Response to discussion Paper on management and supervision of ESG risks for credit institutions and investment firms (EBA/DP/2020/03)

Go back

1. Please provide details of other relevant frameworks for ESG factors you use.

Even though Baltic International Bank is not one of the signatories of the United Nations’ Environment Programme Finance Initiative (UNEP FI)’s Principles for Responsible Banking, the bank has included these principles into its strategy and has followed them since 2016. The Bank uses some methodologies to evaluate the compliance with the ESG principles of its counterparties, but it does not use any distinct methodology to identify or evaluate specifically ESG risks.

2. Please provide your views on the proposed definition of ESG factors and ESG risks.

A more descriptive definitions of terms ‘ESG factors’ and ‘ESG risks’ are used in internal documents of the bank, however, the main ideas used in the documents are correlating with the definitions proposed in the Discussion paper in question. Therefore, the Bank is prepared to adopt and incorporate the proposed definitions in the relevant internal documents.

3. Do you agree that, for the purpose of assessing their inclusion in institutions’ and supervisors’ practices from a prudential perspective, ESG risks should be approached primarily from the angle of the negative impacts of ESG factors on institutions’ counterparties? Please explain why.

Yes, the Bank maintains its opinion that it would be beneficial to approach ESG risks primarily from the angle of negative impacts. Mainly, such approach makes the institutions be more cautious about possible negative influence on the financial performance or solvency of their projects, themselves or counterparties. In that way the negative risks can be identified and evaluated sooner, giving a chance to prepare to minimize the negative impacts or choosing not to close the deal with such entities at all.

4. Please provide your views on the proposed definitions of transition risks and physical risks included in section 4.3.

Definitions accurately capture the main concepts and without excessive example lists explain the main characteristics of the risks.

5. Please provide you views on the proposed definition of social risks and governance risks. As an institution, to which extent is the on-going COVID-19 crisis having an impact on your approach to ESG factors and ESG risks?

The proposed definitions maintain the main concept of “exposure of financial institutions to counterparties that may experience financial difficulties due to negative impacts of ESG factors”.
Covid-19 as unexpected social factor has had a significant influence on the way we deal with consequences primarily in our own internal environment. This period has brought us constant changes and challenges, as one of them being the telecommuting and ensuring continuity of work. However, these changes made us develop more efficient and more technologically advanced ways to continue the workflow, as well as made us consider the health of our employees and clients more seriously than ever.. Therefore, it would be true to say that this period of Covid-19 has made us address ESG factors differently and adapt to the current situation in the world.

6. Do you agree with the description of liability transmission channels/liability risks, including the consideration that liability risks may also arise from social and governance factors? If not, please explain why.

Yes, we do agree with the description of liability risks and it is true that such risks may arise from social and governance risks. The example provided is clear and understandable; however, it is clear that financial institutions may be exposed to liability risks because of a direct misjudgement or faulty governance policies of counterparties, especially, in credit-debit relationship.

7. Do the specificities of investment firms compared to credit institutions justify the elaboration of different definitions, or are the proposed definitions included in chapter 4 also applicable to them (in particular the perspective of counterparties)? Please elaborate on the potential specificities of investment firms in relation to ESG risks and on how these specificities, if any, could be reflected in this paper.

Bank believes that the definitions provided in chapter 4 are applicable for credit institutions just as well as for investment firms. The definitions capture the main ideas not the specific conditions of whether the definition is applicable to investment institutions or credit institutions only. Moreover, many financial institutions still have mixed products including crediting, investments and managing private or public clients’ portfolios. Therefore, we believe the short and concise definitions with the elaborate explanations are applicable for financial institutions in general.

8. Please provide your views on the relevance and use of qualitative and quantitative indicators related to the identification of ESG risks.

As a Bank that has incorporated general ESG approach to business practices since 2016 we are concerned that there are still uncertainty about the use of indicators. Surely, such quantitative measurements as an amount of greenhouse gas emissions or water consumption, and even amounts of produced waste may be applied as indicators, but they are irrelevant if every financial institution evaluates ESG factors differently. Even if environmental indicators may be measured, there is still uncertainty about what indicators do we measure governance or social factors?

We do apply our own indexes when evaluating investment options for portfolio management. However, we use a pool index. The index consists of two reference indexes and one of our own. What makes it confusing, especially to clients, is that completely different factors are taken into account within these indexes; therefore, they cannot be compared on equal terms. In addition, the fact that many companies are disclosing as little information as possible of the ESG factors is the other half of the problem. In addition, standard measures and methodologies are often not applicable to smaller companies that leads to insufficient information.

9. As an institution, do you use or plan to use some of the ESG indicators (including taxonomies, standards, labels and benchmarks) described in section 5.1 or any other indicators, inter alia for the purpose of risks management? If yes, please explain which ones.

Baltic International Bank specialists do not use methodologies for specifically ESG risk management. However, recently Financial and Capital Market Commission in Latvia has requested to include ESG risks into risk management systems of financial institutions. Accordingly, in time we plan to adapt relevant methodologies from the standards and taxonomies.

10. As an institution, do you use or plan to use a portfolio alignment method in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.

Right now, the Bank does not use portfolio alignment method by aligning specific portfolio goals with globally agreed climate targets. However, we do follow the main Principles of Responsible Banking, consider how big the part of portfolio coincides with ESG principles and plan to increase this part. Additionally, the Bank publishes its non-financial report yearly.

11. As an institution, do you use or plan to use a risk framework method (including climate stress testing and climate sensitivity analysis) in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.

Right now, the Bank does not use risk framework method in managing specifically climate related ESG risks. However, we have incorporated stress testing according to EBA Guidelines on institutions’ stress testing in our risk management approach.

12. .As an institution, do you use or plan to use an exposure method in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.

The Bank has implemented the ESG Approach in the Loan granting process, including evaluation of individual Borrowers, encompasses identification of potential ESG Risks and monitoring of the risks identified. The Bank provides services to its clients based on principles of private banking, therefore, each loan application is evaluated and considered, and the offer is tailored to each specific client’s needs. The approach does not concentrate on environment factors/risks alone, but considers factors of all three categories – environment, social and governance factors within the specific entity.

13. As an institution, do you use or plan to use any different approaches in relation to ESG risk management than the ones included in chapter 5? If yes, please provide details.

The Bank plans to examine different approaches in relation to ESG risks management including the ones described in chapter 5 and adopt the most suitable to its business model and situation.

15. Please provide your views on the extent to which smaller institutions can be vulnerable to ESG risks and on the criteria that should be used to design and implement a proportionate ESG risks management approach.

Baltic International Bank as one of the smaller financial institutions believes that it is just as vulnerable to ESG risks as every other financial institution. However, we believe that primarily institutions must ensure compliance with the amended UCITS and AIFMD, the Taxonomy Regulations around offering environmentally sustainable investments, and the Disclosure Regulations on providing investors information on the sustainability on financial products. In addition, it is important that Sustainability Risks be taken into account when establishing, implementing and maintaining effective reporting within the firm and with third parties.

16. Through which measures could the adoption of strategic ESG risk-related objectives and/or limits be further supported?

Even though many entities and financial institutions has implemented ESG principles into their business models, we believe that united regulations for such implementation are necessary. Many still do not accept/understand the importance of the ESG approach-related objectives in the strategy, and without understanding of the importance of ESG risk-related objectives adoption institutions might not focus on them. We believe that in many cases, the governance structures of European credit institutions are insufficient to ensure an adequate response to the climate crisis, therefore, guidelines on ESG risks might be the best way to move forward.

17. Please provide your views on the proposed ways how to integrate ESG risks into the business strategies and processes of institutions.

We agree that by extending the time horizon for strategic planning and incorporating long-term ESG-related objectives might be one of the key ways to integrate ESG risks into the business strategies and processes. However, the worldwide pandemic has shown that the short-term or middle-term strategies might have to be changed drastically to preserve the course. As an institution that has implemented ESG principles into its long-term strategy, we are still in the first steps of adopting ESG risks. We believe that ESG risk-related implementations must be done step by step, first defining the requirements.

18. Please provide your views on the proposed ways how to integrate ESG risks into the internal governance of institutions.

Specialised committees might be one of the best ways for ESG risk integration into governance of institutions. However, for smaller institutions risk-management team or committee would be the appropriate to be responsible for ensuring the proper ESG risk controls, if necessary with an ESG specialist and report directly to the board that works as a supervisory control mechanism. In addition, we agree that ESG factors and risks are best to be integrated into already existing institutions procedures and internal regulatory documents. As the bank is planning on reviewing its remuneration policy and possibly aligning it with strategic objectives, it resonates with the idea to align the remuneration policy with the long-term ESG objectives set by institution.

19. Please provide your views on the proposed ways how to integrate ESG risks into the risk management framework of institutions.

As mentioned before, Baltic International Bank already uses the stress tests for economy-related risk management and has implemented the (exposure method) ESG Approach in the Loan granting process. The ESG risk management would be an additional risk category to analyse with already established risk management approaches, still, methodologies for ESG risk identification and analysis must be incorporated into internal regulatory procedures and documents in compliance with EU regulations and standards. Furthermore, institutions’ efforts to collect ESG-related data from their counterparties and building an applicable methodology will play a crucial role to address these challenges in the risk management.

20. The EBA acknowledges that institutions’ approaches to environmental, and particularly climate-related, risks might be more advanced compared to social and governance risks, and gives particular prominence in this report to the former type of risks. To what extent do you support this approach? Please also provide your views on any specificities associated with the management of social and governance risks.

The approaches to environmental risks are indeed more advanced compared to social and governance risks; however, they offer several methodologies to implement the base for ESG risk alignment with institution’s risk management. With the current situation, it is evident that ESG risks are becoming drivers to material financial risks and institutions should use all the available risk monitoring and mitigating tools to prevent the occurrence of potential risks or to mitigate the consequences of their accession. First, the base methodologies must be implemented, and then methodologies for social and governance risk analysis can be developed.

22. Please provide your views on the incorporation of ESG factors and ESG risks considerations in the business model analysis of credit institutions.

Taking into account the requirements to integrate ESG risks into institutions governance and risks management approaches, it seems only natural to include ESG factors and risks into the business model analysis. As a business model refers to a company's plan for making a profit, identifies the products or services it plans to sell to the identified target market, and refers to any anticipated expenses, it would be best to consider the possible impact of ESG factors.

23. Do you agree with the need to extend the time horizon of the supervisory assessment of the business model and introduce as a new area of analysis the assessment of the long term resilience of credit institutions in accordance with relevant public policies? Please explain why.

Baltic International Bank has set its ESG-related long-term goals in its strategy in accordance with the objectives of The European Green Deal. Accordingly, the viability and sustainability assessment of the business model would bring clarity if it were compliant with the goals set. However, we do not agree that the assessment of the long-term resilience of credit institutions should be introduced as a new area of analysis, because the business models are analysed periodically. Analysing these periodic assessments within longer time periods we already understand whether the credit institution is able to generate acceptable returns given its strategy, forecasts and business environment Such assessments usually include analysis of business profitability, viability and sustainability against the time horizon of the relevant public policies or broader transition trends.

24. Please provide your views on the incorporation of ESG risks considerations into the assessment of the credit institution’s internal governance and wide controls.

We agree that the supervisory review should proportionately include considerations of how ESG risks are integrated in the credit institution's internal governance framework, corporate and risk culture, remuneration policies, risk management systems and wide control.

Name of the organization

Baltic International Bank