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    ESMA to Develop Indicators for Monitoring Climate Risk

    February 15, 2022

    The European Securities and Markets Authority (ESMA) published the first trends, risks, and vulnerabilities report for 2022. The report presents the risk dashboard and covers the structural developments in market-based finance, sustainable finance, and crypto-asset markets. ESMA included, for the first time, environmental risk as a category in its risk dashboard while the statistical annex to the report covers the new risk indicators on climate-related disclosures, reputational risk of firms, and carbon markets in the European Union. As part this risk analysis, ESMA also published special features, including one on monitoring environmental risks and another on text mining environmental, social, and governance (ESG) disclosures in rating agency press releases.

    As per the special feature on monitoring environmental risks in the European Union markets, proposal is to integrate climate risk as a new risk category alongside the existing liquidity, market, credit, contagion and operational risk categories in the risk assessment and monitoring framework. This feature article underpins the work of ESMA in the area of risk analysis by providing a comprehensive framework through which climate risks can be monitored in the context of the securities markets in European Union. It also highlights some of the challenges specific to risks stemming from climate change. This new risk category is intended to capture physical and transition risk drivers and their mitigants, in addition to the potential risks associated with green finance. With the addition of climate risk as a new risk category into the regular ESMA risk assessment, three core risks have been identified, which relate to abrupt changes in market sentiment, greenwashing, and weather-related hazards. ESMA aims to focus its analytical efforts on developing climate-specific risk monitoring indicators. Policy measures ensuring that investors and financial market participants factor the risks associated with ESG factors into their decision making can further help to channel savings into sustainable investments. ESMA aims to extend its quantitative analysis to empirically assess the probability, impact, and potential losses stemming from climate risks over time. 

    The second key feature assesses the implementation of ESMA guidelines on the disclosure of ESG factors in the press releases of credit rating agencies. The assessment was conducted by applying natural language processing techniques to a unique dataset of over 64,000 press releases that were published between January 01, 2020 and December 30, 2020. ESMA found that the overall level of disclosures has increased since the introduction of the guidelines; however, there is still room for further improvement, as the extent of ESG disclosures differs significantly across both credit rating agencies and ESG factors, especially environmental topics. ESMA also observed divergences in disclosures for rated entities that are highly exposed to ESG factors, relative to their sector peers. Based on the assessment, ESMA will consider the appropriate supervisory and policy tools to enhance transparency in this area. In 2022, ESMA plans to work on how ESG factors are incorporated by credit rating agencies into their methodologies and share its findings with the European Commission. ESMA will continue to engage with the rating agencies to understand the underlying drivers of the observed heterogeneity and to ensure that the guidelines are implemented consistently. ESMA is also in the process of conducting a Call for Evidence to gather information on the market structure, revenue, and product offerings for ESG rating providers in the European Union, the results for which are expected before the second quarter of 2022.  


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    Keywords: Europe, EU, Banking, Securities, Credit Risk, Market Risk, ESG, Climate Change Risk, Cryptoassets, Sustainable Finance, Risk Dashboard, ESMA

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