Why banks and insurers do not have to fear an in-depth examination in 2020

Frankfurt Many German banks and insurers should breathe a sigh of relief: Even for the 2021 financial year, they do not have to show their auditors how effectively they have already implemented the requirements of a leaflet from the financial supervisory authority Bafin on sustainability risks from 2019.

In the coming weeks, final talks between the Bafin and the Institute of Auditors (IDW) are to take place for this further delay, according to financial circles.

The Bafin had already determined this in the previous year. A corresponding internal letter from the IDW, which defines the test standards in Germany, is available to the Handelsblatt. Among other things, it went to the “Big Four”, the major audit firms EY, PwC, KPMG and Deloitte, and reported on a meeting of IDW representatives with the Bafin. The most important result: For the 2020 financial year, Bafin expects “no further discussion and reporting by the auditor on how the companies supervised by Bafin deal with sustainability risks”.

What sounds technical would have very real implications if strictly implemented. Bafin’s binding requirements for dealing with sustainability risks in risk management would result in more extensive auditing and reporting obligations on the part of the auditor. That would be an additional burden for the German financial institutions – not only because of the higher expenses for the examination.

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The German supervisors are showing patience in the financial sector despite the increasing debate about greenwashing. The US financial regulator SEC wants to clarify whether the fund subsidiary of Deutsche Bank, DWS, cheated on information about sustainable investments. The trigger are allegations by a former employee that the fund subsidiary painted too rosy a picture of the extent of its sustainably managed investments.

“Checklists” undesirable

The Bafin is silent about the reasons for the patience with the financial institutions. But it is rather unusual for a regulatory authority on the one hand to scrutinize the banks in supervisory discussions, but on the other hand to slow down the auditors in their monitoring.

In financial circles one can hear that the supervisors wanted to enable the banks to first think about suitable methods and processes for measuring sustainability risks. Pure “checklists”, which the auditors could set up at short notice and which would then only be “ticked off”, are viewed critically by the supervisory authorities, they say.

Officially, the Bafin did not want to explicitly confirm the suspension of stricter inspection obligations for 2021 either. A spokesman emphasized that the leaflet on dealing with sustainability risks is not legally binding, but rather describes an expectation of the Bafin. “There is no legal basis for checking the leaflet and therefore no obligation to check it,” he said.

The Bafin asked the auditors to give the company “in a particularly stressful situation due to the pandemic time to individually implement the expectations” of the authority. However: “All significant risks are to be checked by the auditors and included in the report,” said the spokesman. “This also applies to sustainability risks, provided that these lead to the materiality thresholds of the supervised risks being exceeded.”

In plain English: Serious ESG risks can and must be checked by the auditors, for example when a particularly large number of loans to “dirty” companies burden the risk profile of a bank.

Relief in 2020

What the banks will be spared in this way was already evident in the previous year. At that time, the postponement of more stringent inspection obligations made things easier for the institutes concerned. The aforementioned IDW letter was entitled: “Dealing with sustainability risks in risk management” at banks and insurance companies.

According to this, the auditors “do not necessarily have to report on which measures [Finanzinstitute] implemented or initiated in connection with sustainability risks ”, as stated in the IDW letter from the previous year. Once again, the auditors would not have to compare “the good practice approaches in dealing with sustainability risks set out in the Bafin information sheet with the measures implemented, initiated or planned by the institute”. This so-called “gap analysis” would fail again.

Complex sustainability analysis

The background to the decision is the fact sheet from the end of 2019. At that time, after consulting the industry, the Bafin published a handout on how to deal with sustainability or so-called ESG risks. This means dangers in the areas of the environment, social affairs and corporate governance. From the point of view of the supervisory authority, these are of growing importance in view of climate change, among other things.

“The Bafin expects that the supervised companies ensure that sustainability risks are dealt with and document this,” it says.

However, the leaflet has so far been published as a non-binding guide – and not as a fixed part of the minimum requirements for risk management (Marisk) that the Bafin imposes annually on the credit institutions it supervises in a circular. Nevertheless, the Bafin set a direction: banks should pay more attention to environmental and so-called ESG risks in the future.

Insiders now expect binding requirements from Bafin for the 2022 annual audit at the earliest – and thus more work for Germany’s auditors.

Of course, that doesn’t mean that the Bafin doesn’t care how the banks deal with sustainability risks. “Bafin includes sustainability risks in its regular supervision, that is, it is already looking to implement the expectations from the leaflet,” said a Bafin spokesman on request. “In addition, it is considering whether, when and how sustainability risks should be included in the respective minimum requirements.” It can be assumed that the EU Commission will submit appropriate regulatory proposals.

Mixed echo

The Bafin initiative met with a divided response. The Association of German Banks (BdB) welcomes the postponement of more stringent audit obligations for another year. “The climate risks have slipped into the focus of the regulator. That is good and correct, the banks also have an interest in transparency, ”said Torsten Jäger, Head of Sustainability at BdB. “But now new processes have to be developed to properly map sustainability risks.”

It takes time and a good database to make the risks measurable, says Jäger. “We shouldn’t forget how badly the banks were burdened by the corona pandemic. Against this background, it is correct that the examination of the information sheet was postponed. “

The IDW, on the other hand, is calling for more speed. “We have to be aware that the successful management of ESG risks can be of decisive importance for the prosperous development of a company,” explains IDW board spokesman Klaus-Peter Naumann. “The IDW has therefore dealt with environmental risks and their assessment in the course of the annual financial statements for years.”

It is good that the Bafin has been driving the topic since 2019 – now the banks have to grow into the new requirements. Against this background, the IDW takes a critical view of the fact that there is still no obligation to examine sustainability risks in more detail.

“It is right not to immediately burden financial institutions with all the requirements. However, a mandatory gap analysis would have been helpful in order to make progress transparent, ”explained the IDW boss. “Our expectation is that the regulatory review of ESG risks will become binding by 2022 at the latest.”

On the other hand, the environmental associations are very skeptical: “You can clearly accuse the Bafin of negligence,” criticized Stefanie Jellestad from the Urgewald climate organization. “In the European context, countries like Great Britain and France set out much earlier and more consistently.”

Bafin is again doing the German financial industry no favors if it gives the banks more time instead of putting pressure on them. The supervisor gave the motto: “free learning, instead of exams and grades”. In view of the rapidly advancing climate crisis, this is fatal. A review by the auditors must come “very quickly”.

ECB calls for more commitment

Important: Bafin only takes over banking supervision for smaller institutions, systemically important large banks supervise the European Central Bank (ECB). And this also deals with the topic.

Almost a year after the first Bafin leaflet, in November 2020, the ECB published its “Guide to Climate and Environmental Risks”, in which it formulated the “expectations of the supervisory authority with regard to risk management and disclosures”. The ECB only specified its requirements again in August 2021: “The clock is ticking for banks to manage climate and environmental risks,” warned the ECB in its supervisory newsletter.

The institutions supervised by the ECB must therefore already act with regard to climate and ESG risks. “After the publication of the guide, the ECB Banking Authority asked banks to assess themselves against the 13 expectations set out (…) and to submit action plans detailing how they can bring their business practices in line with the guide,” writes the ECB. The German Bafin also acts in the same way.

And the ECB made a clear requirement for the national supervisory authorities: They would have to apply the expectations set out “in a proportional manner” also in the supervision of the less significant institutions, according to the guideline.

More: How investors are deceived with pseudo-green investments

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