Ratings agency puts case for integration of ESG risks into financial reporting using “common set of internationally comparable metrics”.
Banks’ ability to carry out climate change related stress tests could be vastly improved by standardisation of corporate ESG risk disclosures, according to a new report published by Fitch Ratings.
As more prudential regulators have introduced climate-related stress testing requirements, banks have sought greater harmonisation of the variables and scenarios employed within the tests. Due to banks’ heavy reliance on input from corporate clients to conduct the tests, Fitch Ratings has called for a common sustainability standard, ideally led by a single authority, arguing that banks require standardised data on how physical and transition environmental factors translate into financial risks. This change, Fitch Ratings states, will help to ensure that stress tests make use of reliable, high quality and easily comparable data, therefore leading to improved stress test results.
Further, standardisation of ESG reporting and disclosure would allow market participants to compare and assess how ESG risks impact the creditworthiness of banks more easily, enabling investors and analysts to benchmark against peers. “Our view is that market participants, including credit rating agencies, would be better served if ESG business risks were integrated into financial reporting using a common set of internationally comparable metrics,” Fitch Ratings stated.
Currently, market participants report that they find the lack of disclosure standardisation confusing, with a lack of standardised sustainability reporting making comparison difficult across companies and geographies. Inefficient data reporting can in turn prove costly to reporting companies. Meanwhile, several banks in the UK and France have warned that data gaps may make it difficult for them to provide some of the model inputs required.
Whilst some ESG impacts may already be reflected in financial reporting, the link between financial and non-financial reporting is often unclear, making it difficult to assess how and if banks are allocating sufficient capital to absorb expected ESG losses.
As Fitch Ratings calls for market disclosure harmonisation, climate-change risk reporting guidelines set out by the Task Force on Climate-related Financial Disclosures (TCFD) are rapidly becoming internationally recognised and used. A number of countries report in line with the guidelines, whilst banks which are founding members of the TCFD align their disclosure with its recommendations.
The new report follows on from a number of developments relating to sustainability reporting standards. In September, the World Economic Forum’s International Business Council (IBC) published a set of ESG metrics for inclusion in financial reporting by issuers, in conjunction with the big four accounting firms.
The five major voluntary standards setters – the CDP, the Climate Disclosure Standards Board, the Global Reporting Initiative, the International Integrated Reporting Council, and the Sustainability Accounting Standards Board – announced a joint effort to develop a single ESG reporting system, complementary to the IBC. The IFRS Foundation, which oversees the work of the International Accounting Standards Board, has also published a consultation paper assessing the level of demand for sustainability standards.
Fitch also noted that proposed EU legislation to amend the Non-Financial Reporting Directive would bring it in line the bloc’s disclosure and taxonomy regulations, requiring large companies to provide public sustainability information of a higher level of detail and standardisation.
“This is good news as, once in place, investors should be better informed about companies’ climate and environmental data and about the sustainability of their investments,” said Fitch. “And banks will have access to more standardised comparable information, to help fulfil their ESG and climate-change related disclosures.”