Global central banks have released recommendations for banks that are developing climate transition plans to meet mandatory prudential requirements.
The Network for Greening the Financial System (NGFS), which includes more than 100 central banks and supervisory members, published three reports on Wednesday setting out in unprecedented detail what the initiative considers to be the elements of a credible transition plan from a prudential perspective.
The reports could provide a much-needed frame of reference for EU banks, which will for the first time next year be required to hand over their transition plans as part of the supervisory process to determine how much capital each bank needs to set aside to absorb potential losses.
There are expectations that some banks will already have to prepare corporate transition plans as part of voluntary net-zero exercises or under the EU’s sustainability reporting regime and – if approved – its due diligence directive, but prudential transition planning is largely unchartered territory.
Prudential disclosures must be strictly linked to traditional financial risk measures around profitability and solvency, while corporate transition plans have a broader scope of demonstrating the long-term climate viability of business models.
EU banks have until now had limited access to official guidance on the topic, save for a set of draft guidelines published in January by the European Banking Authority (EBA) soon after transition plan requirements were signed into law. The documents notably did not provide much granularity on the KPIs or line items which banks should be considering in their plans.
The EBA, which writes the prudential rules enforced by the ECB, has set a deadline of end-2024 to finalise the guidelines.
The NGFS has proposed that banks should demonstrate the implementation of “a clear, scientific and robust methodology” to assess client climate performance, use “escalation processes as needed” for clients with an unacceptable level of climate risks, develop plans to respond to significant deviations from climate targets, and use sector-specific engagement policies for “hazardous” activities.
The central banks suggested five overarching reporting pillars under which bank transition plan elements could be grouped: governance, engagement, risk analysis, viable actions, and monitoring and reviewing.
Prudential supervisors may also want to consider whether banks have processes in place to avoid greenwashing, the extent to which banks are considering nature risks, and broader social transition aspects, the NGFS said.
With regards to implementation, the network suggested that central banks could consider fully outsourcing the assessment of climate plans to third parties as a way of reducing supervisory burdens, or conduct joint reviews with third-party providers.
The NGFS said it will continue to study “the interaction between scenario analysis and transition planning, strategy setting, and understanding target setting from supervisory perspectives” in future reports.
EM insights
Separately, the NGFS reported on key differences in how banks within emerging markets and developed markets are approaching corporate-level transition plans, based on a survey of 37 banks conducted with the Institute of International Finance (IIF).
The study found that emerging market banks perceived themselves as more vulnerable to physical and transition climate risks compared to developed market banks, and said that they faced more obstacles to develop the plans.
These include data unavailability, the lack of national and sector-specific climate policies, and a limited understanding among clients regarding climate issues.
However, emerging market banks were more optimistic about the benefits of developing a transition plan and “generally anticipate a positive impact on transition financial flows” as a result, said the NGFS.
In contrast, developed market bank respondents said that negative consequences may result in the financial sector withdrawing capital from hard-to-abate sectors, “potentially reducing international trade relations and investments”.
The NGFS also noted that emerging market financial institutions which have developed transition plans usually prioritise climate adaptation and broader sustainability objectives beyond environmental factors, while the focus in developed markets is primarily on climate and mitigation.
