The Imperative of an Integrated Taxonomy for Financial Institutions

In today's rapidly evolving financial landscape, the intersection of finance and sustainability stands as a critical central point. ESG data has emerged as the cornerstone, influencing investment decisions, shaping risk management strategies, guiding long-term sustainability initiatives, and ensuring regulatory adherence for financial institutions. As we delve into the realm of ESG data and its regulatory landscape within the financial sector, it is essential to underscore the imminent EU-driven regulatory transformations poised to reshape the industry. While ESG regulations are imperative for regulatory compliance, the integration of ESG data into existing systems poses multifaceted challenges for financial institutions.

This article aims to offer a comprehensive overview of the potential benefits an integrated taxonomy can offer to this problem. Additionally, it will briefly address the main issues that financial institutions encounter while fulfilling ESG reporting obligations.

What Value Does an Integrated Taxonomy Bring?

An integrated taxonomy is a harmonized set of business terms with clear unambiguous definitions describing the business’ data need for data attributes (so-called consumer requirements), linked to each other with relationships. By consolidating various consumer requirements, it simplifies complex reporting structures, leading to streamlined processes. This integration is rooted in determining granular data requirements and populating the taxonomy through data analysis. The outcome is a unified data collection process that enhances reporting agility, facilitates reconciliation and making it easier to include and update changes in regulations. For financial institutions, this translates to efficient reporting and mitigation of challenges such as information inconsistencies between data consumers, data duplication and a fragmented reporting landscape. Embracing an integrated taxonomy empowers institutions to navigate the intricate landscape of regulatory reporting more effectively, fostering transparency, accuracy, and adaptability.

Why is ESG Reporting So Important?

Navigating the European regulatory landscape for ESG requirements is a complex effort marked by rapid evolution and interdependence. In recent years, a multitude of ESG regulations, directives, and frameworks have been planned, each possessing distinct scopes, requirements, and levels of detail. These regulations, united under the EU Green Deal's banner, collectively shape a dispersed collection of data requirements that must be consistently implemented. Important reports include:

EU Taxonomy: A classification framework to promote EU’s transition to sustainable economic activities.

EBA Pillar 3: Regulation for ESG disclosure to transparently show how climate change affects balance sheets and how banks mitigate those risks.

SFDR: Regulatory reporting requirement for financial market participants on the sustainability and (adverse impacts) of their investment products.

CSRD: Directive for large and listed companies to provide transparency on their sustainability risks.

In this complex regulatory landscape, the significance of an integrated taxonomy framework emerges prominently. As financial institutions strive to navigate these dynamic requirements while driving their sustainability goals, an integrated taxonomy emerges as a decisive tool for efficiently managing ESG data and reporting obligations.

What Are the Key Challenges in ESG data integration?

Based on various exercises we conducted, the challenges of the banks can be clustered into four main themes when looking at the integration of ESG data: unclear definitions, missing requirements, reusability and incorrect granularity.

1. Data requirements definitions unclear: One of the foremost challenges in handling ESG data is the lack of clear and universally accepted definitions for data requirements. The ambiguity surrounding the exact meaning of data requirements can create hurdles in data collection and reconciliation.

2. Missing data requirements: As the regulatory landscape evolves, financial institutions may encounter situations where new data requirements need to be added to their existing data sets. Implementing and sourcing these requirements require dedicated focus and time, which can be difficult to prioritize with existing programs and initiatives in the bank.

3. Reporting term leveraging with existing data: The translation of reporting templates to data requirements can prove to be difficult; often banks think they are using data requirements when they are actually using reporting terms. The problem with this is that there is a difference in granularity. In fact, the added value of data requirements are their reusability for various reports due to their low granularity and can thereby greatly accelerate delivery.

4. Data requirements require further decomposition: ESG data requirements can be intricate and consist of multiple underlying data requirements. Breaking down these requirements into more granular components is essential to ensure accurate and comprehensive reporting. This process of decomposition can be resource-intensive and require knowledge of both reporting and data.

Conclusion

In the evolving ESG regulatory landscape, financial institutions are at a critical juncture. Embracing ESG data integration is not merely a compliance obligation but a strategic necessity that can improve risk assessment, reputation, and long-term viability. By addressing the challenges of merging diverse data streams and ensuring data quality, banks can foster a more sustainable and responsible financial sector. This journey to align financial and ethical objectives will significantly influence the industry's trajectory in the coming years.

We have explored the decisive role of an integrated taxonomy in helping banks achieve ESG reporting successfully. Additionally, we have also created a Pillar 3 ESG reporting benchmark to assess trends and identify outliers among EU banks. We summarized the key findings and challenges in this article. But our journey does not end here. In the next instalment of this series, we will explore the critical steps of merging diverse data streams and ensuring data quality. Stay tuned!

Contact

If you would like to know more about Deloitte’s Regulatory and Data & Analytics services within Financial Services, please reach out to Yuri Jolly – Director – Risk Advisory, Nizar Es-Skali – Senior Manager – Risk Advisory or Maitrie Ramautar – Junior Manager – Risk Advisory.