EBA published a discussion paper that sets out a comprehensive proposal on how environmental, social, and governance (ESG) factors and risks could be included in the regulatory and supervisory framework for credit institutions and investment firms. The Capital Requirements Directive (CRD) 5 and the Investment Firm Directive (IFD) mandate EBA to develop a report assessing the potential inclusion of ESG risks in the review and evaluation performed by competent authorities and elaborating on the arrangements, processes, mechanisms, and strategies to be implemented by institutions to identify, assess, and manage ESG risks. The purpose of this discussion paper is to present the understanding of EBA on the relevance of ESG risks for a sound functioning of the financial sector and to collect stakeholder feedback with a view to further informing the report of EBA. The comment period for this discussion paper ends on February 03, 2021 and the report is expected to be delivered in June 2021.
The discussion paper elaborates on the relevance of ESG risks for the financial sector and provides a uniform definition of ESG factors and ESG risks, including definitions of physical risks and transition risks as the main transmission channels for environmental risks. The discussion paper includes proposals for common definitions of ESG risks to credit institutions and investment firms as risks that stem from the current or prospective impact of ESG factors on its counterparties. In the discussion paper, ESG factors and ESG risks are identified and explained, giving particular consideration to risks stemming from environmental factors and especially climate change, reflecting ongoing initiatives and progress achieved by institutions and supervisors on this particular topic over the recent years. Social and governance factors are also included in the analysis, in accordance with the EBA legal mandates, and the paper explores why and how these factors can also be sources of risk for institutions. The paper also defines, elaborates, and presents examples to substantiate the relevance of ESG risks for the financial sector. One example is also dedicated to social impact triggered by the COVID-19 pandemic. As a third transmission channel for ESG risks, this discussion paper also identifies liability risks as the financial risks stemming from the exposure of institutions to counterparties potentially held accountable for the negative impact of their activities on ESG factors.
The paper also presents a non-exhaustive list of quantitative and qualitative definitions, indicators, and metrics for a non-exhaustive list of ESG factors, together with a description of several tools and methodologies that can support the identification, evaluation, and assessment of ESG risks, namely the alignment method, risk framework method, and the exposure method. The methods may be used to better understand and compare the interaction of ESG risks in given exposures and portfolios. Together with the progress made in the definition of common taxonomies (like the EU Taxonomy Regulation), these analytical tools can help overcome some of the challenges for the assessment of ESG risks. The discussion paper argues that the impact of ESG risks materializes in the form of existing prudential risks (such as credit risk, market risk, operational risk). After presenting the rationale for the incorporation of ESG risks in the institution’s business strategy and business processes, the paper includes several policy recommendations regarding the way in which institutions can embed ESG risks in their internal governance and risk management frameworks in a proportionate manner. Finally, the paper elaborates on the effective way to proportionately reflect ESG risks in the supervisory review for credit institutions and makes several policy recommendations in this respect.
Comment Due Date: February 03, 2021
Keywords: Europe, EU, Banking, Securities, COVID-19, ESG, Climate Change Risk, CRD5, IFD, Basel, Proportionality, Sustainable Finance, EBA
Leading economist; commercial real estate; performance forecasting, econometric infrastructure; data modeling; credit risk modeling; portfolio assessment; custom commercial real estate analysis; thought leader.
Previous ArticleEBA on Application of Product Oversight and Governance Arrangements
The European Banking Authority (EBA) published the final draft regulatory technical standards on disclosure of investment policy by investment firms, under the Investment Firms Regulation (IFR).
The European Banking Authority (EBA) published version 5.1 of the filing rules for supervisory reporting.
The European Central Bank (ECB) Guideline 2021/1829 on the procedures for the collection of granular credit and credit risk data has been published in the Official Journal of European Union.
The Australian Prudential Regulation Authority (APRA) published the prudential practice guide CPG 511 to assist banks, insurers, and superannuation licensees in meeting requirements of CPS 511, the new prudential standard on remuneration.
The Office of the Comptroller of the Currency (OCC) published a bulletin that provides an updated self-assessment tool for banks to evaluate their preparedness for cessation of the London Interbank Offered Rate (LIBOR).
The Financial Stability Board (FSB) published a report that examines the progress made toward disclosures aligned with recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).
The Basel Committee on Banking Supervision (BCBS) published the progress report on adoption of the Basel III regulatory framework in member jurisdictions.
The French Prudential Supervisory Authority (ACPR) has implemented, in its information system, updates linked to the Data Point Model (DPM) version 3.1.
The European Banking Authority (EBA) published a thematic note that aims to identify and raise awareness of the transition risks of benchmark rates, as the London Interbank Offered Rate (LIBOR) and the Euro Overnight Index Average (EONIA) are close to being phased out.
In a letter to the federally regulated financial institutions and pension plans, the Office of the Superintendent of Financial Institutions (OSFI) published a summary of the feedback received to the January 2021 discussion paper on ways to address climate risks.