The ECB’s new sustainable finance & climate data indicators highlight some of the most pressing data quality and methodology issues in producing the information needed to guide climate change mitigation. As financial institutions work with the data they do have, they will need to combine insights from many sources to inform their strategy and decision-making around climate risk.

  • The ECB’s statistical committee has released climate and sustainable finance indicators combining available data to create a picture of the euro zone’s financial sector climate exposure and sustainable finance response.
  • One of the most challenging issues with the data available today is the difficulty in pinpointing the effectiveness of financial institutions’ efforts to align with trend-altering trajectories towards a net zero future
  • The ECB’s indicators highlight the challenge that all financial institutions and regulators will face whereby the necessary action to mitigate climate change will have to precede the data they would like to have to guide the decision-making process.

The European Central Bank has released an explanation of the regular indicators it will begin to release showing different sustainable finance and climate risk metrics. In doing so, it has highlighted challenges to the methodology for the data currently available, as well as challenges for financial institutions and investors using the data to drive climate action into the future.

The ECB’s sustainable finance and climate indicators (transition and physical risk) relate to three outputs:

  • Sustainable finance: Experimental indicators showing the coverage and composition of sustainable and green bond issuance and holding within the euro area, relying on issuer self-labels and more comprehensive data coverage for green bonds when compared with other labelled bonds.
  • Transition risk: An analytical indicator of financed emissions and an emissions-intensity metric is produced for financial sector stakeholders based on a ‘waterfall’ approach, including data on various levels of company-specific and country-sector-year emissions estimates.
  • Physical risk: Three types of analytical indicators based on data availability measuring potential exposure at risk, the addition of risk scores, and a metric that (data allowing) could provide exposure at risk and computation of expected annual losses covering flood, wildfire and water stress risks.

The metrics cover many of the major financially relevant risks, including those related to financial stability. However, the quality of data underpinning these indicators, even though they have been compiled based on loan- and security-level data, is still somewhat rudimentary. For financed emissions, for example, the data combining emissions from the EU’s Emissions Trading System and the necessary non-financial corporate balance sheet data are available for under half of the total loan data available. The rest have to be estimated based on country-sector-year averages.

Furthermore, the coverage of emissions relates to different scopes that are quite narrow for considering the full impact of climate transition-related risks. Where data are collected at the entity-level, only Scope 1 emissions are covered. At the group level, global Scope 1 and 2 emissions are incorporated. Scope 3 emissions data are not covered, although these are important for investors and financial institutions exposed to multiple parts of the value chain.

The Statistics Committee of the European System of Central Banks, who compiled the data, concede the limitations of the data. They noted that “the intention of this release is also to facilitate a public debate and allow an open exchange of views (including on methodological aspects) with the research community and other stakeholders on how to achieve further progress towards the derivation of statistical indicators”. As a result, they conceded that “this is still a work in progress and the use of these indicators is subject to a number of caveats [and that] further improvements, in some cases significant ones, are required and will be addressed in future work”.

One of the specific limitations addressed in relation to transition risk indicators was that a point-in-time survey of the existing exposures would not naturally translate into clear indicators of progress towards decarbonization.

This issue has been considered by others, including the RFI Foundation in the context of our financed emissions in Islamic markets research. One of the clearer explanations of the issue came from the Institutional Investors Group on Climate Change (IIGCC) who, in replying to a UK government Transition Plan Taskforce “Call for Evidence”, warned of the hazards for investors in approaching a reduction of their financed emissions through divestment alone.

In the context of financial sector transition plans, the IIGCC cautioned the task force to: “Avoid encouraging ‘paper decarbonisation’ through the sale/divestment of carbon-intensive assets by setting expectations that companies and investors should achieve emissions reductions through transitioning their business models and strategies and through stewardship/engagement.”

The ECB’s recent data included a similar caution in relation to financed emissions “due to different data coverage rates and because it is currently impossible to disentangle changes in carbon footprints arising from divestment (from high-emission sectors) and from greening of underlying assets.”

The reason the time series issue is so challenging to measure is that it requires using historical data on the trends in financed emissions and allocations of finance & investment applied to a future where the objective of climate mitigation requires these trends to change. However, the data visible to central banks and investors capture only a slice of the financial sector, and target setting to reduce financing to high-emitting sectors will more likely push more of it beyond the field of view.

The speed limit on transition — which needs to be as rapid as possible — has multiple elements accelerating or holding it back. None of the elements on its own can accelerate the pace enough, and the more items that are present, the greater the likelihood of successful climate transition.

These cover more than just what is under the control of the financial sector, including governmental policy to internalize costs of GHG emissions through carbon taxes, regulation, or incentives for low-emission alternatives. They include disclosure regulations for non-financial companies on the credibility and progress of their transition plans and broader disclosure about their measurement of total value chain emissions.

There is no time to wait on the other measures needed for the climate transition for investors and financial institutions to incorporate climate considerations in their financing & investment decisions. Analytic indicators such as those the ECB recently released, and other sources to add detail or expand coverage, even if imprecise, will support development of financial institutions’ capabilities to understand, respond to and work to mitigate their climate-related financial risks.

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Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.

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Blake Goud

Promoting adoption of responsible finance in Islamic markets & Islamic finance. CEO @RFIFoundation.