Understanding the EBA position paper
Background and objectives
This discussion paper is part of the EBA mandates on Sustainable Finance, and especially Article 98 of CRDV which concerns the potential inclusion of ESG risks in the supervisory review and evaluation process 1. On 3 November 2020, the EBA thus issued a Discussion Paper (thereafter the DP), “On management and supervision of ESG risks for credit institutions and investment firms”2 .
This DP aims at collecting the views of credit institutions and investment firms about EBA proposals. These proposals deal with how ESG factors and ESG risks could be included into business strategies, governance, risk management and regulatory and supervisory frameworks.
The definition of ESG factors and ESG risks. It also includes the description and the definition of the main transmission channels for environmental risks (i.e. physical and transitions risks) and for ESG risks in general (liability risks). The EBA gives examples to understand how these risks can materialize and how they are interconnected. A list of ESG factors is available in the appendix.
The definition of ESG indicators and metrics along with a description of methodologies for identifying and assessing ESG risks.Three types of methods are presented: (i) the alignment method, which measures how an institution’s portfolio is aligned relative to global sustainability targets 3 (ii) the risk framework method, which measures how sustainability related issues affect the risk profile of a bank’s portfolio and its standard risk indicators, and (iii) the exposure method, which assesses how individual exposures and clients perform in terms of ESG risk. The EBA outlines that these definitions and methods are a basis for discussion. Similarly, the indicators and metrics are not claimed to be exhaustive or definitive. The EBA does not either indicate any preferences between the three methodologies, which, by the way, could complete each other in EBA’s view.
The incorporation of ESG risks in institutions’ activities. The rationale behind is that ESG risks materialize in the form of existing prudential risks (credit risk, market risk, operational risk). Thus, the DP discusses how ESG risks should be integrated into institutions’ business strategies and processes, internal governance and risk management framework. Stress-testing is also underlined as being a fundamental block to consider.
The reflection of ESG risks in the supervisory review. This part logically follows the previous one. Recognizing that the current supervisory framework does not explicitly integrate ESG risks and especially their long-term impact, the EBA makes recommendations in that respect.
1 Two other mandates have been given to the EBA: one for the development of a technical standard in order to include ESG risks in the Pillar 3 (art. 434a and 449a of CRR2) and the other one for the potential inclusion of ESG risks into the Pillar 1 (art. 501c of CRR2).
2 EBA Discussion paper October 2020
3 An example is the PACTA Tool
Understanding the EBA position paper
On management and supervision of ESG Risks for credit institutions and investment firms
A total of 29 questions are addressed relatively to these topics. The consultation runs until 3 February 2021. The answers will be reviewed to issue a final report in June 2021, with a submission to the European institutions in December 2021.
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