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?
NA
Question 2: Do you have comments on the proportionality approach taken by the EBA for these guidelines?
Proportionality is fundamental to the emphasis on materiality assessment embedded in the approach suggested by the Guidelines. However the Guidelines are not fully aligned with the understanding of ESG risks proposed by the Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Disclosure Directive (CSDDD) (see also answer to question 3) and risk creating conceptual inconsistencies burdensome for banks, some of which will be covered by all measures, in addition to being problematic from a sustainability perspective. The Guidelines should be revised to align with the double materiality approach introduced under the CSRD European Sustainability Reporting Standards (ESRS) which captures both financial materiality and impact materiality dimensions of sustainability.
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.
Below we outline two concerns with the he approach taken by EBA.
First, the EBA’s approach is biased towards the E in ESG and specifically towards Climate. Whilst indeed the climate emergency necessitates urgent action, this should not happen at the expense of other sustainability factors including non-climate dimensions of E as well as S and G factors. The EBA should rather take a balanced and holistic approach considering all three dimensions of sustainability on equal terms in accordance with the approaches of CSRD, CSDDD and SFDR. The DIHR recommends that the environmental bias is addressed across the document, whilst maintaining an emphasis on the need to ensure a green and just transition in time.
Second, while the EBA refers to the double-materiality concept in the introduction to the draft Guidelines, it fails to apply this concept in a manner consistent with the CSRD and with key underlying sustainability frameworks including the OECD Guidelines on Multinational Enterprises (OECD MNE Guidelines and the UN Guiding Principles on Business and Human Rights (UNGPs) (for more background on the relevance and content of these standards see answer to question 26).
Instead the EBA in the introduction introduces a conditionality for ‘environmental and social materiality’, i.e. ESG risks should be taken ‘into account to the extent that they affect the financial risks institutions are exposed to’. This conditionality is not aligned with the CSRD or CSDDD approach to impacts and impact materiality and should be removed so as to foster policy coherence as well as management of sustainability risks by banks that are material to people or the planet even if they may not, in the short term, be financially material to the bank. The CSRD ESRS defines double materiality in the following manner: “Double materiality has two dimensions, namely: impact materiality and financial materiality. Unless specified otherwise, the terms “material” and “materiality” are used throughout ESRS to refer to double materiality. 38. Impact materiality and financial materiality assessments are inter-related and the interdependencies between these two dimensions shall be considered. In general, the starting point is the assessment of impacts, although there may also be material risks and opportunities that are not related to the undertaking’s impacts. A sustainability impact may be financially material from inception or become financially material, when it could reasonably be expected to affect the undertaking’s financial position, financial performance, cash flows, its access to finance or cost of capital over the short-, medium- or long-term. Impacts are captured by the impact materiality perspective irrespective of whether or not they are financially material” (CSRD ESRS 1 para 37 & 38).
It should be noted that the proposed ESG Rating Regulation further clarifies the understanding of double materiality as including both financial risks and risks to people/environment, and requires ESG data providers to be transparent about which methodology they use in their ESG rating offerings.
The double materiality approach should be reflected throughout the document not least in section 4, specifically in 4.1. on materiality assessment, thereby aligning the approach with CSRD. Concretely paragraph 12 should be amended so as to refer to both financial materiality and impact materiality as being unconditionally part of the reference methodology.
Finally, as it relates to the interaction element of question 3 indeed EBAs approach should emphasise that E, S and G risks often interact. For instance an environmental impact can have social effects (such as when pollution of a water stream affects local communities´ access to clean water) or vice versa (such as when climate change is displacing local communities causing environmental impacts associated with their displacement).
Question 4: Do you have comments on the materiality assessment to be performed by institutions?
It is recommended that Section 4 should be amended so as to align with the double materiality approach to ESG engrained in the CSRD. The approach in the Guidelines is currently biased towards financial materiality. This should be changed so as to ensure that materiality assessments consider both financial and impact materiality in alignment with CSRD ESRS requirements. Paragraph 12 in particular should be updated to this effect whilst it is recommended that section 4 overall is amended to reflect further the approach to materiality assessment introduced by the CSRD ESRS (see also answer to question 3).
Relatedly paragraph 14 should further include a new sub-section 14 d) engagement with affected stakeholders or their representatives. This is to ensure robust results of the materiality assessment and to align methodology with the CSRD which emphasizes that engagement is fundamental to due diligence and the double materiality approach (see ESRS 1, 24 and 61(b)). “Engagement with affected stakeholders is central to the undertaking’s on-going due diligence process (see chapter 4 Due diligence) and sustainability materiality assessment. This includes its processes to identify and assess actual and potential negative impacts, which then inform the assessment process to identify the material impacts for the purposes of sustainability reporting” (ESRS 1 24).
Paragraph 14(b) should further be amended to include “the assessment of the impact of ESG risks on people and the environment”.
Paragraph 15 is welcomed, including because it brings about coherence with the CSRD and the underlying instruments on responsible business conduct (OECD MNE Guidelines and UNGPs (for more context on this instruments see answer to question 26). However the paragraph should be amended slightly to align fully with ESRS 1 paragraph 45 which recognises that “The materiality assessment of a negative impact is informed by the due diligence process defined in the international instruments of the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises. For actual negative impacts, materiality is based on the severity of the impact, while for potential negative impacts it is based on the severity and likelihood of the impact. Severity is based on the following factors: (a) the scale; (b) scope; and (c) irremediable character of the impact. In the case of a potential negative human rights impact, the severity of the impact takes precedence over its likelihood.” In effect paragraph 15 should include above nuances about when and how severity and likelihood applies, how severity is to be understood, and that severity takes precedence over likelihood for human rights impacts.
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 agree with the approach outlined in paras. 16 and 17 and suggest that future versions of the Guidelines may consider forthcoming Sector standards on sustainability reporting under development by EFRAG following the CSRD mandate, with a view to the first sector standards being adopted in 2026. These target so-called high impact sectors, as seen from a sustainability perspective.
Question 6: Do you have comments on the data processes that institutions should have in place with regard to ESG risks?
Paragraph 23 b should be amended as it relates to data requests on social risks in order to align the approach with that of international standards on social sustainability such as the OECD MNE Guidelines and UNGPs and the emphasis on these standards by the CSRD, SFDR social principal adverse impact indicators, Taxonomy minimum safeguards and CSDDD.
Concretely we recommend the following replaces related content in 23.b.i-v:
- due diligence procedures to ensure alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights. (exact text of taxonomy minimum safeguards art. 18)
- negative material impacts on own workers, workers in the value chain, affected communities and consumers/end-users (to align with CSRD ESRS 2 SBM 3 and ESRS S1-S4) including information on due diligence efforts to avoid and address such impacts
In addition a new paragraph should be added to 4.2.1. to highlight the need to complement data provided by counterparties with ESG risk data from other sources including by way of engagement with affected stakeholders and / or their legitimate representatives. This is to align institutions´ own risk management practices with the expectations of international guidelines on Responsible Business Conduct including OECD MNE Guidelines and UNGPs both of which emphasize the need for engagement with affected stakeholders for the purpose of identifying and assessing negative impacts on human rights / social matters.
Question 7: Do you have comments on the measurement and assessment principles?
Section 4.2.2. should be adjusted to explicitly address measurement and assessment principles as it relates to both financial materiality and impact materiality.
Question 8: Do you have comments on the exposure-based methodology?
We welcome the mentioning of UN Guiding Principles on Business and Human Rights and OECD MNE Guidelines in paragraph 33. The paragraph should be expanded to highlight that institutions can consider sector and country risk levels on social, including human rights, and governance matters as a way to assess exposure across counterparties especially where limited information exists at counterparty level.
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.
For social and governance matters the portfolio based methodology can point to social and governance related metrics of SFDR Principal Adverse Indicators as relevant portfolio level indices.
Question 10: Do you have comments on the ESG risks management principles?
NA
Question 11: Do you have comments on section 5.2 – consideration of ESG risks in strategies and business models?
The section should be amended to achieve a better balance between environmental and social issues. Concretely we recommend 43.b.and c reads ‘ESG risks, in particular environmental risk drivers including transition and physical risks and human rights risk drivers’
Question 12: Do you have comments on section 5.3 – consideration of ESG risks in risk appetite?
Paragraph 46 outlines that the risk appetite should specify the type and extent of ESG risks institutions are willing to assume. This should be further nuanced indicating that this should include no appetite / exclusion areas, e.g knowingly lending to companies that will use the money to violate human rights. This can be coupled to the definition of severe impacts.
Question 13: Do you have comments on section 5.4 – consideration of ESG risks in internal culture, capabilities and controls?
We welcome this section and its emphasis on the importance of leadership, culture, capabilities and controls. To further strengthen the approach the section should be expanded to explicitly address the role of the institution’s incentive structures/performance pay and ensuring that such systems underpin effective ESG risk management and avoids any cross-pressures on staff.
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?
NA
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?
NA
Question 17: Do you have comments on section 5.8 – monitoring of ESG risks?
The section should be expanded with a provision for institutions to have in place operational level grievance mechanism in alignment with OECD MNE Guidelines and UN Guiding Principles on Business and Human Rights. This mechanism can act as a channel for identification of risks and incidents which would otherwise be undetected and will hence strengthen the robustness of the approach to monitoring.
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?
The section should clarify in the beginning that such plans should address ESG risks across environmental, social and governance factors to avoid a misinterpretation of the section to address only the issue of climate transition.
Question 19: Do you have comments on section 6.2 – governance of plans required by the CRD?
To further strengthen the approach the section should be expanded to explicitly address the role of the institution’s incentive structures/performance pay and ensuring that such systems underpin effective implementation of the plans and avoids any cross-pressures on staff.
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?
To better reflect metrics in relation to social and governance the section could refer to social and governance Principal Adverse Impact indicators of SFDR as well as social and governance metrics of CSRD ESRS.
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?
NA
Question 22: Do you have comments on section 6.5 – transition planning?
The section should include reference to ‘just transition’ to ensure that institutions’ transition planning also addresses social impact aspects related to workers, communities and consumers related to the green transition as captured by ‘just transition’.
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?
NA
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?
NA
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.
NA
Question 26: Do you have other comments on the draft guidelines?
The Danish Institute for Human Rights (the DIHR) welcomes the opportunity to provide feedback to the European Banking Authority draft Guidelines on ESG Risk Management. The DIHR’s response draws from the expertise of its Human Rights and Business Department, which has worked for over 20 years with companies, financial institutions, state actors and civil society to enable a better management of human rights related risks in the context of private sector activities.
Central to these efforts is work to promote and build capacity for the implementation of internationally recognized standards such as the UN Guiding Principles on Business and Human Rights (UNGPs) and OECD Guidelines for Multinational Enterprises (OECD MNE Guidelines). These standards have for more than a decade provided stakeholders with a common reference point for operationalizing responsible business conduct including as it relates to social sustainability. In 2011, the UN endorsed the UNGPs which clarified that all businesses, including financial market participants, have a responsibility to respect human rights that should be implemented through a process of human rights due diligence. This standard of due diligence has been integrated in the OECD MNE Guidelines which expand its application to other responsible business conduct areas such as environment, anti-bribery, and consumer protection.
The UNGPs and OECD MNE Guidelines have gained wide legitimacy and are referenced in ESG related EU regulation on corporate sustainability and sustainable finance such as the Corporate Sustainability Reporting Directive (CSRD), Corporate Sustainability Due Diligence Directive(CSDDD), EU Taxonomy and Sustainable Finance Disclosure Regulation (SFDR). The comments and recommendations submitted in this consultation response aim to streamline the EBAs approach with these internationally recognized standards and the relates EU regulations in order to decrease administrative burdens on institutions, enable policy coherence and ensure sustainability impacts for people and the planet.