EU to Conduct One-Off Scenario Analysis to Assess Transition Risk
The European authorities recently made multiple announcements that impact the banking sector. Among them, the Securities and Markets Stakeholder Group (SMSG) provided advice to the European Securities and Markets Authority (ESMA) on the consultation on guidelines for funds names using ESG or sustainability-related terms. In addition, ESMA published a list of Synthetic Securitizations, a set of Questions and Answers (Q&A) on the European crowdfunding service providers regulation, and the guidelines on standard forms, formats, and templates to apply for permission to operate a Distributed Ledger Technology (DLT) market infrastructure (in effect from March 23, 2023). Finally, the most notable development is the European Commission (EC) request to the European Supervisory Authorities (ESAs), the European Central Bank (ECB), and the European Systemic Risk Board (ESRB) to conduct a one-off scenario analysis exercise to assess transition risks in the move toward a more sustainable economy.
The EC letter notes the importance of ensuring that financial institutions are well-prepared to handle the transition to a low-carbon economy, as this will require significant investment and changes to the business model. The letter emphasized the need for cooperation and coordination among financial institutions, regulators, and policymakers to ensure a smooth transition to a low-carbon economy. Therefore, EC is inviting ESAs, ECB, and ESRB to cooperate in a one-off exercise, which will assess the resilience of the financial sector and is different from the usual climate stress tests. EC is inviting the development of severe but plausible scenarios that could affect the financial system as a whole over the period up to 2030. One of the scenarios should focus on climate-change related risks that could already materialize in the near term, whereas the other scenario could combine such climate-change related risks with other stress factors. The adverse scenario(s) should be developed by the ESRB’s Task Force on Stress Testing to ensure consistency across sectors and synergies with the scenarios used in another stress test.
According to EC, the purpose of this exercise is not to set micro- or macro-prudential requirements for financial institutions; thus, the exercise should not limit itself to estimating capital losses and shortfalls in financial institutions. The results in terms of capital losses/adequacy should then feed into a modeling process indicating how shocks and their possible amplification through contagion and second-round effects could affect the overall availability of capital and economic activity. Results should be as differentiated (notably by countries, types of financial institutions, economic sectors) as possible so that they can be used by policymakers to better understand how climate-related shocks can affect the financial system in the period up to 2030.
EC expects to receive results from this exercise ideally by the end of 2024 and in any case not later than the first quarter of 2025, to provide input to the work of the new European Commission. The exercise should, therefore, be launched as soon as possible and could be based on ethe nd-2022 balance sheet data. The team in charge of conducting the exercise should develop a detailed roadmap and timetable and report on progress, to the governing bodies, of the addressees and the Commission at key moments, and in particular when the scenarios are to be validated, the sectoral work is completed, and fed into the cross-sectoral modeling and at the beginning of the phase in which all elements will be integrated into the final report. As per EC, the final deliverable should be an integrated single report combining the sectoral work conducted in a consistent manner and the cross-sectoral modeling.
Related Links
- SMSG Advice on Fund Name Guidelines
- Q&A on European Crowdfunding Regulation
- Press Release on Letter from EC
- Request for a One-Off Scenario Analysis Exercise (PDF)
- Guidelines to Apply for Permission to Operate a DLT MI
- List of Synthetic Securitizations (XLSX)
Keywords: Europe, Banking, ESG, DLT, Q&A, Synthetic Securitization, SMSG, Climate Change Risk, Scenario Analysis, Crowdfunding Service Providers, Transition Risk, Stress Testing, ECB, ESRB, ESMA, EC
Featured Experts
James Partridge
Credit analytics expert helping clients understand, develop, and implement credit models for origination, monitoring, and regulatory reporting.
Emil Lopez
Credit risk modeling advisor; IFRS 9 researcher; data quality and risk reporting manager
Nihil Patel
Data scientist; SaaS product designer; credit portfolio analyst and product strategist; portfolio modeler; correlation researcher
Previous Article
EC Adopts Green Bond Regulation, Issues Rule Supplementing CRRRelated Articles
OSFI Issues Phase2 Consultation on Climate Scenario Exercise for Banks
The Office of the Superintendent of Financial Institutions (OSFI) recently announced a consultation on the second phase of the Standardized Climate Scenario Exercise (SCSE) for banks and other financial institutions it regulates in Canada.
BIS and Central Banks Experiment with GenAI to Assess Climate Risks
A recent report from the Bank for International Settlements (BIS) Innovation Hub details Project Gaia, a collaboration between the BIS Innovation Hub Eurosystem Center and certain central banks in Europe
Nearly 25% G-SIBs Commit to Adopting TNFD Nature-Related Disclosures
Nature-related risks are increasing in severity and frequency, affecting businesses, capital providers, financial systems, and economies.
Singapore to Mandate Climate Disclosures from FY2025
Singapore recently took a significant step toward turning climate ambition into action, with the introduction of mandatory climate-related disclosures for listed and large non-listed companies
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
EBA Proposes Standards Related to Standardized Credit Risk Approach
The European Banking Authority (EBA) has been taking significant steps toward implementing the Basel III framework and strengthening the regulatory framework for credit institutions in the EU
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
