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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From a market risk perspective, ESG risk would channel itself through existing risks, again via concentration to ESG exposures, for example if the credit spread widens for bonds as the market perceives increased trapped production capacity not rendering productive. This concentration could be measured by understanding the exposure to high-risk sectors. A holistic alignment or risk scoring approach would help the industry to standardise.
25. Please provide your views on the incorporation of ESG risks considerations in the assessment of risks to capital, liquidity and funding.
Incorporation of ESG risks in credit, market, operational, liquidity and funding is a good step forward for the industry. There are clearly challenges both on methodological and on data availability side that in due time will evolve and improve. For credit risk management, risk assessment is focused on recent (relevant) data with forward looking information. The impact of sustainability risks, specifically transition risks and environmental risks, can be longer term forces with no clear impact on short term profitability or trapped assets not visible in the current credit risk methodological framework. From that perspective, we agree that the approach should be on understanding the build-up of concentration to sectors, countries and counterparties susceptible to these risks. The timing might be uncertain but diversification is a very strong tool to manage these risks on an ongoing basis. As more borrower level information becomes available firms can start incorporating ESG at a borrower level in a more quantitative way. One area of attention is that incorporating ESG will be qualitative in nature initially where ESG considerations are a ‘top-up’ for pricing after initial scanning or applying an ESG score and flagging an exposure to increased sustainability risks. One recommendation can be to introduce formal quantitative metrics, similar to the EU Taxonomy, that are comparable between banks and more easy to integrate. Data un-availability can be circumvented by proposing an industry average. A very basic starting point can be to scale the SA Credit Risk Weights for exposures in certain industries and introduce soft ESG limits for single name concentration risk.From a market risk perspective, ESG risk would channel itself through existing risks, again via concentration to ESG exposures, for example if the credit spread widens for bonds as the market perceives increased trapped production capacity not rendering productive. This concentration could be measured by understanding the exposure to high-risk sectors. A holistic alignment or risk scoring approach would help the industry to standardise.