EBA publishes its Report on management and supervision of ESG risks for credit institutions and investment firms

23 June 2021

  • This report provides institutions with common definitions of ESG risks and their transmission channels and identifies evaluation methods that are needed for effective risk management.
  • The EBA recommends integrating ESG risks into business strategies, governance and risk management as well as supervision in a timely manner.
  • This report provides steer on supervisory expectations and sets the foundations for future EBA Guidelines on the topic.

The European Banking Authority (EBA) published today its Report on Environmental, Social and Governance (ESG) risks management and supervision. The Report, which is a key component of the EBA’s broader ESG work, provides a comprehensive proposal on how ESG factors and ESG risks should be included in the regulatory and supervisory framework for credit institutions and investment firms.

The Report focuses on the resilience of institutions to the potential financial impact of ESG risks across different time horizons. This requires careful assessments by institutions and supervisors who should take a comprehensive and forward-looking view, as well as early, proactive actions.

Impact of ESG risks. The Report outlines the impact that ESG factors, especially climate change, can have on institutions’ counterparties or invested assets, affecting financial risks. Also, the Report illustrates available indicators, metrics and evaluation methods that are needed for effective ESG risk management and identifies remaining gaps and challenges on this front.

Recommendations to incorporate ESG risks-related considerations. The EBA provides recommendations for institutions to incorporate ESG risks-related considerations in strategies and objectives, governance structures, and to manage these risks as drivers of financial risks in their risk appetite and internal capital allocation process. The EBA also recommends developing methodologies and approaches to test the long-term resilience of institutions against ESG factors and risks including the use of scenario analysis.

Proposal for a phase-in approach. To further enhance the supervisory review and evaluation process (SREP), the EBA sees a need to extend the time horizon of the supervisory assessment of the resilience of institutions’ business models, applying at least a 10 year horizon to capture physical risks, relevant public policies or broader transition trends. The Report proposes a phase-in approach, starting with the inclusion of climate-related and environmental factors and risks into the supervisory business model and internal governance analysis, whilst encouraging institutions and supervisors to build up data and tools to develop quantification approaches to increase the scope of the supervisory analysis to other elements.

This Report should be considered in conjunction with the EBA and ESAs disclosure publications under the Capital Requirements Regulation (CRR), the Taxonomy Regulation and the Sustainable Finance Disclosure Regulation (SFDR) which provide key metrics to support strategies and risk management. The EBA will publish Pillar 3 disclosure requirements on ESG risks, transition risks and physical risks, as defined in this Report, later this year.

Legal basis and background

Article 98(8) of the Capital Requirements Directive (CRDV) and Article 35 of the Investment Firms Directive (IFD) mandate the EBA to develop a report providing uniform definitions of ESG risks, and appropriate qualitative and quantitative criteria (including stress tests and scenario analyses) for the assessment of the impact of ESG risks on the financial stability of institutions in the short, medium and long term. They also mandate the EBA to elaborate on the arrangements, processes, mechanisms and strategies to be implemented by institutions to identify, assess and manage ESG risks and to assess their potential inclusion in the review and evaluation performed by competent authorities.

The Report has been transmitted to the EU Parliament, the Council and the European Commission, which are invited to take it into consideration in the context of the Renewed Sustainable Finance Strategy and the review of CRR/CRD. The Report and its recommendations will be used by the EBA as a basis for the development of EBA Guidelines on the management of ESG risks by institutions and an update of the SREP Guidelines to include ESG risks in the supervision of credit institutions. The EBA will also take a sequential approach and leverage on the output of this Report to further enrich the SREP guidelines for investment firms under Article 35 of the IFD in due time.

 

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Franca Rosa Congiu

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