Sustainable finance: four priorities for Nordic banks in 2024

At a glance

• In this article, we identify four strategic priorities for Nordic banks in the context of sustainable finance in 2024. Whilst the themes are familiar, 2024 brings new angles and developments, placing the themes at the top of banks’ and regulators’ agendas.
• Nordic banks should revisit their sustainability strategies in light of updated leading practices and requirements, taking into account their evolving transition plans and the changing regulatory landscape. To maximise their prospects of success, banks should prioritise ensuring the commitment of the Board to their transition plan; enhancing regulatory strategy capabilities; and developing a firm-wide ESG data strategy.
• In 2024, banks will also have to navigate the increasingly complex sustainability disclosures and reporting landscape, with the immediate priority being implementing the Corporate Sustainability Reporting Directive (CSRD).
• While the extent to which the banking capital framework will be amended to incorporate sustainability risk directly is still under debate, in the absence of a formal Pillar 1 requirement banks should work on enhancing how sustainability risk is incorporated into their ICAAP and their risk management.
• Transition plans also need to be further developed and implemented in 2024. Banks should adopt a risk-based approach to focus on the most important aspects of their business models given challenging implementation timelines and the complexities of data collection. In particular, it will be key to develop an understanding of financed emissions.
  

Who this blog is for: a range of stakeholders across the Nordic banking sector, including Board members and executives working across sustainability, risk management, regulatory compliance, regulatory affairs, reporting, and data management.

Overview

Although Nordic banks are amongst the leading pack of institutions paving the way for sustainable finance globally, including by setting ambitious net-zero and financed emissions targets, the rapidly evolving landscape demands constant attention and adaptation. Regulation is an important driver of this change and a critical consideration for banks as they set plans to meet their net-zero commitments and support the transition of the real economy.

This article highlights four regulatory priorities that Nordic banks need to focus their minds on in 2024. While the priorities will be familiar, this article focuses on what is new and/or different and aspects that cut across the themes this year – notably in relation to sustainability data.

Our four priorities are:

1. setting a top-down, comprehensive sustainability strategy;
2. navigating the increasingly complex sustainability disclosures landscape;
3. exploring the impact of sustainability-related risks on capital requirements; and
4. building a credible transition plan.

For each of these priorities, we explore the challenges that banks are grappling with, and set out actions they can take to anticipate and respond to regulatory scrutiny. Building an effective sustainability data strategy is a common theme across these four priorities. Data in the context of sustainability is always important. However, we analyse what is distinct about the data strategy for each theme. We then take a brief look at the future and what is next in sustainable finance regulation in the Nordics.

This article builds on the EMEA Centre for Regulatory Strategy’s 2024 Financial Markets Regulatory Outlook for Sustainable Finance.

1) Setting a top-down sustainability strategy: a strategic imperative

Although Nordic banks have been incorporating sustainability principles into their business strategies for some time, the bar for what “good” looks like is constantly rising. Nordic banks should revisit their strategies and roadmaps in the context of this moving sustainability target, particularly as we expect sustainability-driven regulatory change to hit an inflection point in 2024. Banks need to ensure they have in place a comprehensive top-down strategy, connecting all the moving parts on sustainability across regulation and business strategy.

Nordic banks will face a number of challenges in doing this. First, they need to stay on top of regulatory developments in the EU and locally, maintaining a comprehensive overview given the sheer number and complexity of incoming regulations and the connections between them. Second, effective engagement with stakeholders (including investors, customers, employees, regulators, and communities) will be critical for banks to understand regulatory changes and adapt to shifting patterns in investment flows and consumer demand. And third, despite increasing availability, sustainability data will also continue to pose challenges, particularly given the regulatory emphasis on a more quantitative approach, including the push for banks to conduct more climate stress and scenario testing as well as monitor and report detailed sustainability- and transition-related metrics. Banks that succeed in enhancing their data capabilities will be better placed to leverage opportunities and manage risks. Banks need to develop a comprehensive firm-wide data strategy to address issues and build capacity. Overcoming obstacles in data collection, interpretation and accessibility will be key to achieving this.

To navigate these challenges effectively, Board members and senior executives need to ensure that sustainability remains a priority and set an appropriate “tone from the top”. Banks’ second and third lines of defence (including risk, compliance, and internal audit functions) also have an important role to play in challenging and providing assurance on the bank’s sustainability strategy. The risk function, in particular, should play a key role in this, making sure sustainability risk is truly embedded within the risk management framework and policies, enabling informed and consistent decision‑making across the business.

Ensuring there is an overview as well as a forward-looking plan to stay ahead of evolving regulations will also be important. One key priority for Nordic banks this year will be to address corporate sustainability reporting requirements and meet expectations on transition planning.

2) Sustainability reporting and disclosures: a call to action for Nordic banks

Addressing corporate sustainability reporting requirements will be a key priority for Nordic banks in 2024. Most Nordic banks need to do more work to meet the new requirements in full – particularly the largest banks that will need to report under the CSRD in 2025. And this is not all – there is also the EU Taxonomy, the Sustainable Finance Disclosure Requirements (SFDR), EBA Pillar 3 disclosures, and not least the Corporate Sustainability Due Diligence Directive (CSDDD), which would increase due diligence requirements if it enters into force. These new requirements will require firms to report more exhaustively on how sustainability is integrated into operations and business strategy, how risks and opportunities are managed across the organisation and value chain, and associated risk and governance arrangements.

Nordic regulators are already asking questions around banks’ implementation of sustainability-related disclosures and reporting. The Swedish FSA has, for example, reviewed firms’ SFDR reporting, particularly how they integrate sustainability risks into their operations. The Danish FSA has also reviewed sustainability disclosures in key investor information for article 9 funds. Furthermore, tackling greenwashing risk (particularly in the context of disclosures) is a clear priority amongst Nordic regulators, with both the Swedish and Norwegian FSAs singling this out as a top priority going forward.

The landscape is looking increasingly complex, at an increasingly rapid pace. To implement the various requirements in time will be no mean feat, necessitating a significant programme of work across finance, operations and control functions, and securing appropriate governance, resources and key stakeholder buy-in early on. Figuring out the overlap between the initiatives will also take some time and effort. What’s more – although the key reporting requirement, CSRD, is known, there remain important areas of uncertainty, and standards themselves are still developing. This dynamic needs to be factored into any action that Nordic banks take in 2024.

Nordic banks will have to develop a firm-wide, cohesive sustainability disclosure strategy that encompasses and maps out the various obligations (including most importantly the CSRD, SFDR and EBA Pillar 3 disclosures) and how they interact. The strategy should also be informed by the Board’s overall risk appetite for adopting various disclosures and reporting requirements beyond the mandatory minimum. Establishing a data collection framework will be help drive strategy, and move beyond simply facilitating the use of sustainability metrics. If done appropriately, such a strategy could be used to drive a wider set of changes across the organisation which could increase the effectiveness of the reporting throughout the bank by identifying synergies and dependencies.

3) Capital: putting a number on it

The prudential treatment of sustainability (in particular, climate-related financial risk) has been a priority for banking supervisors for some time, but their work has not yet concluded. In our view, we are unlikely to see any significant revisions to the banking capital framework in 2024 to accommodate sustainability risk. But, it is clear that regulators expect banks to consider the potential impact of sustainability risk on capital outside of Pillar 1 – and there could be penalties for not doing so. In the EU, the ECB has led the way in setting expectations for SSM-supervised banks (i.e., including ECB-regulated Finnish banks), clarifying that climate and environmental risk models should be in place by end 2024. There will also be a number of developments that will accelerate the adoption of more advanced expectations for all Nordic countries in 2024. This includes for example recent recommendations from the EBA to enhance Pillar 2 frameworks to capture environmental and social risks.

Quantifying sustainability risk and assessing its impact on capital remains a significant challenge for banks. The use of the Pillar 2 framework to address climate-related financial risks is comparatively well-established amongst EU, including Nordic, supervisors. Banks are already required to identify and explain how they manage material exposures in their ICAAP, although in our experience, banks still have work to do in this regard. At the core are issues around data availability and measurement – what is difficult to measure is difficult to manage. Historical data does not fully reflect sustainability risks, which are more forward-looking in nature. Banks also need to understand better their counterparties’ exposures to sustainability risks than they do today, as it will help them come to a view on their transition risk profiles. Enhanced sustainability-related corporate sustainability reporting should help gathering transition data from counterparties – although this is still some time off.

Given the fast-evolving landscape, Nordic banks need to continue to monitor and stay on top of relevant guidance and expectations from the ECB and the EBA on the prudential treatment of sustainability risk. They should revisit their ICAAPs to ensure they have an updated view of material exposures. Where banks do not include climate or wider sustainability risk in their scenario analysis, they should develop a plan for doing so. Where banks do – they should explore moving from more qualitative scenario analysis to more quantitative stress testing. Lastly, it will be key for Nordic banks to develop an approach for collecting sustainability-related data to feed into any stress or scenario analysis. Maintaining parallel shadow models could also be helpful (especially for banks not subject to the SSM rules) to model the potential capital impact of sustainability risks in the background, anticipating that this will, at some point, form part of actual capital requirements.

4) From obligation to opportunity: building credible transition plans

Transition plans outline how banks intend to manage and mitigate climate-related risks but also capitalise on opportunities as the world transitions to a low-carbon economy. They serve as a guiding document for customers, investors and staff in detailing how banks will achieve their sustainability goals, particularly in reducing emissions. In recent months, several large Nordic banks have published their first transition plans, with more to follow as part of CRR3/CRD6 under which transition plans are mandatory. The EBA is currently consulting on guidelines to manage sustainability risk, including what it refers to as “prudential transition plans” (see link to our article here). Further, companies in scope of CSRD are expected to publish their transition plans under ESRS E1 on climate change on a comply or explain basis.

Banks have more to do to meet expectations on transition planning and will need to step up their efforts in 2024 – Nordic banks in scope of CSRD that identify climate change as a material risk will have to disclose their transition plans in 2025. The short implementation timeline is a significant hurdle, requiring an efficient and risk-based approach to be able to meet the requirements in time. Key for banks will be to have a good understanding of the emissions being financed. This is difficult, however, because many banks have yet to gather data and establish a methodology to estimate financed emissions. Industry-wide standards such as the Partnership for Carbon Accounting Financials (PCAF) provide helpful starting points for banks, but many Nordic banks still mainly rely on their customers’ transition pathways for their own transition. While some pioneers are developing tools for systematic data collection and launching innovative financial products, their dependence on the actions of the underlying portfolio companies remains high.

To overcome these challenges, banks need to take a strategic and rounded approach to transition planning, using the transition planning process to drive discussions internally and with their customers. The transition planning efforts should set out and deliver a programme of sustained engagement with portfolio clients and companies. To be successful, Nordic banks must secure the appropriate resources and expertise required for transition plan implementation. Overcoming the data challenge to enable effective transition planning will be key given tight reporting deadlines, requiring innovative solutions and, ideally, industry collaboration. Putting in place appropriate monitoring mechanisms will also be critical for timely action, whilst providing a flexible framework that can adapt to changing circumstances.

Looking to the future – what comes next?

Although the priorities and immediate deadlines for Nordic banks in 2024 are clear, uncertainty about the pace of change and direction of travel of sustainability regulation will increase as other priorities compete for policymakers’ attention. The case for sustainability, however, and the momentum behind the transition are well-established and will not be reversed – and many banks will conclude that they cannot afford to delay action.

Looking ahead, we expect policymakers to increase attention on transition finance, and how to mobilise banks and other financial institutions to fund the transition to net zero. Financing transition projects remains challenging for banks, partly because of a lack of consensus on what “green finance” constitutes. Meanwhile, climate will continue to dominate discussions, but nature will become a greater priority for policymakers and banks alike following the finalisation of the Taskforce for Nature-related Financial Disclosures (TNFD) framework. Nordic banks are slightly behind their peers in terms of starting to assess nature-related risks and their impact on business models. And lastly – although we don’t expect to see any significant developments around incorporating sustainability-related risks into the banking capital framework in 2024, this could change quickly. The EU’s insurance regulator, EIOPA, is already exploring and consulting on policy options for the prudential treatment of sustainability risk within the insurance capital framework. If this goes ahead, it might fuel further action in the banking sector – banks need to be ready for that eventuality.