ESG data quality: Pillar 3 disclosures in focus

21 February 2024

The ECB is responsible for assessing banks’ compliance with Pillar 3 disclosure requirements. Pillar 3 disclosures are highly relevant for transparency because they provide market participants and the public with information on banks’ risks, capital adequacy and risk management. To assess banks’ compliance with the disclosure requirements the ECB, among other things, collects published Pillar 3 information from banks on an annual basis and compares it with data they have reported to the supervisors. If the ECB identifies misalignments between the two datasets or any other misrepresentation, it requests banks to correct the information. It also publishes the selected Pillar 3 information after each reconciliation exercise to allow for transparent bank-level comparisons of key risk metrics.

Environmental, social and governance risk disclosures

Disclosing climate-related and environmental (C&E) risks is particularly important as these factors can materially influence financial stability and risk profiles, directly impacting the broader financial system. Sound and meaningful disclosures are therefore key to understanding banks’ environmental, social and governance (ESG) risk exposure.

The ECB’s specific expectations for C&E exposures are set out in its Guide on climate-related and environmental risks, which was published in November 2020. Since then, even though banks have increased the amount of information they publish and have continued to work on their measures, several ECB assessments have found that C&E disclosures require further improvement. This includes the latest assessment in April 2023.

A critical regulatory development towards better disclosures has been the implementation of the European Commission’s implementing regulation relating to the disclosure of ESG risks. This requires eligible banks to disclose information in comprehensive qualitative and quantitative templates, as outlined by the European Banking Authority, as of the first reference date of 31 December 2022. The ECB included some of the newly disclosed ESG information from these templates in its November 2023 release of annual Pillar 3 information. Even though the inaugural standardised ESG disclosures face serious data quality issues and must be treated with caution, they do serve as a valuable additional source for industry benchmarking and investor assessment of banks’ C&E risks.

Between March and August 2023, the ECB collected Pillar 3 information from 107 banks through their public Pillar 3 disclosure documents, and 41 banks corrected and republished their 2022 Pillar 3 reports following thorough quality assurance. Of the 107 banks, 86 disclosed ESG risk data. The process, however, gave rise to challenges, as ESG risk information was dispersed across various reports and data were presented in different formats. Compounding the complexity, the data collected were extensive, often comprising over a thousand data points per bank.

Overall, the ECB found that despite the complexity and novelty of the disclosure’s templates, all eligible banks managed to disclose most of the required data. Several areas for improvement were identified. Some banks already collaborated and published a report that identifies common practices to facilitate more transparent disclosures, thereby mitigating a lack of comparability.

Banks struggled to populate quantitative templates

Challenges persisted, notably in the realm of data quality and particularly in quantitative templates. Issues ranged from misreported units to differences between banks in the use of metrics and concepts. For example, in template 1 several banks failed to disclose data on exposures towards sectors that contribute significantly to climate change or data on average weighted maturity. Other banks could not match the sum of sub-sectors to the aggregate. Similar challenges surfaced in template 2 where banks failed to completely disclose ESG data on commercial and residential real estate portfolios and repossessions in the EU area. In template 4, only 35 banks disclosed data at aggregate level while clearly identifying the data provider and the data source relating to the most polluting firms. In template 5 on physical risk, only 19 banks disclosed data for at least two geographical areas where the sum of maturity datapoints matched the sum of physical risk datapoints.

Qualitative templates were patchy

Of the 86 banks disclosing ESG risk information, approximately 24% adhered fully to the qualitative disclosure requirements for each ESG risk. Around 70% of banks provided partially compliant qualitative information on environmental and social risks, and 62% on governance risk. Banks often failed to offer detailed qualitative information and did not clearly differentiate the integration of environmental, social, and governance risks into their governance and risk management frameworks. Much of the forward-looking information was not sufficiently disclosed, such as banks’ plans to meet targets related to business model and strategy, including plans over the medium and long term. Banks also need to explain better how they identify, measure and monitor activities and exposures sensitive to ESG risks, covering relevant transmission channels and ensuring a link with assessments of conventional risks.