EU Pillar 3 ESG Reporting: Key Requirements & Challenges

As initiatives to mitigate climate risk grow, financial regulators around the world are responding with a host of requirements, designed to help banks and other financial institutions navigate the transition to a greener economy as reflected by their portfolios.

Enter the Pillar 3 framework for EEA-listed large credit institutions. In January 2024, the European Banking Authority (EBA) published international technical standards (ITS) for its Pillar 3 implementation on ESG risks as part of the Basel Framework.

Set to go live in early 2025, the EU Pillar 3 ITS is a broad set of requirements which aim to bring further efficiency and transparency to the disclosure process. The standards also share some common features with the EU Green Taxonomy, the classification system that defines environmentally sustainable economic activities for guiding investments toward the EU’s climate and environmental goals.

“Pillar 3 places particularly strict reporting requirements on credit institutions, especially due to their critical role in financing green activities.”

Let’s start by breaking out some of the key elements of the new Pillar 3 standards and their associated ESG disclosures.

According to the EBA’s final report of its international technical standards (ITS), these disclosures can be divided into four groups:

Quantitative templates measure bank exposures to sectors that heavily contribute to climate change. Meanwhile, disclosure of qualitative information is intended to convey how each mitigating action helps support a sustainable economy.

The EBA divides the quantitative disclosure tasks into specific templates: four for transition risk, one for physical risk and three for mitigation actions.
 

The report also outlines the qualitative information required for communicating ESG risks:
 

Since the EBA’s Pillar 3 ITS and the European Commission's EU Taxonomy both originate in the European Union, there are naturally parallels. However, don’t assume that the requirements are identical. Let’s explore a few points of divergence.

NACE classification

The EU Taxonomy and EBA’s Pillar 3 implementation both use the EU’s Nomenclature of Economic Activities (NACE) classification system for statistical data. NACE codes, which capture information such as sector and activity, give regulators granular insights into climate-risk exposures.

However, there is a key difference. A full NACE code consists of four “levels” of increasing granularity. Unlike the EU Taxonomy, Pillar 3 requires the classification to be conducted either at NACE code level 1 or 2, not level 4, the most granular of the classification levels.

GAR calculation

Both Pillar 3 and the EU Taxonomy require credit institutions to disclose their green asset ratios (GAR). GAR is the proportion of an institution’s book considered sustainable according to the EU Taxonomy Technical Screening Criteria (TSC).

Despite the requirement to disclose GAR under both regulations, the calculation methods differ on two fronts.

Additionally, Pillar 3 requires the disclosure of the banking book taxonomy alignment ratio (BTAR), which includes exposures to counterparties not subject to disclosure obligations under the Non-Financial Reporting Directive (NFRD), as well as those currently assessed under alternatives to the European Taxonomy (i.e., other mitigating actions).

Although these requirements currently do not exist in the ESG EU Taxonomy regulation, this could change in the future.

Multiple-collateral assessment

Under Pillar 3, loans with multiple collateral are assessed differently from those under the EU Taxonomy, specifically for templates 2 and 5. Only immovable collaterals are considered as part of the assessment of collateralized loans in Pillar 3; other types of collateral (e.g., cash) are excluded.

On the other hand, there are no specific treatment methods under the EU Taxonomy for collateralized-loan value based on collateral type; the key assessment priority is of the loan itself, not its collateral.

Financial institutions are faced with several technical challenges in aligning their reporting processes with the new requirements. These challenges span various aspects of data management, evolving market practices and the integration of ESG factors into financial reporting.

Data collection and credibility

Data collection and credibility top the list of reporting challenges under Pillar 3. The data required for calculations and reporting is new and specific. It must also be meaningful and credible—not just for reporting purposes, but also to achieve the institution’s own sustainability goals.

Evolving market practices

Another challenge is the emergence of new trends and regulatory developments, within and outside the EU. For example, the International Sustainability Standards Board (ISSB) is currently finalizing requirements for entities to disclose information about their climate-related risks and opportunities. Outside the EU, Brazil’s Social, Environmental and Climate Risks Document (DRSAC) requires similar information to Pillar 3.

Reconciliation with financial reporting

Reconciliation between Pillar 3 reporting and ordinary financial reporting is not as straightforward as it might appear. The difference in the granularity of the required data (e.g., gross carrying amount for Pillar 3 versus the carrying amount for financial reporting) means that there is no direct match even between the “total” fields across the regulatory templates.

Since the new Pillar 3 standards are far from the last ESG requirement that credit institutions will face, an ESG reporting solution needs to flexibly scale in response to the changing landscape. This flexibility must comprise the ability to address data-intensive and high-computing requirements. It must also address:

• Technical reporting challenges related to the EBA’s integration of the ESG Pillar 3 module as part of its data-point model and XBRL Taxonomy framework, effective December 2023. Institutions need technical capabilities to accurately generate and submit these XBRL reports.
• ESG data-collection and reporting obligations. Credit institutions (and financial firms more generally) need trusted technology in place that allows them to approach ESG monitoring and disclosure requirements efficiently and with confidence.

Institutions can certainly leverage regulatory overlap by reusing data attributes and providers across ESG Pillar 3 and the ESG EU Taxonomy. However, caution is required, as reporting requirements vary in certain areas.

That's why it's essential for institutions to adopt a proactive approach to data collection and retention. An end-to-end system for managing ESG risks and regulations may be the most effective path forward here.

“With more ESG requirements on the horizon, credit institutions need a reporting solution that can flexibly scale to meet an evolving regulatory landscape. As regulations continue to expand, firms must build reporting systems that adapt effectively to new standards and disclosure expectations.”