ISDA published a report that discusses the role of derivatives in sustainable finance in EU. The report highlights how derivatives markets can contribute by enabling EU to raise and channel the necessary capital toward sustainable investments. The derivatives markets can also help firms hedge risks related to environment, social and governance (ESG) factors; facilitate transparency, price discovery, and market efficiency; and contribute to "long-termism." This report is the result of an effort by the Center for European Policy Studies (CEPS) in Brussels, which manages the European Capital Markets Institute (ECMI).
In this report, the use of derivatives by market participants is being examined in the context of the EU sustainable regulatory framework that is being developed. The report also examines the EU Sustainable Finance Action Plan and the most relevant policy initiatives from a derivatives’ perspective. The report calls EU Taxonomy the flagship project of the Sustainable Finance Action Plan. The EU Taxonomy sets the framework for what is regarded as sustainable, while the disclosures framework will enhance the transparency surrounding sustainable investments. Derivatives will be developed to reference these new measurements and metrics with a view to contributing to the financing of projects and funding of companies in the transition to a sustainable future. Another important aspect of the Sustainable Finance Action Plan is the development of an EU Ecolabel framework for certain financial products to be applied once the EU sustainability taxonomy is adopted. The EU draft Ecolabel for retail financial products proposes requirements for the use of derivatives by retail investment funds. The EU Ecolabel defines the minimum environmental performance of such products by defining green thresholds on portfolio level for funds, and by defining whether companies’ green economic activities fulfill thresholds.
The report also discusses how supervisors are calling for an alignment of the prudential treatment of greens assets with the current credit risk framework. The revised Capital Requirements Regulation (CRR) 2/Capital Requirements Directive (CRD) 5 package includes a mandate (Article 501c of CRR 2) for EBA to assess, by June 2025, whether a dedicated prudential treatment of exposures related to assets or activities associated substantially with environmental and social objectives would be justified (as a component of Pillar 1 capital requirements). In particular, it should determine the effective riskiness of exposures related to assets and activities associated with environmental and social objectives compared with the riskiness of other exposures; the appropriate criteria for the assessment of physical risks and transition risks and how to develop them; and the potential effects of a dedicated prudential treatment of exposures associated with environmental and social objectives and activities on financial stability and bank lending in EU. In addition, the Renewed Sustainable Finance Strategy is consulting on whether the current macro-prudential policy toolbox for the financial sector in EU is fit for purpose to identify and address potential systemic financial stability risks related to climate change.
The report emphasizes that European Green Deal is the cornerstone of EU response to the COVID-19 pandemic, given the massive amounts required for a sustainable and green recovery. Derivatives markets can play a significant role in the context of the European Green Deal and the transition toward a low-carbon economy. They facilitate capital raising via the hedging of risks related to sustainable investments. Moreover, they enhance the transparency and the price formation process of the underlying securities and, thus, foster long-termism. Overall, ESG products have demonstrated their resilience during the market decline caused by the pandemic and will play a pivotal role in accelerating the transition to a sustainable economy.
Keywords: International, Europe, EU, Banking, Insurance, Securities, Sustainable Finance, COVID-19, Derivatives, ESG, Climate Change Risk, CRR/CRD, Basel, Credit Risk, Disclosures, ISDA
Leading economist; commercial real estate; performance forecasting, econometric infrastructure; data modeling; credit risk modeling; portfolio assessment; custom commercial real estate analysis; thought leader.
Previous ArticleACPR Launches Pilot Exercise on Assessment of Climate Risks
PRA published the policy statement PS8/21, which contains the final supervisory statement SS3/21 on the PRA approach to supervision of the new and growing non-systemic banks in UK.
EBA published a report that sets out the final draft regulatory technical standards specifying the conditions according to which consolidation shall be carried out in line with Article 18 of the Capital Requirements Regulation (CRR).
EBA updated the list of other systemically important institutions (O-SIIs) in EU.
BCBS published two reports that discuss transmission channels of climate-related risks to the banking system and the measurement methodologies of climate-related financial risks.
UK Authorities (FCA and PRA) welcomed the findings of FSB peer review on the implementation of financial sector remuneration reforms in the UK.
PRA and FCA jointly issued a letter that highlights risks associated with the increasing volumes of deposits that are placed with banks and building societies via deposit aggregators and how to mitigate these risks.
MFSA announced that amendments to the Banking Act, Subsidiary Legislation, and Banking Rules will be issued in the coming months, to transpose the Capital Requirements Directive (CRD5) into the national regulatory framework.
EC finalized the Delegated Regulation 2021/598 that supplements the Capital Requirements Regulation (CRR or 575/2013) and lays out the regulatory technical standards for assigning risk-weights to specialized lending exposures.
OSFI launched a consultation to explore ways to enhance the OSFI assurance over capital, leverage, and liquidity returns for banks and insurers, given the increasing complexity arising from the evolving regulatory reporting framework due to IFRS 17 (Insurance Contracts) standard and Basel III reforms.
ECB published results of the benchmarking analysis of the recovery plan cycle for 2019.