Response to consultation on draft Guidelines on the management of ESG risks

Question 1: Do you have comments on the EBA’s understanding of the plans required by Article 76(2) of the CRD, including the definition provided in paragraph 17 and the articulation of these plans with other EU requirements in particular under CSRD and the draft CSDDD?

While Reclaim Finance welcomes the general elements identified by the EBA in its understanding of CRD-base transition plans, we draw the regulator’s attention to several elements in paragraph 11 to 19 that could mislead banks and do not contribute to proper risk management of climate-related and ESG risks:

• The EBA should explicitly state that there is only on “transition plan”, that provide an answer to all CRD and non-CRD requirements:

In paragraph 13, the EBA makes a distinction between two types of transition plans. One focusing on business model change, and the other on the prudential side. This distinction is sensible and correspond to the spirit of the transition plan requirements included in several EU legislations (CRD, Solvency II / CSRD, CSDDD). The Network For Greening the Financial System (NGFS) makes a similar distinction in its stock take on transition plans (see: NGFS, Stock take on transition plans, 2023). 

However, this distinction should not mean that banks should adopt two different plans. Indeed, dividing risk management and business model transition would disregard the many synergies between those two essential objectives and could create a lack of coherence. If the full list of elements needed to fulfill CRD-based obligations might differ from the full list of elements needed to plan and operate a shift in the business model, many of these elements will converge. In its report on climate transition plans, Reclaim Finance shows how key elements from a robust transition plan would help bank met the ECB’s supervisory expectations on climate-related and environmental risks (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). 

To avoid any confusion and ensure “inter-operability with other legislative initiatives”, the EBA should explicitly state that banks are expected to adopt one transition plan that met all regulatory and supervisory obligations and expectations. 

• The EBA should clarify that misalignment with climate policy goals can be source of risk and that alignment is a risk mitigation lever:

In paragraph 14, the EBA underlines that the guidelines do not require full alignment with climate and sustainability goals. If this statement is understandable providing the nature of CRD-based transition plans and definition laid out by the EBA in this section, it could mislead banks into thinking that alignment with climate goals is not meaningful to risk management and meeting regulatory and supervisory expectations. 

It is already clear that alignment is relevant to financial supervision and could play an important role in risk management and mitigation. A misaligned bank exposes itself to heightened transition risks – including litigation risks (see: Frank Elderson, “Come hell or high water”: addressing the risks of climate and environment-related litigation for the banking sector”, ECB, 2023) - while also contributing to the overall buildup of those risk with an increased probability of “disorderly” transition as well as higher physical risks. A misaligned bank is also likely to be more exposed to sectors and activities that concentrate climate-related risks such as the fossil fuel sector. 

The European Central Bank (ECB) itself underlined in a recent report that EU banks were not aligned with climate goals and that this could be problematic from a risk perspective (see: ECB, Risks from misalignment of banks’ financing with the EU climate objectives, 2024). The ECB notes that: “Alignment assessment is widely recognised as a useful method for quantifying transition risks in a credit portfolio, alongside techniques like scenario analysis, stress testing, exposure analysis and determining financed emissions. While these other methods give an indication of the carbon intensity of a credit portfolio at a certain point in time, alignment assessment provides insight into whether the corporations in a credit portfolio are moving towards low-carbon production. Banks and regulatory and supervisory authorities alike are currently embracing alignment assessment as a tool for evaluating risks and exploring strategies that have a positive impact on the climate.” In an occasional, ECB research team also identified the relevance of the greenwashing risk created by insufficiently substantiated net-zero commitment for supervisors (see: ECB, An examination of net-zero commitments by the world’s largest banks, 2024). In the US, new scenario modelling approach from the Department of Insurance of California considers forward-looking plans and alignment with climate scenarios in quantifying the exposure of insurers (see: California Department of Insurance, The hidden cost of delaying climate action for West Coast insurance markets, 2024)

Providing all these elements, the EBA should clarify that alignment is an important risk management and mitigation consideration. 

• The EBA should acknowledge that fossil fuels have already been connected to high level of climate-related risks and specific measures should be adopted, including ending support to new production: 

In paragraph 15, the EBA underlines that “the goal of prudential plans is not to force institutions to exit or divest from carbon intensive sectors”. While this reminder is understandable considering the perimeter and object of CRD-based transition plans, it ignores the fact that a few highly emitting sectors and activities have already been identified as concentrating climate-related risks. 

Indeed, despite major limitations in scenario and stress testing (see: Sandy Trust and all, The Emperor’s New Climate Scenarios, 2023 / Finance Watch, Finance in a hot house world, 2023), preliminary exercises all identified fossil fuel activities as higher risk. This is notably the case of the stress test conducted by the ECB, the ACPR and other European regulators and supervisors (see: ESRB, Towards macroprudential frameworks for managing climate risk, 2023 / ECB, The Road to Paris: stress testing the transition towards a net-zero economy, 2023 / ACPR, Les principaux résultats de l'exercice pilot 2020, 2021 / Luis de Guindos, “Shining a light on climate risks: the ECB’s economy-wide climate stress test”, ECB, 2021). Recent scenario analysis conducted by the Department of Insurance of California further underlined that the plans of oil and gas companies in US West Coast insurers’ portfolios are not aligned with policies implemented in 2021 implies “exposure to transition risk even in the absence of any additional collective climate action”, and that coal and oil and gas have the highest probability of default in delayed/disorderly transition scenarios (see: California Department of Insurance, Executive Summary The hidden cost of delaying climate action for West Coast insurance market, 2024).

Beyond the results of stress tests and quantitative analysis, fossil fuel assets are notably exposed to a “stranding risk” (see: Carbon Tracker, Oil & Gas: 2023 Assessments for Climate Action 100+, 2023 / Harry Benham, “Energy is a very long game: yet fossil fuel companies are taking a lot of short-term risks”, Carbon Tracker, 2024 / Institut Rousseau and al, Actifs fossiles, les nouveaux subprimes ?, 2021). This is especially the case for assets tied to new production projects, as these assets are not needed in a scenario where actions are carried out to limit global warming to 1.5°C and will take decades to recover their investment cost. New fossil fuel production assets have a high chance to be closed before amortization or require the faster closure of pre-existing assets, and thus are a major source of risks as identified by the International Energy Agency (IEA) (see: IEA, World Energy Outlook 2023, 2023 / IEA, The Oil and Gas Industry in Net Zero Transitions, 2023 / IEA, NZE 2023 Update, 2023). This also means that bank’s continued support to fossil fuel developers (see: Rainforest Action Network and al, Banking On Climate Chaos 2023, 2023 / Reclaim Finance, Oil and Gas Policy Tracker, online tool / Reclaim Finance, Coal Policy Tracker, online tool) breaches their net-zero and climate commitments, thus bringing additional transition risks (see: ECB, An examination of net-zero commitments by the world’s largest banks, 2024). 

If oil and gas production is predominantly localized outside of EU and OECD countries, this does not mean that investors and banks are less exposed to the asset standing risk (see: Gregor Semieniuk and al, “Stranded fossil-fuel assets translate to major losses for investors in advanced economies”, Nature Climate Change, 2022). However, asset stranding risk is not considered by EU banks, despite its effect being potentially amplified by the indirect exposure to fossil fuels and second-round effects in financial markets in case of sudden loss of value (see: Winta Beyene and al, Financial institutions' exposures to fossil fuel assets: An assessment of financial stability concerns in the short term and in the long run, and possible solutions, Economic Governance Support Unit of the European Parliament, 2022). This is especially worrying since fossil fuel exposures already constitute a high share or even exceed the Common Equity Tier 1 (CET1) of these banks (see: ECB, Risks from misalignment of banks’ financing with the EU climate objectives, 2024 / Institut Rousseau and al, Actifs fossiles, les nouveaux subprimes ?, 2021 / Bank of England, Financial Stability Report, 2019).

At a macro-prudential level, the ECB and European Systemic Risk Board (ESRB) have long used fossil fuel exposures and related criteria in their analysis (see: ESRB and ECB, The macroprudential challenge of climate change, 2022 / ESRB, Towards macroprudential frameworks for managing climate risk, 2023). The EIOPA is now considering introducing additional capital requirements on fossil fuels (see: EIOPA, Consultation on the Prudential Treatment of Sustainability Risks, 2023), a proposal that has been championed by civil society organizations focusing on financial stability (see: Finance Watch, A safer transition for fossil banking: Quantifying capital needed to reflect transition risk, 2022). Additionally, establishing restrictions on financial services to the fossil fuel industry is an element of the good practices identified by the ECB on climate and environmental risk management (see: ECB, Good practices for climate and environmental risk management, 2022), and that excessive support to this industry is one of the factor of misalignment of European banks with climate goals identified by the central bank (see: ECB, Risks from misalignment of banks’ financing with the EU climate objectives, 2024).

Providing these elements, the EBA should underline in paragraph 15 that fossil fuel assets are tied to high risk, and that assets linked to fossil fuel development are even riskier. Furthermore, it is essential to explicitly acknowledge that immediately ending financial services to new fossil fuel projects and the companies that develop them and phasing out support to fossil fuels – starting with coal - are important for managing climate-related risks. 

While preserving the spirit of the CRD and the staying within the principles of the EBA’s understanding of CRD-based plans presented in this document, the above-mentioned elements should lead the EBA to review the definition of CRD-based transition plans in paragraph 17 to ensure that such plans:

1. Enable regulators, supervisors and other stakeholders to understand the alignment of the bank with climate and environmental policy goals and how any misalignment is managed;
2. Identify the exposure of banks to the fossil fuel sector, and especially to fossil fuel development, as well as the restrictions and measures taken to manage it. Banks can rely on the Global Coal Exit List and Global Oil and Gas Exit List from Urgewald to identify fossil fuel companies and those developing new production projects.

Question 3: Do you have comments on the approach taken by the EBA regarding the consideration of, respectively, climate, environmental, and social and governance risks? Based on your experience, do you see a need for further guidance on how to handle interactions between various types of risks (e.g. climate versus biodiversity, or E versus S and/or G) from a risk management perspective? If yes, please elaborate and provide suggestions.

Reclaim Finance underlines that:

• The EBA should already provide recommendations on biodiversity risk management, starting with deforestation:

Preliminary work from regulators – and notably from the Banque de France and NGFS (see: Banque de France, A “Silent Spring” for the Financial System? Exploring Biodiversity-Related Financial Risks in France, 2021 / Banque de France, Bulletin 237/7 - Biodiversity loss and financial stability: a new frontier for central banks and financial supervisors?, 2021 / NGFS-INSPIRE, Central banking and supervision in the biosphere: An agenda for action on biodiversity loss, financial risk and system stability, 2022) – has shown that biodiversity risk can be significant and widespread in the economy and must be addressed. 

While approaches to handle this risk are not as elaborated as for climate, significant work has already been launched - notably through the Task Force on Nature-Related Financial Disclosure (TNFD), Science-based targets for nature (SBTN) – and biodiversity risks seem to share many characteristics with climate-related risks (see: Hugues Chenet and al,  Developing a precautionary approach to financial policy – from climate to biodiversity, INSPIRE, 2022). Furthermore, a large body of scientific evidence is available (see: IPBES assessments), and key sectors and companies have been identified as potentially high-risk for deforestation (see: Forest 500, Annual Report 2024: A decade of deforestation data, 2023 / Ministère de la Transition Ecologique, Tableau de bord d'évaluation des risques de deforestation, SNDI, 2021). 

Providing the above-element, regulators and supervisors should immediately provide recommendations on biodiversity risks. They can start by focusing on deforestation, where data is more readily available and where bank exposure has already been analyzed by civil society organizations (see: Forest&Finance, Banking On Biodiversity Collapse 2023, 2023 / Forest 500, Annual Report 2024: A decade of deforestation data, 2023).

• The EBA should note that some activities are likely to be exposed to several types of ESG risks and should be examined with extreme care:

Some activities are likely to be sources of climate, biodiversity and other ESG risks because they have a significant impact on all these issues. This is notably the case of fossil fuel activities, which have been connected to numerous biodiversity, human and indigenous rights scandals on top of being at the heart of the climate crisis (see: Fossil Fuel Non-Proliferation Treaty, How coal, oil and gas sabotage all seventeen Sustainable Development Goals, 2022), but also of other activities such as those significantly heavily involved in deforestation and nature depletion.

This “cross-risk” exposure should be acknowledged by the EBA. It also backs the case for a stricter approach to fossil fuel restrictions as explained in our response to question 1 of the consultation. 

Question 5: Do you agree with the specification of a minimum set of exposures to be considered as materially exposed to environmental transition risk as per paragraphs 16 and 17, and with the reference to the EU taxonomy as a proxy for supporting justification of non-materiality? Do you think the guidelines should provide similar requirements for the materiality assessment of physical risks, social risks and governance risks? If yes, please elaborate and provide suggestions.

Reclaim Finance agrees with the specification of a minimum set of exposures to be considered as materially exposed to transition as per paragraph 16. However, we warn of the potential negative consequences of the derogation open in paragraph 17.

Indeed, the list of activities in paragraph 16 include only a handful of sectors that highly contribute to climate change and are by essence highly exposed to climate-related risks. Some of these sectors, including oil and gas and coal mining, cannot operate a transition as they must be phased-out to meet climate goals. In these circumstances, opening a derogation to obligations in paragraph 16 could be problematic. The fact that this derogation would require a high level of alignment with the EU taxonomy does not provide strong guarantees as (i) some activities that are incompatible with the transition can still be carried out and (ii) the exact level of alignment required is not clearly established. 

Additionally, we suggest the EBA provide other such requirements for biodiversity risk, and more specifically regarding deforestation. As explained in our response to question 3, activities heavily responsible for deforestation have been well-identified and it is already possible to analyze banks’ exposure to them (see: Forest&Finance, Banking On Biodiversity Collapse 2023, 2023 / Forest 500, Annual Report 2024: A decade of deforestation data, 2023).

Question 6: Do you have comments on the data processes that institutions should have in place with regard to ESG risks?

Regarding paragraph 23, Reclaim Finance underlines that the data collected from large corporate counterparties should at least include:

• “Current and forecasted greenhouse gas (GHG) scope 1, 2 and 3 emissions” in both absolute and intensity terms.
• Investment (capex) in fossil fuels, split between investment in existing infrastructures and new ones, and operational expenses (opex) related to fossil fuel consumption and/or infrastructures.
• “Energy and water demand and/or consumption” both in terms of economic factor inputs or revenue base.

We stress that data collection on investment in fossil fuels – and especially new fossil fuel production and transport projects – are especially important to consider the risk related to the exposure of companies active in the sector. As highlighted in our answers to questions 1 and 3, financial services to fossil fuels are especially relevant to determine ESG risks. Furthermore, considering high-carbon – and especially fossil fuel - capex and opex is coherent with the EU ESRS (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024).

Additionally, Reclaim Finance suggests the EBA asks banks to collect some data related to biodiversity. It can start with data related to deforestation, with data on the dependency to high-risk activities - both in terms of economic factor inputs and revenue base – and the investment (capex) in such activities.

Question 7: Do you have comments on the measurement and assessment principles?

The measurement and assessment principles are yet to account for the uncertainty that characterize many ESG risks, including on climate and biodiversity (see: Hugues Chenet and al, “Finance, climate-change and radical uncertainty: Towards a precautionary approach to financial policy”, Ecological Economics, 2021 / Hugues Chenet and al, Developing a precautionary approach to financial policy – from climate to biodiversity, INSPIRE, 2022). 

Doing so would require precautionary approach on the measurement and evaluation of this risks. This approach entails: (i) immediately focusing on some activities that have been identified as especially exposed to risks, as identified in our responses to questions 1 and 3; (ii) pushing banks to rely on “high stress” scenarios and analyze tail risks.

Question 8: Do you have comments on the exposure-based methodology?

When defining the set of risk factors and criteria that banks should use to conduct the assessment of environmental risks at exposure level, the EBA should at least ensure that:

• GHG emissions are analyzed both in absolute and intensity terms (paragraph 31 b)).
• Current and forecasted investment (capex) in high carbon activities – and especially fossil fuels - are considered.

Reclaim Finance underlines that considering high-carbon – and especially fossil fuel - capex is coherent with the EU ESRS (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024).

Reclaim Finance also notes the EBA rightfully covers both off and on balance sheet activities in paragraph 31 a. We stress that the same approach should be applied systematically throughout the document to ensure ESG risk in off balance sheet activities are properly considered. Indeed, bank balance sheet lending have been making up a decreasing share of overall private lending (see: Greg Buchak and al, “The Secular Decline of Bank Balance Sheet Lending”, National Bureau of Economic Research, 2024). In this context, extending all aspect of financial regulation and supervision – including related to ESG and climate risks – to off-balance sheet activities and intermediation is essential to proper risk management. 

Question 9: Do you have comments on the portfolio alignment methodologies, including the reference to the IEA net zero scenario? Should the guidelines provide further details on the specific scenarios and/or climate portfolio alignment methodologies that institutions should use? If yes, please elaborate and provide suggestions.

Reclaim Finance supports the analysis of the alignment of portfolios and the use of the IEA NZE scenario. Indeed, the IEA NZE is a reputable source used by many financial practitioners, and IEA scenarios were used by them long before this scenario was published. However, we note that “fossil fuel production” is surprisingly missing from the list in paragraph 36 and should be added.

Furthermore, we identified several missing elements in the portfolio-based methodology notably:

• The EBA should make clear that analysis of the alignment of portfolio should go beyond mere emission-based metrics to consider the real alignment of specific sectors:

A consensus is emerging that methodologies that measure the alignment of portfolios are unprecise and not sufficient to measure alignment with climate policy goals (see: OECD, Assessing the climate consistency of finance, 2022 / OECD, Assessing net-zero metrics for financial institutions, 2023 / Institut Louis Bachelier, The Alignment Cookbook, 2020). Focusing on a single GHG-based alignment indicator at portfolio level could easily give a misleading image of the risk level of the portfolio through changes – even provisional – in portfolio affectation and/or assets prices. 

It is therefore essential the EBA pushes banks to look beyond GHG emissions to consider how companies in their portfolio transition their activities and how they contribute to “real-world” decarbonization (see: Paddy McCully, “Financial institutions targets must be based on real-world decarbonization”, Reclaim Finance, 2023). This implies looking at sectoral transition milestones identified in the IEA NZE. For example, such milestones require coal to be phased-out by 2030 in the EU/OECD and 2040 worldwide and no new investment to be conducted in new oil and gas production (see: IEA, World Energy Outlook 2023, 2023 / IEA, The Oil and Gas Industry in Net Zero Transitions, 2023 / IEA, NZE 2023 Update, 2023). While such milestones are not identifiable for all sectors in the short term, they exist for most of the ones mentioned in paragraph 36.

• The EBA should make clear that the alignment analysis must be based on a 1.5°C no/low overshoot scenario with a limited level of negative emissions:

If the EBA references the IEA NZE, it provides little detail on the type of scenario that should be used in paragraph 35 a). But, today, initiatives related to GHG target setting and transition planning require the use of 1.5°C low/no overshot scenarios (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). Key initiatives also consider the level of negative emission in these scenarios, trying to ensure only a limited level is used. 

Such considerations are highly relevant to a risk approach: (i) Higher overshot scenarios are often linked to a delayed transition that brings higher transition risks and are connected to periods of higher global warming and tipping points that could increase physical risks; (ii) Relying on high levels of negative emissions means that high carbon activities are less exposed to transition risk, but such a high level of negative emissions is not likely to materialize and therefore risk are artificially underestimated.

In paragraph 35 a), the EBA should state that scenarios should be 1.5°C no/low overshot with a limited level of negative emissions. 

Question 10: Do you have comments on the ESG risks management principles?

In paragraph 42, the EBA asks institutions to “develop a robust and sound approach to managing and mitigating ESG risks over the short, medium and long term, including a time horizon of at least 10 years”. The 10 years time horizon appears limited to fully consider long term risks, especially climate related risks. On one side, transition risks extend beyond this time horizon, with many net-zero commitment and climate pledges aiming for 2050. On the other, physical risks are likely to be even higher in beyond this time horizon due to global temperature and related consequences. The EBA should at least opt for a 20 years time horizon that lead banks to look beyond 2040.

Furthermore, when listing a range of tools that banks should consider to mitigate risks in paragraph 42 a) to e): 

• The EBA should clarify that engagement activities must be linked to clear timebound objectives and an escalation strategy, and especially consider investment/development of high carbon activities:

Engagement from financial institutions covers a wide range of activities with very different impact on the behavior of counterparties. It can refer simply having side discussions with companies on ESG topics (“tea and biscuits” engagement), or merely being a member of joint engagement initiatives. But it can also mean having a detailed engagement strategy that include an escalation process and clear timebound objectives to put pressure on companies, with a real impact on their practices and plans (see: Reclaim Finance, Climate Stewardship: A guide for effective engagement practices, 2023). 

Only effective engagement practices that result in changes to company behavior are susceptible to contribute to mitigate ESG risks. On the contrary, ineffective engagement could contribute to higher exposure to risks by contributing to maintaining exposure to companies that do not mitigate their own risks exposures. The EBA should therefore clarify that engagement should be based on clear timebound objectives and an escalation strategy that include ceasing all or part of the financial services provided to the company (see: Reclaim Finance, Climate Stewardship: A guide for effective engagement practices, 2023).

Furthermore, as underlined in our response to question 1, 6 and 8, considering investment (capex) in high carbon activities is essential to understand and mitigate risks. The EBA should add assessing counterparties’ investment in such activities – and especially those related to fossil fuels - and encouraging their phase-out in the engagement items listed in paragraph 42. A).

• The EBA should acknowledge the use of fossil fuel sectoral policies and other restrictions:

The EBA lists the “diversification of lending and investments portfolios based on ESG-relevant criteria e.g. in terms of economic sectors or geographical areas” as one of the ESG risk mitigation tools to be considered. Today, many financial institutions already consider this, notably by adopting sectoral policies that restrict their support to some activities and objectives to increase support to higher ESG-ranked activities or companies. 

In this regard, sectoral policies that apply to the fossil fuel sector are the most widespread and can especially contribute to proper risk management, but other ESG sectoral restrictions have been used (for example on tobacco). The EBA should thus acknowledge the role of sectoral policies – and especially fossil fuel focused policies - in ESG risk mitigation.

Question 11: Do you have comments on section 5.2 – consideration of ESG risks in strategies and business models?

In paragraph 44. b), the EBA mentions a time horizon of at least 10 years. As explained in our response to question 10, this time horizon is insufficient and should be at least extended to 20 years.

Question 17: Do you have comments on section 5.8 – monitoring of ESG risks?

In paragraph 72 a) to j), the EBA lists indicators that should be monitored by institutions. This list should be modified to ensure proper monitoring of ESG risks:

• The EBA should ensure off balance sheet activities and facilitated emissions are also fully monitored:

Off balance sheet activities constitute a large share of bank activities and has been increasingly contributing to the financing of the economy (see: Greg Buchak and al, “The Secular Decline of Bank Balance Sheet Lending”, National Bureau of Economic Research, 2024). But, so far, these activities remain largely out of the scope of both bank’s voluntary climate-related targets and commitments and climate-related financial supervision. This partly explains the fact that between 2016 and 2022 49,1% of the fossil fuel financing of the world’s 60 largest banks to the 100 biggest fossil fuels companies came from underwriting (see: Rainforest Action Network and al, Banking on Climate Chaos 2023, 2023). If this trend continues, the risk of a migration of the financing of ESG/climate negative activities and of the financial risk they bring to off balance sheet activities is high. This has potential macro stability implications and repercussions in the non-bank financial sector. 

Furthermore, like on balance sheet exposures, off balance sheet exposures are not without direct risks for banks. EU regulators and supervisors have acknowledged climate-related risks that comes from high-carbon – and even more so fossil fuel - bonds (see: ECB, “Climate-related risks to financial stability”, Financial Stability Review 2021, 2021 / EIOPA, Consultation on the Prudential Treatment of Sustainability Risks, 2023). Financial institutions themselves have acknowledged their responsibility on facilitated emissions and off-balance sheet activities (for example through involvement in the PCAF or SBTi Financial Net-Zero workstreams). 

Additionally, failing to consider fully off-balance sheet activities and related emissions in prudential regulation would encourage banks not to include these activities into their climate alignment strategies and transition plans. This would increase the transition risk related to misalignment explained in our answer to question 1.

Providing all these elements, the EBA should clarify that ESG risk monitoring also fully covers off balance sheet activities and that facilitated emissions should be monitored. To enable an analysis under different risk profiles, financed and facilitated emissions should be reported and monitored separately. 

• The EBA should ask institutions to monitor investment in fossil fuels and other high impact activities:

Requiring institutions to monitor the “amount and share of income (interest, fee and commission) stemming from business relationships with counterparties operating in sectors that highly contribute to climate change in accordance with Recital 6 of Commission Delegated Regulation (EU) 2020/1818 i.e. the sectors listed in Sections A to H and Section L of Annex I to Regulation (EC) No 1893/2006” is not sufficient. As explained in our response to question 1, 6, 8 and 10, it is essential institutions consider investment in such activities, and especially those related to fossil fuels. 

Question 18: Do you have comments on the key principles set by the guidelines for plans in accordance with Article 76(2) of the CRD?

In a recent report, Reclaim Finance analyzed 26 prominent public frameworks to identify the essential elements that should be included in any corporate transition plan (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). We showed that including these elements would enable companies to comply with CSRD obligations in a meaningful way, while also providing banks with the information needed to meet the ECB supervisory expectations on climate related risks. New analysis from the Climate and Sustainable Finance Commission (CCFD) of the French Market Authority (AMF) underlines the key elements needed to comply with the CSRD and contains quality factors that largely converge with our analysis (see: Climate and Sustainable Finance Commission of the AMF, Reporting on climate transition plan in ESRS format, 2024 – full version only available in French).

Comparing the elements gathered in these analyzes to the principles set by the guidelines for CRD-based transition plans shows the principles are not sufficient to foster good practices in climate-risk management – notably compared to the practices identified by the ECB (see: ECB, Good practices for climate and environmental risk management, 2022) - and do not fully consider obligations under the CSRD/ESRS. As noted in Reclaim Finance’s report (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024), many supervisory expectations set by the ECB can be linked to key aspects of transition plans, notably:

• The criteria applied to fossil fuels and other harmful activities.
• The decarbonization targets and their quality/alignment. 
• The decarbonization strategy, and especially the elements related to financial planning.
• Engagement activities and their consequences for companies.
• The integration of climate objectives in reporting and governance.

We therefore urge the EBA to be more prescriptive on the content of CRD-based transition plans, notably building on the “red flags” identified by Reclaim Finance (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). Doing so would significantly contribute to climate-related risk management and mitigation, and notably contribute to address specific risks stemming from misalignment with climate goals, insufficiently substantiated net-zero commitments, and high carbon exposures. 

Question 19: Do you have comments on section 6.2 – governance of plans required by the CRD?

Many frameworks already provide recommendations to ensure climate transition plans are integrated in governance. Many of these recommendations are also relevant to CRD-based plans, as they would help ensure these risk management tools are properly considered inside the institution and contribute to their implementation. 

Building on our analysis of 26 frameworks and own recommendations we believe (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024) the EBA should:

• Ask institutions to establish responsibility for monitoring the implementation of the plan at board level in paragraph 84.
• Provide more detailed requirements on the competencies of teams tasked with defining and monitoring the plan, notably regarding climate science in paragraph 88.
• Add a recommendation asking institutions to review whether the incentives of the teams tasked with defining and monitoring the plan are coherent with this plan. 

Add a recommendation to clarify the review process of the plan.  

Question 20: Do you have comments on the metrics and targets to be used by institutions as part of the plans required by the CRD? Do you have suggestions for other alternative or additional metrics?

The list of proposed metrics and targets is much too unprecise and uncomplete to foster good risk management practices through transition planning. On the contrary, if it remains the same it will even drive banks to use widely different metrics and targets that are non-comparable and make supervising them difficult.

Recent developments have highlighted the inherent complexities in measuring the financial sector’s contribution to climate change — and the ways in which this complexity enables the sector to manipulate metrics and methodologies in its favor. Major gaps in data on corporate-level emissions, flaws in the methodology used to measure “financed emissions,” poorly structured and opaque target designs, and the potential use of offsets all weaken the impact of financial institution decarbonization targets (see: Reclaim Finance, “Financial institutions targets must be based on real-world decarbonization”, Reclaim Finance, 2023). From a risk perspective, this means that focusing on GHG targets set by financial institutions may provide misleading information on the risk profiles of institutions and portfolios. 

To remedy this, the EBA should look for better designed, more ambitious, and more diverse types of targets (see: Reclaim Finance, “Financial institutions targets must be based on real-world decarbonization”, Reclaim Finance, 2023). To say it differently, proper climate-risk management – much like impact management – requires a basket of targets and metrics that go well-beyond GHG targets as well as the improvement of such targets. 

To ensure GHG targets remain relevant, the EBA should:

• Push financial institutions to cover all activities and jurisdictions with targets and metrics. This requires rewording paragraph 89, but also extending emission coverage in paragraph 94. a) to include facilitated emissions. Indeed, as explained in our response to question 17, covering facilitated emissions is essential to consider climate-related risks. 
• Ask for emission targets to be differentiated to cover individual sectors, asset classes, and gases, as well as aggregated across portfolios, and gases (by using the metric of CO2-equivalent). 
• Ask financial institutions to also set targets for the total emissions of the companies that they finance, both at a sectoral and portfolio-wide level, without using an attribution factor. If emissions of the companies that an institution finances are not dropping, it would be an important sign that the efforts of financial institutions to help their clients and investees transition are not working. 

To supplement GHG targets, in the logic of fostering “an active risk management approach”, the EBA should:

• Ask financial institutions to adopt sectoral targets based on the evolution of the sector in a 1.5°C no/low overshoot with limited volume of negative emission scenario. Such targets can be based on the evolution of the production in a specific sector or/and on decarbonization milestones in this sector (for example, exiting coal by 2030 for the EU power sector and 2040 worldwide). 
• Integrate fossil fuel sectoral policies in the set of metrics and targets that should be used by financial institutions. Building on the work of the IEA, the EBA should notably push them to adopt a ratio to allocate six euros to sustainable power supply for each euro allocated to fossil fuels (see: Reclaim Finance, “6:1, a ratio to successfully transform our energy system”, Reclaim Finance, 2023 / Beyond Fossil Fuels, Why Beyond Fossil Fuels favours the 6:1 sustainable power supply to fossil fuel financing ratio, 2024). The EBA should also urge financial institutions to especially consider their support to fossil fuel development as explained in our response to question 1. 
• Be more prescriptive on the evaluation of counterparties’ “transition abilities”, notably to ensure investment (capex) plans are considered:

Prominent methodologies on transition planning converge on the need for investment to align with the transition strategy, notably by reducing investment in “brown” activities and increasing those in “sustainable” ones (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). Some investment, including in new fossil fuel production projects, must even immediately stop.  It is therefore not surprising to see investment allocation is one of the key elements that investors look for in climate strategies and plans (see: Climate Action 100+, Net Zero Company Benchmark, 2023 / Climate and Sustainable Finance Commission of the AMF, Reporting on climate transition plan in ESRS format, 2024 – full version only available in French). In this context, it is important for the EBA to ensure financial institutions look at capex allocation from counterparties (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). Misalignment of capex allocation could indicate potential high risk, notably in the perspective of a sudden/disorderly transition. 

Beyond the critical recommendations listed above, Reclaim Finance encourages the EBA to review the “red flag indicators” listed in its recent report on corporate transition plans to provide more detailed guidelines on CRD-based transition plans (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). As underlined in our response to question 18, these red flags are especially relevant to risk management and can converge with the good practices identified by the ECB on climate-related risks.

Question 21: Do you have comments on the climate and environmental scenarios and pathways that institutions should define and select as part of the plans required by the CRD?

The EBA should clarify that targets must be based on 1.5°C no/low overshot scenario, with limited reliance on negative emissions (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). Such scenarios – like the IEA NZE – contribute to proper risk management because scenarios that rely on large volumes of negative emissions and/or significant overshot artificially reduce transition risk exposure of high carbon companies by enabling them to continue to emit larger volumes of GHG for longer. Furthermore, scenarios that rely on large volumes of negative emissions and/or significant overshot could also contribute to larger physical risks as temperature overshot increase physical impacts of climate change and un-realized negative emission volumes would mean much higher global warming.

Limited volumes of negative emissions would notably mean sequestration in scenarios would be limited to 3 Gt CO2/year for BECCS, 3.8 Gt CO2/ year for fossil CCS, and 3.6 Gt CO2/year for afforestation by 2050 (see: IISD, Navigating Energy Transitions: Mapping the road to 1.5°C, 2022).

Question 22: Do you have comments on section 6.5 – transition planning?

Engagement tools and activities are one of the elements the EBA focuses on regarding transition planning. However, as explained in our response to question 10, engagement must be better defined, and notably based on clear timebound objectives and an escalation strategy that include ceasing all or part of the financial services provided to the company (see: Reclaim Finance, Climate Stewardship: A guide for effective engagement practices, 2023).

Furthermore, our comments in question 19 on governance are relevant to the EBA’s expectation on internal processes in paragraph 101. 

Question 23: Do you think the guidelines have the right level of granularity for the plans required by the CRD? In particular, do you think the guidelines should provide more detailed requirements?

Reclaim Finance underlines the guidelines are much too unprecise and vague. More granularity is needed to avoid financial institutions adopt widely different transition plan that are difficult – if not impossible – to supervise and monitor and that do not contribute to proper risk management.

As explained in our response to question 18, ensuring the quality of transition plans – with key elements such as robust decarbonization targets, related financial metrics, fossil fuel restrictions… - is essential to both enable companies to comply with CSRD in a meaningful way and meet the ECB supervisory expectations on climate related risks report (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024). Indeed, many supervisory expectations set by the ECB can be linked to key aspects of transition plans, notably:

• The criteria applied to fossil fuels and other harmful activities.
• The decarbonization targets and their quality/alignment. 
• The decarbonization strategy, and especially the elements related to financial planning.
• Engagement activities and their consequences for companies.
• The integration of climate objectives in reporting and governance.

We therefore urge the EBA to be more prescriptive on the content of CRD-based transition plans, notably building on the “red flags” identified by Reclaim Finance (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024) as well as on the work of the French Market Authority on ESRS transition plans (see: Climate and Sustainable Finance Commission of the AMF, Reporting on climate transition plan in ESRS format, 2024 – full version only available in French). Doing so would significantly contribute to climate-related risk management and mitigation, and notably contribute to address specific risks stemming from misalignment with climate goals, insufficiently substantiated net-zero commitments, and high carbon exposures.

Additionally, we stress that the current guidelines disregard the specific risks coming from high carbon – and especially fossil fuel – exposures, as explained in our response to question 1. The guidelines could therefore drive banks to adopt plans that do not consider the increasing focus on financial regulation and supervision on these activities, creating a coherence gap detrimental to risk management. To remedy this major flaw, CRD-based transition plans should at least include targets to restrict and reduce financial services to fossil fuel companies and projects and disclosure on the financial services specifically provided to new fossil fuel projects and to the companies that develop them.

Question 24: Do you think the guidelines should provide a common format for the plans required by the CRD? What structure and tool, e.g. template, outline, or other, should be considered for such common format? What key aspects should be considered to ensure interoperability with other (e.g. CSRD) requirements?

We believe a common format would be useful if the guidelines are more detailed and precise as explained in question 23. We underlined that the comments made in our consultation response would contribute to interoperability with CSRD. 

We also note that tables showing the connections between EBA guidelines, and the EU ESRS could be helpful. Such tables have been included in Reclaim Finance’s recent report on transition plans (see: Reclaim Finance, Corporate Climate Transition Plans: What to look for, 2024).

Question 25: Where applicable and if not covered in your previous answers, please describe the main challenges you identify for the implementation of these guidelines, and what changes or clarifications would help you to implement them.

The main challenge identified comes from the vagueness of the guidelines. We warn that such guidelines will result in a wide diversity of CRD-based plans, with different level of ambition and robustness. These plans will be very difficult to supervise, and result in confusion and uncertainty regarding climate-risk management. It is likely financial institutions trying to follow the guidelines would not simultaneously meet the expectations of the ECB on climate-related risks, nor provide information that are sufficient to comply with the CSRD. Furthermore, the guidelines do not mandate CRD-based plans to address the exposure to fossil fuels, thus creating a specific gap between expectations on prudential transition plans and general expectations on climate-related risks.

It is therefore essential the EBA add more detailed requirements to its guidelines, as suggested in our response to various questions including question 23.

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