Prudential treatment of assets and risk management​

Regarding the brown penalising factor, ESBG is not in favour of such a tool. Penalization of financing to more exposed sectors to climate risk shall be avoided. It could raise serious concerns, and in particular, it may burden their transition and increase social risks if the needed steps to transition haven’t been taken. 

Finally, a unanimous set of definitions enhances legal certainly and consistency. Similarly, aligned implementation deadlines would be very helpful. Apart from that, specific guidance on what is expected from financial market participants would be appreciated. It would facilitate the better organisation and preparation to comply with the new rules. 

Identified Concerns

ESBG recognises the need to integrate ESG considerations into the risk management process. However, it identifies some lack of harmonisation between the guidance provided by the EBA and ECB. In particular, in the EBA guidelines, the risks of climate change for the financial performance of borrowers are identified as physical risks, such as risks to the borrower that arise from the physical effects of climate change, including liability risks for contributing to climate change, or transition risks, e.g. risks to the borrower that arise from the transition to a low-carbon and climate-resilient economy. The ECB guide, on the other hand, includes in the definition of climate related and environmental risks not only risks deriving from the effects of climate change but also environmental degradation. Also, the EBA guidelines apply from 30 June 2021. In particular, the guidance referring to loan origination procedures, including the assessment of borrower’s creditworthiness and loan pricing, applies to loans and advances that are originated after 30 June 2021. The ECB will apply from the final publication date, i.e. probably from the end of 2020.​​

Why Policymakers Should Act

Prudential treatment of exposures, with the introduction of a green supporting factor or a brown penalising factor, should be risk-based to avoid jeopardising the financial stability of financial institutions and the whole economy. Common definitions, as well as harmonised and realistic implementation deadlines of interdependent rules used by all regulatory and supervisory European bodies, ensure legal certainty and trust. This also facilitates the compliance of financial market participants with the new regulations. Ensuring this, in our view, should be one of the major points to focus on for EU decision-makers.

Background

Climate change and the response to it by the public sector and society in general have led to the identification of new sources of financial risk to which the regulatory and supervisory community is paying increased attention. Notably, climate change gives rise to both transition risk and physical risk. In this context, both public sector policy choices and the expectations of stakeholders are likely to change over time. This makes it essential that financial institutions be able to measure and monitor their exposures in order to deal with transition and physical risks and understand how they can be affected by changes in societal expectations.

In line with the expectation that consideration of ESG factors will be incorporated into all regulatory products, the EBA included references to green lending and ESG factors in its guidelines on loan origination and monitoring which will apply to internal governance and procedures in relation to credit granting processes and risk management. Based on the guidelines the institutions will be required to include the ESG factors in their risk management policies, including credit risk policies and procedures. These guidelines are the first specific policy product developed by the EBA incorporating sustainability considerations.

Furthermore, the revised CRR 2/CRD 5 package (Article 98(8) of CRD 2) calls on the EBA to assess the potential inclusion of ESG risks in the supervisory review and evaluation process performed by competent authorities. To that end, the EBA’s assessment must comprise, inter alia:

• the development of a uniform definition of ESG risks including physical risks and transition risks;
• he development of criteria for understanding the impact of ESG risks on the financial stability of institutions in the short, medium and long terms;
• the arrangements, processes, mechanisms and strategies to be implemented by the institutions to identify, assess and manage these risks; and ​
• the analysis methods and tools to assess the impact of ESG risks on lending and the financial intermediation activities of institutions.​