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?

We disagree with too much distinction between prudential and non prudential transition plans. Focusing on prudential transition plans implicitly allows situations and mitigation actions that would be incompatible with non prudential transition plan. We believe that the principle of only “one transition plan” have to be in mind of the EBA at the risk of creating a schizophrenic situation if not. An example of undesired bias by setting separately prudential and non prudential transition plans would be a prudential transition plan embedding as risk mitigation actions regulatory lobbying against the financial penalization (under whatever form: carbon tax, norms, quotas…)  of climate damaging activities in order to mitigate legal risk, or greenwashed campaigns in order to mitigate reputational risk. EBA can choose various way of ambition to guarantee some consistency. 

1. The most appropriate for us is to consider a single transition plan fed by various regulatory requirements (CSDDDD, CRD6), the non-prudential transition plan being therefore a sub-part of this transition plan.
2. Should different transition plans be kept, there should be a need to ensure a monitoring and control consistency for the overlapping part of the prudential plan and the “non prudential” plan regarding risk identification, analysis and mitigation. As a reminder, financial risks are mentioned 805 times in the delegated acts of the ESRS.
3. A minimal less coherent approach should be to have an explicit statement in guidelines saying that considering the global picture, some situations/mitigation actions are non-appropriate seems in our view a minimum in order to ensure at least a “DNSH” principle of the prudential transition plan vs. the non prudential transition plan.

To our mind the paragraph 17of the background and rationale could be amended with the sentence:

“Whether the bank has published a transition plan within the framework of the CSRD or the CSDDD, the prudential transition plan provisioned by CRD6 should be set as a sub-part of this transition plan. At least, it must show its consistency with the rest of the bank's strategy. This concerns on the one hand the identification modalities, analysis and risk mitigation but also the fact that the transition plan based on the CRD contributes and in any case does not harm the climate strategy published by the company.”

Question 2: Do you have comments on the proportionality approach taken by the EBA for these guidelines?

We’re aligned. Complexity should be measured in terms of ESG risks rather than financial exposure. E.g. for climate in term of GHG exposures rather than credit lines amount.

This requires therefore at least a minimum standard in term of measuring the risk, which might not be obvious regarding various aspects to take into account, and could be subject to progress through time.

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.

As disclosed in Q1, we would like to ensure that there is at least consistency between risk mitigation actions stemming from the prudential transition plan and the non-prudential transition plan. As a matter of fact, it’s true that ultimately impact risk can result in financial risks but it will be through specific risks as mainly legal risk/reputational risks so a different kind than “classical” market/credit risks. This situation could lead to undesired behaviors. As a matter of fact, “legal” and “reputational” risks could be mitigated by both mitigation actions favorable but also non detrimental to transition achievement[MG1] [SR2] 

• E.g. legal risk through lobbying against financially penalizing measures for climate damaging activities or for explicit forbid of financing of some activities.
• E.g. reputational risks through “greenwashing” campaigns.

On how to handle various risks, our recommendation would be to avoid “aggregated score” between different risks and rather focus separately on each meaningful dimension.

• With aggregated metrics, there is always a risk of black-box/highly model-driven/non-interpretative scores.
• Therefore there would be assumed overlaps reflecting the interaction between risks but this is not seen as an issue.

 [MG1]Je rajouterais à la fin « in order to avoid incompatible mitigation actions such as:" pour introduire les 2 bullet points (qui sont justement des cas que l’on cherche à éviter)

 [SR2]Ok

Question 4: Do you have comments on the materiality assessment to be performed by institutions?

14b: please specify under which perspective should be appreciated the “significance” of activities, services and products (ie should be on from the underlying risk perspective, eg GHG financed emissions for climate mitigation risk) 

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.

• 16: technical point but maybe more impactful to quote an actual regulatory element than a recital, meaning quoting SFDR appendix I regarding the definition of sector highly contributing to climate change? 
• Please note that companies will have to consider their material risk and impact on climate and ESG in the context of CSRD reporting and future due diligence process. For the companies concerned, it seems useful to mention a link to their own materiality analysis. Particularly the financial penalties applicable to companies under the CSDDD merit greater vigilance in their risk analysis in the context of CRD-based transition plans. 
• 17: we understand the idea of leveraging on EU Taxonomy but unfortunately, in the absence of “brown taxonomy”, a high level of alignment is not a guarantee of “no material issue” (see for example an Elec Utilities mix producer 60% aligned with 40% coal and no intention at all to phase out the latter: the aligned ratio will be high but the company remains a material issue).
  • Add “with due justification that the non-aligned/non eligible part is not harmful to taxonomical objectives” or something like that?
• At the light of the difficulties stemming from the identification of transition risk, we’re unfortunately not so sure it would provide better results on other type of risks (physical, social, governance).

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

• 23. We would like to propose some reshape in 23. Criteria regarding environmental risk, notably to explicitly embed climate mitigation transition plans as an essential piece of information in order to assess transition risk of a counterparty.

Proposed changes and associated comments are provided in the attached file.

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

27. As disclosed in the synthesis and in Q9 below, we do not consider portfolio alignment methodologies as relevant and would advise to not put them into light. We see them as, mostly, an artificial level of technical complexity highly model-dependent.  

• We have provided a deep-dive analysis of those indicators funded by EU LIFE granting (alignment cookbook), concluding to the large variability of results. Please have a look to the correlation of results issuing form main alignment methodologies p.81 of the report.

As a comparison, we do not see in the “classical” risk framework any common risk metrics that would assess collectively the portfolio risk (liquidity, market, credit...), but rather aggregated values combining individual risks, taking into account if relevant correlations. Thus it seems in our view not straightforward to create some specificities in this area for measuring sustainability risks. To some extent, one could consider that collective metrics performed at an economically sound perimeter (such for instance as a value chain or a sectoral-based perimeter) might bear some relevance, leveraging notably on transition scenarios and objectives that can commonly be disclosed at this level of granularity.

Depending on the solution, in the following proposal “portfolio based” methodologies could either be dismissed or replaced by “sectoral-based” methodologies.

Proposed changes and associated comments are provided in the attached file.

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

• 31. Regarding transition risk, and consistently with 23. amendment, we propose to amend the draft guideline in order to highlight the importance of having a view on the counterparty’s positioning in term of transitioning credibility, as any other aspects will be sub-components of this feature. 

Proposed changes are provided in the attached file.

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.

As stated in question 7, we advise to dismiss portfolio-based methodologies as we consider that asset-level assessment (possibly proxied, aggregated, …) is the relevant level of assessment. To some extent sectoral-based metrics could be considered, leveraging notably on existing transition scenario trajectories and sectoral objectives.

Reaching Paris Agreement is a collective goal, thus failing to reach it (which constitutes mainly a transition risk at the moment) is also a collective risk. Starting from this point, trying to build non-economically sound sub-level collective alignment metrics (such as financial portfolio typically are) is in our view useless and biased. We rather advise to leverage on individual assessment at company’s level (or project level where relevant) as the analysis embrace here a consistent economical perimeter. 

This being said, we consider relevant that the guidelines incorporate messages that companies in given sector of the economy shall all be assessed, such as proposed in 36, and that their transition positioning is assessed leveraging on NZE 2050 or any subsequent scenario. 

Alternatively, should a “portfolio-based methodology” being used, we strongly recommend to precise that only a sectoral-based approach is appropriated given that the goal is not to have a trade-off between human needs such as agriculture, transportation, housing or energy but rather to have credible strategy and associated risk management process at sector level. Portfolio-level metrics encourage banks to finance climate-neutral sectors (luxury goods, services, etc.) rather than contribute to financing the transition. These metrics are a potential brake on the proper implementation of the "non prudential" transition plan.

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

As seen in question 1, the articulation between prudential and non prudential transition plan bears the risk that harmful mitigation actions are taken by financial institution in the context of the prudential transition plan, to the detriment of the non financial transition plan, such as for instance lobbying against climate-favorable policy reforms that would trigger a transition risk to some FI’s counterparties.

It is proposed to explicitly state in the guidelines that such tools are not acceptable.

Proposed changes are provided in the attached file.

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

In the Paris agreement achievement, we foreseen a time-horizon mismatch where it could be relevant for a financial institution to take at short term more “classical” financial risk (or less opportunities) in order to get at long-term less transition/physical risk, with a globally winning situation regarding the magnitude of the respective risks. This very peculiar feature, beyond a handling in 77., might need an explicit wording in the guidelines, for instance in the strategies and business model part.

Proposed changes are provided in the attached file. 

Question 12: Do you have comments on section 5.3 – consideration of ESG risks in risk appetite?

Risk appetite is a framework for dialogue between strategy and risk considerations. It would be useful to take advantage of this framework to ensure overall consistency with any climate commitments made by the bank, the transition plan and its sector-specific dimensions on objectives (decarbonization, financing). All this should feed into the risk appetite and credit limits that the institution must set itself, if we assume that the prudential transition plan must contribute to (or not detract from) the climate transition plan.

Question 13: Do you have comments on section 5.4 – consideration of ESG risks in internal culture, capabilities and controls?

One specific point that maybe could be highlighted is that a specific technicity might be required (especially on climate/biodiversity topics) so Financial institutions might leverage on external parties providing specific technical inputs and this could be explicated in the guidelines as this does not fit per se in the three lines of defense (e.g. set a guideline on how each line of defense should take into account the on-boarding on a given external methodology/expert).

Question 14: Do you have comments on section 5.5 – consideration of ESG risks in ICAAP and ILAAP?

NA

Question 15: Do you have comments on section 5.6 – consideration of ESG risks in credit risk policies and procedures?

The section on credit risk policies and procedures could in our view be more specific on the question of ESG risk mitigation measures. In particular, an analysis of companies' transition plans in high-stake sectors would seem to be a priority.

Proposed changes are provided in the attached file.

Question 16: Do you have comments on section 5.7 – consideration of ESG risks in policies and procedures for market, liquidity and funding, operational, reputational and concentration risks?

We feel that the core issue in term of reputation/litigation risk might be the discrepancies between bank’s transition plan and actions. We think that this should be explicitly stated. 

Proposed changes are provided in the attached file.

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

Some adjustments are proposed in the risk metrics and indicators quoted in 72, mainly to provide visibility to classification system to the detriment on “global portfolio alignment” metrics. As stated in question 7, such portfolio alignment metrics could be either limited or replaced by sectoral alignment metrics.

Proposed changes are provided in the attached file.

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?

74. We strongly recommend to reference the “non prudential” transition plan in order to avoid a schizophrenic climate strategy in the EU legislation.

75. The idea displayed in question 11 that in practice plans could lead to consider risk arbitrage depending on nature and time horizon could be embedded here also in order to highlight that there might be situation with more risk at a given short-term level but for the sake of less risk at long-term level.

Eventually as already stated in question 10, the idea that the prudential transition plan should not “harm” the non-prudential transition plan could be explicitly stated in the Consistency of prudential plans with other processes and communications section.

Proposed changes are provided in the attached file.

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

NA

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?

Consistently with previously stated comments we would like to propose some amendments to the list of metrics. As stated in question 7, portfolio alignment metrics could be either limited or replaced by sectoral alignment metrics.

One can note that taxonomy metrics could be also embedded in order to be consistent with 72. list.

Proposed changes are provided in the attached file.

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?

No, that seems sound.

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

In 102, we do not see the need to exclude by default financial counterparties from transition plan analysis. Furthermore it might be useful to put an emphasis on the need to assess the transitions plans of counterparties, as this is not a self-explanatory data. Thus the following changes are proposed.

Proposed changes are provided in the attached file.

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?

We think the granularity is at the moment globally enough. We however think that it could be relevant to provide quite detailed guidelines on:

• How to assess risk materiality on various ESG risks as the monetary exposure is often not the right metric;
• How to assess specifically whether an asset is low carbon/transitioning in a credible and robust way or not.

As a matter of fact, as displayed in Q26, we believe there is a need for consistency of outputs among FIs on this topic.

As a first try, we can, waiting for more consensual work (see ATP-Col work by WBA), share what we believe should be common principles of what is a good transition plan assessment (see ACT Finance Banking methodology, indicator 4.1 dim. 3, p. 93 and fol.):

Proposed reference is provided in the attached file.

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?

Common format would for sure be an asset for the purpose of supervision efficiency and continuous improvement of plans through the identification of best practices. The difficulty lies in the articulation between prudential and non-prudential transition plans, and whether in practice it can be possible/appropriate to disclose two different plans or a single combination of both aspects. This critical choice between an independent template at EBA level or EBA leveraging on CSRD disclosure items needs further thinking.

At a minimum, as EFRAG is supposed to published sectoral declinations of ESRS, we expect to have an interoperability regarding the financial risk information of the transition plan between both, if not possible to have a single consistent setup.

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.

• Inter-operability between prudential and non-prudential aspects: we need “one transition plan” at company level to avoid a schizophrenic climate strategy. Ideally, the “prudential” transition plan would be a component feeding the CSRD-based disclosed transition plan, if any. At least there shall be a “do not harm” principle in the prudential plan vs. the non-prudential one.
• Need to avoid, or at least not rely frameworks on model-driven metrics that provide a scientific illusion and are easily manageable from model point of view (e.g. implied temperature rise models) => proposal to dismiss signals going in this way.
• Setting up quality assessment framework of the credibility of transition plans. In the end, on the contrary to classical credit risk assessments where it is good to have a diversity of opinion in order to ensure market stability and avoid sheep/panic effects, we are here on a shared issue on how to reach a common goal against a physical problem, global warming. Therefore assessments shall be globally consistent and convergent in order to provide consistent signals in term of financing flows so as to make the real economy actors move. This goes through a mutualization/sharing of common principles, and EBA guidelines could be the place to set these common principles, see Q23. 

Question 26: Do you have other comments on the draft guidelines?

• In order to avoid high reporting burden from corporates, would it be relevant, anywhere data shortage issue is tackled (e.g. 22. Or 32.), to suggest financial institution to rely on mutualization of efforts (e.g. mutualized questionnaire, common initiatives…)? Keeping of course as a safeguard the need to have sufficient understanding of the sources, data and methodologies used and performing regular quality assurance.

See attached file for global overview of our answer.

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