Response to discussion Paper on management and supervision of ESG risks for credit institutions and investment firms (EBA/DP/2020/03)
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- The Future Fit Benchmark (https://futurefitbusiness.org/) that is a relevant framework for the complex issue of natural capital and planetary boundaries, and has already been used by several companies in a concrete and granular way;
- The Water Risk Filter (https://waterriskfilter.panda.org/) is a tool developed by WWF to assess and value the water-related financial risks faced by companies and financial institutions.
- WWF uses the Science-Based Target initiative (https://sciencebasedtargets.org/), an initiative (that WWF is a founder of) in which more than 1000 companies globally have committed or set tailored climate science-based targets to align their business model with a 1.5°C or well below 2°C scenario. It offers a specific methodology for banks and investors.
- A related initiative, the Science-Based Target Network (https://sciencebasedtargets.org/about-us/sbtn and https://sciencebasedtargetsnetwork.org/why-set-sbts-for-nature/, is currently developing methodologies and metrics for companies to set science-based targets for nature (biodiversity, water, etc).
- The PACTA framework (http://www.transitionmonitor.com/en/home/), developed by 2° Investing Initiative (referenced in the EBA discussion paper p60, Box 10), is extremely relevant for financial institutions to assess the degree of alignment of their portfolio with a climate scenario, for the most critical high-carbon sectors. It has been used to date by more than 1000 financial institutions and supervisors including EIOPA, the Bank of England, DNB, the California insurance regulator and more.
Secondly, the fact that the analysis shows that only a limited number of common areas are defined should not lead to the conclusion that therefore only these areas are important; all ESG factors that are used in one or more frameworks might be material to credit institutions/investment firms and therefore relevant for the purpose of managing their ESG risks.
Thirdly, and very importantly, the EBA should take into account the forthcoming legislative review of the NFRD, in which the Commission will likely propose the creation on an EU Non-Financial Reporting Standard: it will radically clarify the corporate sustainability framework and indicators to define ESG factors and risks.
There are other transmission channels for ESG risks that are relevant from a (macro)prudential perspective, such as reputational risk to the financial institution itself. This risk can impact the stability of a financial institution even without having an impact on the financial performance of solvency of institutions’ counterparties, e.g. when a consumer boycott of a financial institution leads to an immediate financial impact to the financial institution but not to the counterparty. The BlackRock study for DG FISMA on ESG integration shows that the majority of banks interviewed indeed consider and recommend a double materiality approach in the context of reputational risk (to themselves).
In addition, the definition of transition risk provided by the NFRD Guidelines and referred to the in the EBA Discussion Paper in paragraph 59 only covers reputational risk of the counterparty, which is worrying.
One concrete example is the North-Dakota Access Pipeline case, where ING withdrew funding under public pressure despite the very limited financial risk to the counterparty – USD 120 million (see https://www.ing.com/Newsroom/News/Features/ING-and-the-Dakota-Access-pipeline.htm.
Our recommendation to implement a proportionate ESG risks management approach is to urge the Commission to develop a granular list of ‘high-impact’ sectors (using NACE codes, and building on available evidence, notably the EU taxonomy). This could be done as part of the NFRD review. With such a list small financial institutions could primarily focus on the most risky sectors (hence counterparties with big ESG impacts, to a large extent), in order to ensure a proportionate and balanced ESG risks management approach.
- Measurable, specific, time-bound sustainability targets to mitigate ESG risks and to align with sustainability policy goals (e.g. the Paris climate Agreement);
- A time-bound transition plan for implementation, that is more granular;
- A significant link of the remuneration of executive management to the achievement of the targets.
Importantly, one way taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that captures ALL the proposed ways.
In addition, we recommend to require that a significant link of the remuneration of executive management to the achievement of the ESG risk objectives (and sustainability targets in a double materiality perspective).
Importantly, one way taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that captures ALL the proposed ways.
Importantly, one way taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that captures ALL the proposed ways.
Institutions should be required to assess their ESG risks until 2050 wherever feasible (e.g. it is feasible for climate risks, using forward-looking climate scenario analysis).
However we think it is a mistake to assume that climate will be the only driver of ESG prudential risk, even in the medium-term future. As documented in the Discussion Paper, the dispersed social impact (labour, gender, wealth) of the Covid-19 pandemic shows that non-environmental risks can lead to relatively sudden and profound economic shocks, e.g. in the real estate market. In addition, our own WWF work with financial institutions and financial supervisors lead us to conclude that non-climate environmental risks (biodiversity, water, pollution) are developing fast and are leading to prudential risks much quicker than most believe. For example, water consumption in water-stressed areas is a growing area of concern for many economic sectors, and climate change will only aggravate the problem by disrupting water flows and the water cycle rain predictability and availability, etc. As we have entered several ecosystem collapses (e.g. massive collapse of pollinators in Europe, which will inevitably impact agriculture), we are convinced that nature risk creation may radically accelerate.
We therefore think that in addition to climate scenario testing in the near-future, sustainability risks should be stress-tested in a broader way, as the EU’s sustainable investment framework is designed to cover ESG issues holistically. Data on non-climate ESG indicators will soon become more readily available once the revision of the NFRD is being implemented and the EU Sustainable Finance Taxonomy is extended to social indicators.
Importantly, one recommendation taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG factors and ESG risks that integrates ALL the proposed recommendations.
Importantly, one recommendation taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that integrates ALL the proposed recommendations.
Importantly, one recommendation taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that integrates ALL the proposed recommendations.
1. Please provide details of other relevant frameworks for ESG factors you use.
Firstly, WWF recommends several other frameworks in addition to those already identified by EBA:- The Future Fit Benchmark (https://futurefitbusiness.org/) that is a relevant framework for the complex issue of natural capital and planetary boundaries, and has already been used by several companies in a concrete and granular way;
- The Water Risk Filter (https://waterriskfilter.panda.org/) is a tool developed by WWF to assess and value the water-related financial risks faced by companies and financial institutions.
- WWF uses the Science-Based Target initiative (https://sciencebasedtargets.org/), an initiative (that WWF is a founder of) in which more than 1000 companies globally have committed or set tailored climate science-based targets to align their business model with a 1.5°C or well below 2°C scenario. It offers a specific methodology for banks and investors.
- A related initiative, the Science-Based Target Network (https://sciencebasedtargets.org/about-us/sbtn and https://sciencebasedtargetsnetwork.org/why-set-sbts-for-nature/, is currently developing methodologies and metrics for companies to set science-based targets for nature (biodiversity, water, etc).
- The PACTA framework (http://www.transitionmonitor.com/en/home/), developed by 2° Investing Initiative (referenced in the EBA discussion paper p60, Box 10), is extremely relevant for financial institutions to assess the degree of alignment of their portfolio with a climate scenario, for the most critical high-carbon sectors. It has been used to date by more than 1000 financial institutions and supervisors including EIOPA, the Bank of England, DNB, the California insurance regulator and more.
Secondly, the fact that the analysis shows that only a limited number of common areas are defined should not lead to the conclusion that therefore only these areas are important; all ESG factors that are used in one or more frameworks might be material to credit institutions/investment firms and therefore relevant for the purpose of managing their ESG risks.
Thirdly, and very importantly, the EBA should take into account the forthcoming legislative review of the NFRD, in which the Commission will likely propose the creation on an EU Non-Financial Reporting Standard: it will radically clarify the corporate sustainability framework and indicators to define ESG factors and risks.
2. Please provide your views on the proposed definition of ESG factors and ESG risks.
We agree with these definitions.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.
While we agree that ESG risks should be approached primarily from the perspective of negative impacts of ESG factors on counterparties, we believe that this is incomplete, and a broader approach is necessary.There are other transmission channels for ESG risks that are relevant from a (macro)prudential perspective, such as reputational risk to the financial institution itself. This risk can impact the stability of a financial institution even without having an impact on the financial performance of solvency of institutions’ counterparties, e.g. when a consumer boycott of a financial institution leads to an immediate financial impact to the financial institution but not to the counterparty. The BlackRock study for DG FISMA on ESG integration shows that the majority of banks interviewed indeed consider and recommend a double materiality approach in the context of reputational risk (to themselves).
In addition, the definition of transition risk provided by the NFRD Guidelines and referred to the in the EBA Discussion Paper in paragraph 59 only covers reputational risk of the counterparty, which is worrying.
One concrete example is the North-Dakota Access Pipeline case, where ING withdrew funding under public pressure despite the very limited financial risk to the counterparty – USD 120 million (see https://www.ing.com/Newsroom/News/Features/ING-and-the-Dakota-Access-pipeline.htm.
4. Please provide your views on the proposed definitions of transition risks and physical risks included in section 4.3.
We agree with these definitions.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.
We largely agree to the description, although we would add that the ongoing discussions about supply chain liability within the EU could lead to increased responsibility of counterparties or even financial institutions for ESG risks inside their entire supply chain. This will make it harder for counterparties and/or financial institutions to seek insurance or risk-sharing arrangements for (indirect) liability risks, which in itself is a prudential risk.8. Please provide your views on the relevance and use of qualitative and quantitative indicators related to the identification of ESG risks.
By nature, several ESG indicators are not of a quantitative nature or operate in a binary way (e.g. absence of documented human rights violations). This means that a robust ESG risk framework must find a way to operationalise and/or quantify indicators that are of a qualitative nature. To date, a common way to do so is by using specialised data providers or NGO reporting to verify any ESG risks related to a potential counterparty, although this is a backward looking approach. We therefore welcome EBA’s attempt to bring qualitative indicators into the prudential regulation framework.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.
In a double materiality perspective, we believe that it is important to focus on ESG risks and impacts, and this includes small financial institutions that can have counterparties with big ESG impacts.Our recommendation to implement a proportionate ESG risks management approach is to urge the Commission to develop a granular list of ‘high-impact’ sectors (using NACE codes, and building on available evidence, notably the EU taxonomy). This could be done as part of the NFRD review. With such a list small financial institutions could primarily focus on the most risky sectors (hence counterparties with big ESG impacts, to a large extent), in order to ensure a proportionate and balanced ESG risks management approach.
16. Through which measures could the adoption of strategic ESG risk-related objectives and/or limits be further supported?
We recommend to require institutions to set a sustainability strategy including three specific elements:- Measurable, specific, time-bound sustainability targets to mitigate ESG risks and to align with sustainability policy goals (e.g. the Paris climate Agreement);
- A time-bound transition plan for implementation, that is more granular;
- A significant link of the remuneration of executive management to the achievement of the targets.
17. Please provide your views on the proposed ways how to integrate ESG risks into the business strategies and processes of institutions.
We fully support the proposed ways to integrate ESG risks into the business strategies and processes of institutions.Importantly, one way taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that captures ALL the proposed ways.
In addition, we recommend to require that a significant link of the remuneration of executive management to the achievement of the ESG risk objectives (and sustainability targets in a double materiality perspective).
18. Please provide your views on the proposed ways how to integrate ESG risks into the internal governance of institutions.
We fully support the proposed ways to integrate ESG risks into the internal governance of institutions.Importantly, one way taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that captures ALL the proposed ways.
19. Please provide your views on the proposed ways how to integrate ESG risks into the risk management framework of institutions.
We fully support the proposed ways to integrate ESG risks into the risk management framework of institutions.Importantly, one way taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that captures ALL the proposed ways.
Institutions should be required to assess their ESG risks until 2050 wherever feasible (e.g. it is feasible for climate risks, using forward-looking climate scenario analysis).
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.
We strongly support the suggestion to introduce climate risk stress testing (scenario testing is more appropriate as it is necessary to assess climate-related risks in a long term way until 2050). It is extremely urgent and should be required annually to all institutions as from 2022.However we think it is a mistake to assume that climate will be the only driver of ESG prudential risk, even in the medium-term future. As documented in the Discussion Paper, the dispersed social impact (labour, gender, wealth) of the Covid-19 pandemic shows that non-environmental risks can lead to relatively sudden and profound economic shocks, e.g. in the real estate market. In addition, our own WWF work with financial institutions and financial supervisors lead us to conclude that non-climate environmental risks (biodiversity, water, pollution) are developing fast and are leading to prudential risks much quicker than most believe. For example, water consumption in water-stressed areas is a growing area of concern for many economic sectors, and climate change will only aggravate the problem by disrupting water flows and the water cycle rain predictability and availability, etc. As we have entered several ecosystem collapses (e.g. massive collapse of pollinators in Europe, which will inevitably impact agriculture), we are convinced that nature risk creation may radically accelerate.
We therefore think that in addition to climate scenario testing in the near-future, sustainability risks should be stress-tested in a broader way, as the EU’s sustainable investment framework is designed to cover ESG issues holistically. Data on non-climate ESG indicators will soon become more readily available once the revision of the NFRD is being implemented and the EU Sustainable Finance Taxonomy is extended to social indicators.
22. Please provide your views on the incorporation of ESG factors and ESG risks considerations in the business model analysis of credit institutions.
We support the EBA policy recommendations on the incorporation of ESG factors and ESG risks considerations in the business model analysis of credit institutions.Importantly, one recommendation taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG factors and ESG risks that integrates ALL the proposed recommendations.
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.
We support EBA’s view that the commonly used timeframes of 3-5 years are insufficient to capture medium-term ESG risks, and that additional time horizons should be assessed in the context of the supervisory assessment. Institutions should be required to assess their ESG risks until 2050 wherever feasible (e.g. it is feasible for climate risks, using forward-looking climate scenario analysis).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 support the EBA policy recommendations on the incorporation of ESG risks considerations into the assessment of the credit institution’s internal governance and wide controls.Importantly, one recommendation taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that integrates ALL the proposed recommendations.
25. Please provide your views on the incorporation of ESG risks considerations in the assessment of risks to capital, liquidity and funding.
We support the EBA policy recommendations on the incorporation of ESG risks considerations in the assessment of risks to capital, liquidity and funding.Importantly, one recommendation taken in isolation cannot deliver sufficient results given the urgency: institutions should be required to develop an integrated approach on ESG risks that integrates ALL the proposed recommendations.