How Can ESG Reporting Be Effectively Encouraged?
What drives effective ESG reporting? What roles do regulatory interventions, market incentives, and the costs of data collection and processing play? Two recent studies shed important light on these and other key questions.
Climate Stress Tests as a Catalyst for ESG Transparency: Banks Adjust Lending and Reporting Practices
Europe’s banks are increasingly in the spotlight as the push toward a more sustainable economy accelerates. As financiers of the real economy, they have become a key focus of regulatory efforts. The climate risks faced by their borrowers threaten not only the stability of individual banks but also the global financial system. Since 2019, regulators in the UK, France, the Eurozone, and the EU have been conducting climate stress tests, requiring banks to simulate how climate risks could affect their loan portfolios and financial health – and to report these findings to supervisory authorities. The goal: to boost transparency and change banks’ behavior. A recent study examines whether these tests have an effect.
Analyzing the 230 largest European banks from 2017 to 2022, researchers found that banks with a prior focus on climate risks, those under strong ESG market pressure, or those particularly exposed to climate risks, significantly increased their climate reporting after the tests. The stress tests also affect lending behavior. Borrowers with high climate risk curtailed their total and long-term loan financing by these banks and experienced lower tangible fixed assets and sales growth. At the same time, banks shortened loan maturities in riskier portfolios and measurably improved their environmental performance – reflected in higher ESG ratings and lower emission intensity. But these effects are limited to banks with the right incentives. Others showed little response.
Guidance for Regulators
Climate stress tests can drive greater transparency and support a greener economy, but they are no silver bullet. In some cases, they may even produce unintended side effects – such as driving business toward less regulated or less climate-conscious banks, thereby undermining broader environmental gains. The effectiveness of climate stress testing ultimately hinges on whether regulatory frameworks and market incentives are working in tandem – or at cross purposes.
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Climate Change in Financial Statements: What Drives Corporate Disclosure
Climate change has become a defining economic force — and greater transparency about how environmental risks and opportunities affect companies is more urgent than ever. Such transparency helps prevent misjudgments in investment and lending decisions, promotes corporate accountability, and supports the shift toward more sustainable business models. However, with the rise of standalone “non-financial” ESG reports, policymakers fear that transparency about how severely companies are affected by climate change is lacking precisely where it arguably matters most: in the regulated and audited financial statements. How visible is climate change today in corporate financial reporting? And what incentives drive that visibility? A recent study suggests the landscape is shifting.
Between 2018 and 2023, climate-related disclosures in IFRS financial statements rose sharply. In 2018, just 15 percent of firms mentioned the word “climate” in their filings; by 2023, that figure had jumped to 75 percent. Similarly, using a language model trained to identify climate-related paragraphs, the research documents that climate-related paragraphs doubled over the sample period. The turning point came in 2021, when the European Securities and Markets Authority (ESMA) declared climate-related disclosures a top enforcement priority. Companies based in countries with more active enforcement authorities reported substantially more climate-related information, pointing to regulatory pressure as a key driver.
But regulatory pressure is only part of the story. The extent to which companies are economically exposed to climate risk and opportunities also plays a critical role. Firms with carbon-intensive business models, a high exposure to regulatory transition risks, or strategic climate opportunities are far more likely to disclose climate information in their financial reports. Interestingly, physical climate risks — such as extreme weather — appear to have little effect on disclosure behavior, possibly due to their complex, uncertain and/or distant nature. Still, significant barriers remain. High data collection and processing costs, along with limited data availability, continue to hinder broader and deeper climate disclosure.
Guidance for Regulators
The study also highlights why climate-related financial reporting matters. Climate disclosures embedded in financial statements differ markedly from those made in ESG reports outside of financial reports: they are more closely tied to a firm’s climate exposure. While ESG reports often provide general statements, financial reports only disclose information when it is financially material. As such, they serve the role of grounding and disciplining the increasingly crowded climate-related information environment in ‘hard facts’. Ultimately, regulatory attention, market incentives, and lower reporting costs will be essential to making climate change a visible, verifiable, and decision-useful part of financial reporting.
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