly met based on evidence.
  • Step 6: Subject to a materiality judgment, DNSH and MSS assessments may rely on the assumed compliance of clients and assets with relevant legislation. They may also rely on certification schemes and labels and require timing flexibility. Indeed, it may be challenging to conclude assessments before transactions are finalised.

Moreover, the report highlighted several recommendations:

  • Need for compatibility/comparability of criteria between the EU Taxonomy and other applicable legislation and regulations, including at national level.
  • Interest in the alignment of taxonomies to facilitate international data collection and provide comparability mechanisms of criteria for the applicability of the EU Taxonomy beyond EU borders.
  • Need for tools to facilitate the collection and handling of data and consequently, facilitate the application of the EU Taxonomy.
  • Banks should start methodical data collection for taxonomy-relevant information as part of new origination, on a best-effort basis, based on internal strategy and priorities.

Finally, on a more technical note, the report states that “most banks cite the challenge of adapting internal information processes and the cost of developing IT tools and support.”

How can Greenomy help?

Calculating your GAR and BTAR can be extremely challenging due to the many reasons outlined above. 

Greenomy automates the collection of existing Taxonomy scores and their consolidation at the bank level. It facilitates the screening of banks’ retail loans through Optical Character Recognition (OCR) and the screening of counterparty activities through a dedicated portal. Moreover, as an ESG market infrastructure, Greenomy shares the efforts in capturing ESG data for reporting purposes between all banks present in the ecosystem, while reducing the costs. Twelve leading European banks, such as the Luxembourg state bank Spuerkeess,  and credit bureaus, such as Schufa in Germany and Cerved in Italy, are already connected.

More generally, Greenomy helps companies, credit institutions and asset managers to comply with the new EU Sustainable Finance Regulations (EU Taxonomy, SFDR, NFRD/CSRD, Pillar III) and redirect finance flows towards sustainable activities in line with the EU Green Deal. Our innovative SaaS solution establishes an all-encompassing sustainability data and analytics ecosystem that connects all critical stakeholders, so that companies, banks and investors have access to a market infrastructure and a one-stop-shop solution for their operations.

If you would like to discuss how to tackle your own reporting requirements, you can book a demo here.
 

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