Developments in regulation in the area of sustainability have been particularly dynamic in recent years. Furthermore, investors are increasingly taking ESG criteria into account in their investment decisions, or they wish to make an impact on sustainability issues through their investments.

BaFin’s role as supervisory authority

The transformation towards a climate-neutral and more sustainable economy requires the targeted use of capital. Various sustainable finance initiatives have been implemented at the European and national levels. These primarily aim to direct private funds towards more sustainable economic activities. For sufficient capital to be directed towards sustainable investments, a properly functioning and stable financial system is essential. Only then will an efficient transition be possible in the real economy. BaFin ensures the stability and integrity of the financial system.

Investors should be able to make investment decisions that are aligned with their sustainability preferences. For this, they need information that is both comprehensive and comprehensible. Investors need to be protected against misleading information and they must receive fair advice that is in line with the statutory requirements. BaFin is dedicated to greater transparency. As part of this, it aims to ensure that consumers are able to make independent, informed decisions.

The integration of sustainability issues in its supervisory activities is one of BaFin’s medium-term objectives and therefore one of the ten focus areas that BaFin has determined for the coming years. BaFin’s understanding of its own role forms the basis for its activities:

• In general, sustainability refers to environmental, social and governance (ESG) aspects. In view of the current state of regulation and the available data, BaFin’s supervisory focus is currently directed towards environmental aspects and in particular climate change.
• BaFin deals with ESG risks as part of its regular supervision of companies in the financial sector.
• BaFin does not pursue its own ESG objectives or influence the flow of capital. Responsibility for deciding whether and how to efficiently direct finance flows lies at the political level.
• BaFin does not set out its own criteria for assessing the effectiveness of investment strategies or financial products in relation to ESG objectives. Within the scope of its mandate, BaFin supervises the implementation of ESG transparency requirements by companies and in financial products. These requirements are stipulated by the legislation.

BaFin’s areas of focus

BaFin’s activities are currently focussed on the following priority areas:

1. Risk-oriented and practicable regulation

As an integrated supervisory authority, BaFin actively contributes its expertise to legislative proposals. In doing so, BaFin follows three principles:

• Supervisory law should pursue the objectives of solvency supervision, conduct of business supervision and market supervision only. This concerns in particular the prudential requirements that institutions must meet: minimum capital requirements (Pillar 1) and additional capital requirements (Pillar 2). In this context, BaFin cautions against the implementation of green supporting and brown penalising factors, since this would result in capital requirements that are not consistent with risk.
• With regard to the further development of the regulatory framework, BaFin – as an integrated supervisory authority – advocates for consistency between the different financial market sectors, for an appropriate degree of proportionality, and for practicability.
• BaFin actively monitors the implementation of new regulations and endeavours to provide legal certainty in their interpretation.

2. More reliable data on financial climate risks

Supervised companies can only effectively manage transition and physical risks in their own balance sheets or in their financial instruments or services if they can access reliable data from companies in all sectors of the economy.

The availability and quality of data will gradually improve over the coming years thanks to more comprehensive disclosure requirements at the company level. These include the Corporate Sustainability Reporting Directive (CSRD), in addition to the European Sustainability Reporting Standards (ESRS), which further specify the requirements.

Specific disclosure requirements will also be introduced for supervised companies.

For supervision, this means specifically that:

• Following a risk-oriented approach, BaFin reviews how supervised companies disclose their sustainability risks and how they provide information about their environmental risks.
• Within the scope of financial reporting enforcement, BaFin monitors companies’ disclosures under the CSRD and increases its capacity for enforcement accordingly.

3. Appropriate management of climate-related financial risks

BaFin does not treat financial climate risks as a new type of risk: climate-related risks are instead monitored according to existing risk categories (credit risks, market risks, liquidity risks, operational risks including liability and reputational risks, underwriting risks, strategic risks). Nonetheless, financial climate risks do entail specific challenges for risk management. There is still a certain lack of clarity with regard to how sustainability risks can be carried over to the established (primarily financial) risk categories under supervisory law. Furthermore, there is a high degree of uncertainty regarding some key variables. As a result, a long-term view in particular will include a broad spectrum of possible scenarios.

BaFin is taking these specific considerations into account. It advocates for various methodological approaches and for their further development.

BaFin’s position in detail is as follows:

• BaFin’s supervisory priorities and activities are proportionate and risk-based. The existing supervisory tools can be utilised.
• Environmental risks are risk drivers with specific characteristics. Supervised companies should therefore work continuously to better identify, measure and manage environmental risks. In this regard, companies should take into account that the availability and quality of relevant data is improving.
• Sensitivity and scenario analyses – both top-down and bottom-up – increase awareness of specific vulnerabilities and concentration risks. Using such analyses, supervised companies can formulate their response to medium to long-term challenges, improve their risk management, and identify and close data gaps.
• BaFin monitors the transition plans of supervised companies following a risk-based approach. In doing so, it does not overstep its supervisory mandate.

4. Preventing and combating greenwashing, in particular through reliable information for investors

Greenwashing describes the practice of presenting information on sustainability that does not clearly and fairly reflect the sustainability profile of a company, a financial product or a financial service. Such information can mislead customers. Market statistics show that, in addition to generating a financial profit, investors are increasingly interested in achieving a positive ESG impact through their investment decisions. Greenwashing can undermine confidence in a functioning market for sustainable investments.

Increased transparency is intended to enable investors to make investment decisions that are aligned with their sustainability preferences. To achieve this aim, information that is useful, fair and not misleading is essential. Specific disclosure and reporting requirements at the product and company levels are intended to increase transparency with regard to sustainability. These requirements can be found, for example, in the Sustainable Finance Disclosure Regulation (SFDR), the CSRD and – in future – in the EU Green Bond Regulation.

It is important that market participants adequately consider – starting at the product development stage – the sustainability-related features of their products and the sustainability goals of their intended target market, i.e. their potential customers. Investors’ sustainability preferences must be duly taken into account as part of investment advice.

On this topic, BaFin’s position in detail is as follows:

• In public debate, the term “greenwashing” is understood in different ways. There is, however, agreement that it concerns practices used in the distribution of products or financial services. Specifically, it describes supervised companies’ failure to disclose the relevant sustainability-related information in a way that is clear and fair. Investors can thus be misled, with the result that their investments may not have the desired ESG impact. Greenwashing is sometimes also used in reference to supervised companies that understate the extent of their transition and physical risks, or that do not transparently disclose how they manage these risks. In both cases, supervisors have a role to play.
• BaFin makes full use of the supervisory tools at its disposal in order to prevent greenwashing: in product and market supervision, BaFin monitors compliance with transparency and disclosure requirements on ESG impacts (in particular the SFDR and Articles 5 to 7 of the Taxonomy Regulation). In its supervision with regard to conduct of business, BaFin pays particular attention to companies’ implementation of the distribution requirements under the delegated regulations on the Insurance Distribution Directive (IDD) and the second European Markets in Financial Instruments Directive (MiFID II). As part of its financial reporting enforcement, BaFin will monitor compliance with the CSRD transparency requirements. BaFin’s solvency supervision (Pillars 1 and 2 of the frameworks for banks and insurers) addresses the appropriate management of transition and physical risks and the corresponding transparent disclosure (Pillar 3).
• With regard to further developments in regulation, BaFin advocates for more easily comprehensible and useful information for investors.
• BaFin monitors compliance with the SFDR.

5. Generating and sharing knowledge in an open dialogue

The topic of sustainable finance is made extremely complex by its highly dynamic nature, the broad scope of affected topics and the immense detail involved. Currently, this can be seen above all in the relevant regulation. It is therefore important for BaFin and the relevant stakeholders to exchange information and share their experience. This also allows us to take steps towards adopting new approaches and solutions. BaFin therefore attaches great importance to open discussions with experts. For this reason:

• BaFin explains its mandate and the limits to its mandate. It maintains an open and in-depth dialogue with all stakeholders and provides platforms to acquire and share knowledge.
• BaFin contributes to the work being done in the European institutions and at the international level. It engages in bilateral discussions with other supervisory authorities. BaFin focusses on ESG topics as part of its technical support to establish or further develop foreign supervisory systems.
• BaFin is an observer on the Sustainable Finance Advisory Committee of the Federal Government. BaFin contributes to ESG discussions led by the Federal Ministry of Finance and by other coordinating authorities.