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 agree that the fundamental objectives of non-prudential regulation differ from those of the CRD. This differentiation is perfectly clear in the consultation paper. The economic reality generated by other, non-prudential legislative pieces will necessarily generate CRD (transition) impacts - impacts that will be, or have to be, integrated into institutions' CRD (transition) plans.
However, the interplay of the new Article 76(2) and other regulations, especially the CSRD, is effectively addressed in the proposed amendments to the CRD: "Where the institution discloses information on ESG matters in accordance with Directive 2013/34/EU the plans referred to in the first subparagraph shall be consistent with the plans referred to in Article 19a or Article 29a of that Directive. In particular, the plans referred to in the first subparagraph shall include actions with regards to the business model and strategy of the institution that are consistent across both plans."
In our view, this constitutes a clear indication from the European Parliament that it considers the amendments to the CRD to fulfill a dual objective: 1) a main, prudential objective in the classical sense, as outlined by the consultation paper, but also 2) a secondary transition alignment objective, similar to the objectives sought by non-prudential regulation.
Question 2: Do you have comments on the proportionality approach taken by the EBA for these guidelines?
No comment.
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.
We acknowledge the Authority's decision to prioritize environmental risks, given their arguably more immediate impact. However, we assert that sustainability risks cannot be evaluated in isolation. Environmental issues, such as desertification, rising temperatures, increasing water levels, and ecosystem destruction, not only have direct environmental consequences but also engender broader socioeconomic macro-trends. Additionally, empirical evidence supports the notion that environmental challenges, particularly those associated with climate change, lead to cascading environmental and social repercussions.
We contend that institutions should be required to assess their preparedness for these trends, particularly at the portfolio level, as outlined in section 4.2.3(b). Such assessments should encompass the intricate interplay with complex macro-economic factors, instead of being limited to purely environmental matters.
We also believe that the nomenclature used should align with the one considered by the CSRD. Paragraph 26 of Chapter 3 generates unnecessary confusion by assimilating "impacts" with "environmental and social materiality." We welcome the integration of the impact concept in the guidelines and encourage the Authority to simply refer to the concepts of impact (outward) and financial (inward) materiality, as in the CSRD.
Question 4: Do you have comments on the materiality assessment to be performed by institutions?
We agree with the course chosen by the Authority, to define as material certain exposures that have substantial climate and environmental risks, aligned with other EU legislation.
We also consider that given the potentially cascading nature of environmental and social impacts on banks' operations, the mandatory long-term assessment should extend beyond 10 years. Many corporations already perform scenario analyses extending to 2050. Such exercise is complex, but would enable the long-term materiality assessment to properly capture long-term environmental and social risks.
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.
We disagree with using EU taxonomy alignment as a proxy for the non-materiality of sectoral exposures. The inclusion of many activities in the EU taxonomy, especially those labelled as 'transitional,' was heavily debated. The medium-to-long-term transition risks carried by associated sectors - including electricity generation from gas, cement manufacturing, etc. - remain high, because energy-intensive industries will inevitably face increased costs as energy prices rise.
If the Authority wishes to reference the EU taxonomy in derogation to paragraph 16, we suggest that, at the very least, 'transitional' activities should be excluded from the derogation.
Question 6: Do you have comments on the data processes that institutions should have in place with regard to ESG risks?
The data requirements for large corporate counterparties, as stated in paragraph 23, would be too burdensome for SMEs. However, these requirements are adaptable. Beyond the requirement set forth in paragraphs 22 and 24, the Authority should set a baseline for ESG-related data collection for non-large counterparties, to ensure a minimal level of data collection across institutions.
Question 7: Do you have comments on the measurement and assessment principles?
No comment.
Question 8: Do you have comments on the exposure-based methodology?
Please refer to Q3. We raise concerns about the guidelines' emphasis on environmental matters, as sustainability issues are more often than not heavily intertwined. Within the specific context of a counterparty, a seemingly minor environmental risk can be associated with significant social risks. Furthermore, environmental issues that may not directly impact a counterparty can instigate social or political unrest in certain regions, thereby disrupting its operations.
Conversely, the evaluation of a counterparty's social and governance risks should extend beyond merely checking its compliance with international standards. It should also encompass an assessment of the effectiveness of the strategies implemented by the counterparty to mitigate these risks.
Finally, the guidelines should explicitly reference principles of double materiality. While the mention of CSRD in paragraph 23 refers to "material impacts on the environment," the exposure-based methodology should explicitly require the assessment of counterparties' environmental, social and governance risks, as well as impacts. Such an explicit inclusion of the "impact" concept would align with the requirement in paragraph 38(b) to assess portfolios' alignment with the UN SDGs.
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.
The redaction of paragraph 36 is a bit convoluted. We encourage the Authority to clarify for which sectoral portfolios would the alignment have to be measured.
Otherwise, we salute the Authority's decision to require institutions to identify nature-related dependencies, as well as the impacts of their portfolios on the UN SDGs.
Question 10: Do you have comments on the ESG risks management principles?
Please refer to Q4 regarding time horizons. We consider that risk management measures over the long term should extend beyond 10 years.
We also contend that engagement strategies should also include SMEs. Non-large corporates will play an important role in the transition to a low-carbon economy, and institutions, through relationship managers, could contribute to this role. This would also prevent the generation of a portfolio-level blindspot, where small ESG-related risks could, in the aggregate, become material to institutions.
Question 11: Do you have comments on section 5.2 – consideration of ESG risks in strategies and business models?
No comment.
Question 12: Do you have comments on section 5.3 – consideration of ESG risks in risk appetite?
No comment.
Question 13: Do you have comments on section 5.4 – consideration of ESG risks in internal culture, capabilities and controls?
Most financial institutions now have dedicated sustainable investment teams. In many institutions, these teams play active roles at multiple stages of the risk lifecycle: they may participate in counterparty risk assessments, assist in drafting and disseminating ESG elements in credit policies and procedures, or provide training to staff across the first, second, or third line of defence. Therefore, we believe that their mention and inclusion in this section would be natural as a key organizational element to foster an "ESG-aware" culture. More specifically, we believe that the guidelines should require large institutions to maintain a dedicated counterparty ESG risks as departments as owners of counterparty-related ESG processes.
Question 14: Do you have comments on section 5.5 – consideration of ESG risks in ICAAP and ILAAP?
No comment.
Question 15: Do you have comments on section 5.6 – consideration of ESG risks in credit risk policies and procedures?
No comment.
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?
No comment.
Question 17: Do you have comments on section 5.8 – monitoring of ESG risks?
We agree with and salute the list of indicators proposed. However, we consider that the monitoring of Scope 3 (financed) emissions should be mandatory for every sector and every portfolio. It is one of the best, most accurate metrics to assess the exposure of financial institutions to transition risks. This would be aligned with the requirement set forth in paragraph 94(a) to include financed emissions as metrics in the CRD (transition) plan.
Furthermore, in reference to paragraph 38(a), metrics related to portfolio-level dependencies on water or natural capital should be included in the list of indicators, as these areas will constitute key drivers of environmental risks in the coming years.
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?
Please refer to Q1 and Q4 regarding time horizons. We consider that risk management measures over the long term should extend beyond 10 years.
Question 19: Do you have comments on section 6.2 – governance of plans required by the CRD?
No comment.
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?
Please refer to Q17.
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 comment.
Question 22: Do you have comments on section 6.5 – transition planning?
We contend that requesting transition plans for only large counterparties might generate a portfolio-level blind spot. Please refer to Q10.
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?
No comment.
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?
No comment.
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.
No comment.
Question 26: Do you have other comments on the draft guidelines?
impak Analytics welcomes and salutes the Authority's efforts in devising the guidelines. As mentioned in our previous comments, we believe that the guidelines should mandate the same level of thoroughness in the management of social and governance risks as they do for environmental ones. However, we recognize that institutions may vary in their levels of sophistication or maturity regarding non-environmental sustainability matters. Therefore, a phased-in implementation of more stringent social- and governance-related requirements could be a viable option.
The same could be applied to the management of small and medium counterparties, from which ESG-related data should also be required, to ensure the sound management of portfolio-level ESG risks by institutions.