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In ESG era, new green asset ratio could give Europe's banks an edge over rivals

European banks may gain an edge over their U.S. peers with a proposed "green asset ratio" designed to give investors clarity on increasingly important environmental issues, according to market participants.

The European Banking Authority has recommended that banks adopt a greet asset ratio, or GAR, to show how their economic activities are environmentally sustainable, putting the proposal out to consultation.

The ratio would measure the sum of a bank's climate-friendly loans, advances and debt securities compared with total assets. It would be compiled in accordance with the European Union's taxonomy rules, launched last year, which categorize economic activities and their effect on climate change. Disclosures under the new measure are expected to start gradually from 2022.

Gerald Podobnik, CFO of Deutsche Bank AG's corporate bank, said the move toward greater environmental disclosure would help European banks.

"I do not expect a competitive disadvantage compared to U.S. banks," he said via email. "On the contrary, I think Europe is leading the pack here and the U.S. will follow."

In the U.S. the Securities and Exchange Commission in March sought input from business leaders as it develops its own plans for environmental, social and governance oversight.

Better transparency

U.K.-based Barclays PLC and France's BNP Paribas SA have ranked in the top 12 banks globally financing fossil fuels between 2016 and 2020, extending total loans of $146 billion and $121 billion, respectively, according to figures from Netherlands-based nongovernmental organization BankTrack. The biggest financier is U.S.-based JPMorgan Chase & Co.

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Investors' increasing concern over how banks and companies tackle environmental issues is likely to make the green asset ratio an attractive metric, said Sam Theodore, an independent analyst and senior consultant for Scope Group, a credit rating and financial analysis agency.

One common complaint from investors is that the companies they cover, including banks, are not transparent enough with regard to ESG issues, he said.

"The introduction of a GAR, probably in a few years once the climate-related regulatory disclosure becomes mandatory and widespread — which will not be the case before 2022-23 at the earliest — should in fact increase the attractiveness of EU banks for investors, as they will have 'a hook to hang their hat on' with respect to ESG," Theodore said via email.

He said the move by the EU would likely put pressure on regulators in other jurisdictions to follow suit as investors' demands for further transparency on environmental issues grow.

Indeed, the likelihood of banks elsewhere following suit is already part of the European Banking Authority's outlook on the issue. The EBA is a regulatory agency of the EU.

"We think that once some banks start disclosing this information on a comparable way, stakeholders may expect similar information from other banks," said EBA spokesperson Franca Rosa Congiu.

Concerns over rigidity

However, there are already concerns that the EU's green taxonomy as a whole, along with the GAR in particular, might be too prescriptive.

Mark Carney, former governor of the Bank of England and adviser to the U.K. government on climate change, has said that while the goals of the EU taxonomy are laudable, it would be damaging if it was too rigid to be workable. He suggested the EU should adopt a "50 shades of green" approach to allow for recognition of companies that are in the process of transitioning from "brown" activities to greener processes.

Maureen Schuller, head of financials sector strategy at ING Groep NV, said the move toward a GAR was likely to give European banks an edge over their peers, but warned that the ratio would be likely to exclude certain bank assets that could not be easily classified in terms of their environmental effect.

In principle, the GAR would only provide information on assets that are taxonomy-aligned, she said in an interview. A bank may be making great efforts to "green" its assets, but they would be excluded if they did not conform to the taxonomy.

As an example, Schuller noted that a bank financing the transition of a building from the lowest level of energy performance certificate rating to a mid-level rating would probably contribute to bigger energy efficiency gains than when funding the transition of an already quite efficient building to the top rating, but the former would not be reflected in the GAR.

"When you come to analyze the GAR you have to be aware that certain parts are missing and that certain things are not reflected in it," Schuller said. A low or negative "brown" taxonomy would make such efforts more visible, she said.

Still, banks ought to ensure they are prepared, Deutsche's Podobnik said.

"Given ESG is such a megatrend, any company or region that is at the forefront of developments will be well positioned to benefit from the opportunities the transition brings," he said.