Response to discussion Paper on management and supervision of ESG risks for credit institutions and investment firms (EBA/DP/2020/03)
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impact of ESG factors on banks’ business models to counterparty credit risk). From the point of view of holistic banking risk management, the approach seems far too narrow. We support the distinction between neutral ESG factors (‘ESG factors are environmental, social or governance characteristics that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign or individual.’) and ESG risks (‘ESG risks mean the risks of any negative financial impact to the institution stemming, from the current or prospective impacts of ESG factors on its counterparties’). However, since the term “prospective” impacts of an ESG factor could be rather ambiguous, we consider that it would be helpful to clarify the meaning offering, at the same time, also a clearly defined timeframe. Since ESG factors are by definition neutral, their potential positive impact on the financial performance or solvency of an entity, sovereign or individual should also play a role from a risk assessment perspective.
As regards ESG risks it is important to have a consistent and coordinated definition across the regulatory framework; definitions of ESG risks have to be in line with the Taxonomy Regulation, the Disclosure Regulation, the approach outlined in the ECB Guide on climate-related and environmental risks and also the EBA GL on Loan origination.
With reference to the definitons of ESG risks we would like to point out the importance of a concerted approach over all relevant regulations, guidelines etc. We see the paper as an attempt for a broad and common definition for ESG risiks that can be applied to all existing and coming requirements. It is important to pay attention to the fact that it must be in line with the Taxonomy Regulation, the Disclosure Regulation, the ECB Guide on climate risks, the EBA GL on Loan origination etc.
We have noticed that the definition in the discussion paper is slightly different from the definition in the Disclosure Regulation. According to the discussion paper, ESG risks mean the risks of any negative financial impact to the institution stemming from the current or prospective impacts of ESG factors on its counterparties’. The Disclosure Regulation (EU/2019/2088) instead refers to sustainability risk as ‘an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment’. On one hand, the Disclosure Regulation focuses on material negative impacts while on the other hand the Discussion paper includes every negative impact in the definition. Moreover, the Disclosure Regulation has the value of an individual investment in mind whereas the Discussion Paper focuses on the counterpart as a whole.
What seems to be neglected is the fact, that ESG factors could have positive effects as well. Regarding the positive side we want to point out to Par. 113 and 114 of the discussion paper, where the alignment of the portfolio with globally agreed climate targets is mentioned. To incentivise and compensate banks' efforts and additional costs for promotion of sustainability and investments in sustainable activities and counterparties, there is a strong need for a green supportive factor. As the EBA uses the discussion paper as a basis for the mandate according to Article 501c CRR2, this should be considered in this context as well.
We would like to point out that the availability of data is the biggest problem in this area. Reliable, adequate, recent, and low-cost data is not available at the moment. The availability of these data will be a key factor for adequate banks’ risk management, for the development of new financial products and for helping consumer and businesses to transition. They are a prerequisite for the development of quantification methodologies.
As the ECB “Guide on climate-related and environmental risks” and TEG “Taxonomy: Final report of the Technical Expert Group on Sustainable Finance” cover the differences between “outside-in” and “inside-out” understanding of ESG risks, it is clear, that the latter is mostly relevant for industrial enterprises whose impact on environment can be tangible and grave. Financial institutions are on the receiving end of ESG risks exposure, not as much causing climate change as facing ESG factors as additional risk components within their credit risk, counterparty risk, market risks and other risk types. The definition may be adjusted in the following way: “ESG risks mean the risks of any negative financial effect to the institution stemming from its exposure to counterparties, who suffer or may suffer the impact of ESG factors”.
Limiting the scope of the problem according to item 39. seems justified, as direct exposures to ESG factors are already covered within management arrangements. Indirect exposure to ESG factors should be understood and measured as additional volatility factor to the price of assets and additional counterparty risk component.
The proposed definitions of social risks and governance risks seem clear and comprehensive, though one must be aware of difficulties in estimating social and governance factors of counterparties.
The COVID-19 crisis is changing the approach to ESG factors and risks in the following ways:
1. introduction of home office and the necessity to deal with personal information about employees (health status, family arrangements, contact tracing, vaccination) exacerbate the problem of data protection;
2. efficient organization of home office work, especially during global lockdown, requires additional support for some categories of employees (families with children, larger households, single parents, women);
3. particular attention is required in labour rights protection areas – necessary changes in work organization should not harm employees.
On customers side, the COVID-19 impact on ESG risks is not straightforward and it is too early to identify any negative impact, especially on client engagement. At this point of time, ECB is focusing on climate related risks (for example in the ECB Guide on climate-related and environmental risks). It seems unclear, how the industry should deal with the two other risk components in the meanwhile, especially to avoid a double counting in case the “S” and “G” risks have already been taken into consideration when assessing other existing risks (e.g. operational or credit risks).
Furthermore, we ask ourselves, what the indicative weighting should be between E, S and G.
It is important that governance risk considerations are aligned with the current EC (European Commission) consultation on sustainable corporate governance. Finally, a unified and standardised approach towards the financial materiality of social and governance factors is necessary.
According to the discussion paper (para. 105) ‘The impact of ESG factors on institutions materializes through different channels that affect the entire value chain of the activities of any counterparty to which institutions are exposed. ESG indicators must therefore incorporate information about the transmission channels as well’. It seems unclear what this requirement that ESG indicators should incorporate information about the transmission channels mean in concrete.
Assuming that this question refers to counterparty credit risk, ESG indicators are relevant to the extent they provide an indication of the counterparty’s ability to service their debt. The examples in the paper do not show a sufficiently concrete nexus between the counterparty and the ESG factors. At this point in time, this is probably to some extent due to the lack of relevant data (as opposed to forecasts and models).
There are also other approaches that could be considered by financial institutions that do not strictly align with the categorization and definitions of methods provided by EBA (portfolio, risk framework or exposure method). We agree that the exposure method as described in 5.2.3 is a good fit for the origination compared to the other methods listed (some small, non-complex financial institution consider exposure method to be the best approach to measuring and managing ESG risks), but only for larger companies, where the relevant information and underwriting processes support a more in-depth assessment at client level (even through the relevant data is still scarce, and if available then rather at the level of group of connected clients, although it is expected to improve over time in line with the non-financial disclosure requirements). However, it is not deemed to be appropriate for smaller clients (i.e. SME and micro companies), where a more automated approach to underwriting is applied. For the latter client segments a form of an aggregated exposure approach may be more adequate, i.e. the ESG factors and relevant risks are assessed at the industry segment / sub-segment and not individual clients and any risks are addressed through lending strategies and standards (i.e. exclusion criteria, risk parameters, etc). We recommend to reflect this also in any future guidelines as an acceptable approach. Any other listed approaches are not seen as meaningful for the purpose of underwriting / origination due to data availability issues and thus from the point of view of automation and digitalization of the origination process, which are critical for financial institutions in a long-term.
The discussion paper takes this into account to a certain extent and explicitly states that ‘The decision on which methodological approach to choose will also depend on the size, the complexity and the business model of the respective institution and consequently the approach taken by a small, non-complex institution will likely differ from the one taken by a large institution’ (para. 109).
However, it should be explicitly clarified that small and non-complex institutions as defined in Article 4(1)(145) CRR II can apply simplified approaches (other than the three approaches laid down in the discussion paper) for the assessment and evaluation of ESG risks. Additionally, EBA should grant some time flexibility in implementing a certain approach, as choosing a specific methodology has significant investment implications for the ICT system development.
E, S and G factors manifest themselves in existing risk categories [E.g. hard coal or lignite plant operators], particularly as many ESG factors do not manifest themselves in increased risk overnight (this is ultimately true even of the COVID 19 pandemic).
A measure in this context could be to set incentives for institutions to provide capital for the transition. This could be achieved (for example) through the introduction of a balanced green supporting factor for special exposures (green mortgage loans). Since there are studies that come to the conclusion that those exposures are also less risky, by incentivizing the granting of such exposures this measure could generally support the adoption of strategic ESG risk-related objectives and/or limits.
An important contribution to the adoption of strategic ESG-risks-related objectives can come from regulators in the form of recommended practices and methods. That would help all institutions and exacerbate the general effort to face ESG risks.
As regards ESG data it would be important to know, what ESG data the supervisors consider important/relevant to be collected by banks. Currently available scoring attempts differ substantially in terms of quantitative but also qualitative data that are taken into consideration for the assessment of ESG profiles of clients. ESG data is broadly considered to be relevant in the future, but it is hard to decide on assessment methodologies and eventually impossible to quantify and measure ESG profiles (due to a lack of standardized and unified data, lack of clear methodologies and materiality maps). Hence, a measure in this regard would be to clarify which data the supervisors consider important/relevant to be collected by banks.
Furthermore, (notwithstanding the need to specify and unify the data demand) it is also well known that ESG relevant data is broadly not available currently. There is no publicly available data source and most companies do not yet disclose relevant non-financial data. A publicly available ESG data hub on EU level would be favorable for fostering transparency and avoiding greenwashing. Hence, we support the envisaged initiative for a single access point in the EU (ESAP) for non-financial data. The availability of reliable, adequate, recent, and low-cost data is the major issue which has to be solved.
By getting better data allowing institutions to better understand the mechanics by which ESG factors translate into risk. Further, the models supporting ESG factors and their development are complex. Smaller institutions would be better served if they were able to purchase such supporting models. However, such models must then also be understood in-house, in order to properly use the output data purchased.
While we recognize that the engagement/dialogue with clients is an important tool to transition and transform economies towards a more sustainable trajectory (para. 180f), the discussion paper should contain a clarification that the engagement with customers and other relevant stakeholders should be performed on a best effort basis.
As EBA requests that institutions should be able to generate on a timely basis aggregated data “to meet a broad range of on-demand request” (page 114), banks cannot invest in developing the ICT systems as long as Taxonomy is incomplete and the revised NFRD is not implemented. This makes it difficult to fulfill this request.
Specialized ESG-Committees (para. 203ff)
Institutions should not be obliged to set up specific organizational structures (e.g. a specialized committee in charge of ESG risks/sustainability). It should be up to supervisors to assess whether the established governance arrangements are efficient. Hence, it should be left for institutions discretion whether there is a need to establish a specialized committee in charge of ESG risks/sustainability within the management body (since the governance structures of the institutions vary). Centralized or decentralized network/group structures may require different solutions.
Skills and experience of the management body (Para 204)
Regarding Paragraph 204 we want to point out that the skills and expierence in this context have to be removed. („It is equally important that the members of the management body are collectively and key function holders who are individually suitable including that they have sufficient knowledge, skills and experience with regard to ESG factors.“). On one hand, skills and experience are individual requirements that can´t be fulfilled on the level of the consolidated management board. On the other hand it is yet not possible to have sufficient experience with ESG factors at this stage as the experience in this field has to be built up gradually. Skills are personal and individual and need not to be analysed in the light of ESG factors as they are sustainable per se.
Remuneration (para. 213ff)
Remuneration policies currently are in focus as a tool for various different purposes (ESG risks, sustainable corporate governance, etc.). In this regard it has to be underlined that the integration of ESG risks into risk-management will automatically make remuneration more ESG-risk related. The EBA GL on sound remuneration practices stipulate explicitly that: ‘The institution should define the objectives of the institution, business units and staff. These objectives should be derived from its business and risk strategy, corporate values, risk appetite and long-term interests and consider also the cost of capital and the liquidity of the institution.’ Thus, as the current regulatory framework for remuneration practices is very risk-oriented, the integration of ESG in the risk management and risk strategy will automatically provide also a focus on ESG-risks.
Beyond this, (as regards the linkage between variable remuneration and sustainability objectives) we are of the view that it must remain the responsibility of the financial institution to decide what share of variable remuneration relates to non-financial performance. Furthermore, we think that this linkage between the non-financial performance and the remuneration does already exist in the current supervisory framework (CRD IV, GLs on sound remuneration policies). CRD IV, the EBA GL on sound remuneration policies and the ECB Guide on climate-related and environmental risks take a holistic approach regarding remuneration and in our view stimulate sustainability-oriented behaviours in banks. We are of the view that the current framework ensures that sustainability targets will be reflected in the banks’ objectives and business strategy and those aspects would have to be considered as company values in variable remuneration.
However, since some EU banks are operating in the CEE Market with several geographies facing a different environment, we see the following problem: in some of those regions there are unequal levels of policy incentives for a green transition, there are fewer reporting and disclosure requirements and typically lower regulatory standards of environmental protection, etc.; this might make it significantly harder for banks operating in these markets to fulfill the supervisory requirements towards sustainable finance. A future SREP process, which includes ESG criteria, should guarantee a level playing field in Europe independent of the geographical scope a banking group is working in.
It is not sufficiently clear how the ESG risks will be included in SREP, especially if they will be embedded in the business model analysis (or in each existing element) or if there will be a seperate element in SREP. This especially in the view of the fact, that ESG risks materialize in prudential risks and should be included in existing risk categories. So clarification would be needed here. In this context it also needs to be resolved how "a new area of analysis in the supervisory assessment" is meant regarding the long term resilience of the business model.
In general we also want to point out that new SREP Guidelines should not become applicable before all underlying acts have been published and a sufficient period for implementing the new requirements has been ensured.
We welcome the idea of legally and undoubtedly incorporating ESG risks into CRD. The ways of addressing ESG considerations in the assessment of risks to capital, liquidity and funding seem appropriate and clearly defined.
Since ESG factors are defined as (neutral) environmental, social or governance characteristics that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign or individual, the ESG factors listed in Annex 1 should have the potential to materialize in a positive or a negative way.
However, some of the listed ESG factors have a strong negative connotation. It is hardly imaginable, how these factors can have a positive impact on the financial performance (for example heatwaves, floods, biological hazards etc.). Hence, we are of the view that some of those ESG factors should be formulated in a more neutral way in order to be in line with the definition of ESG factors.
1. Please provide details of other relevant frameworks for ESG factors you use.
The definitions of ESG factors given in the abovementioned frameworks are sufficient; no other regulations are required to define the general understanding of ESG factors. On the level of specific industries and companies TEG “Taxonomy: Final report of the Technical Expert Group on Sustainable Finance” is of high importance, helping to define green/non green assets. While no more regulatory frameworks are necessary to define ESG factors, better coordination between the regulations and their implementation deadlines is required. At the same time, we consider that the financial institutions should be allowed some flexibility in identifying the ESG risks in their portfolios and operations, and build appropriate processes, frameworks to manage and mitigate these risks.2. Please provide your views on the proposed definition of ESG factors and ESG risks.
The proposed definition of ESG factors seem full and clear (with a view of the potentialimpact of ESG factors on banks’ business models to counterparty credit risk). From the point of view of holistic banking risk management, the approach seems far too narrow. We support the distinction between neutral ESG factors (‘ESG factors are environmental, social or governance characteristics that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign or individual.’) and ESG risks (‘ESG risks mean the risks of any negative financial impact to the institution stemming, from the current or prospective impacts of ESG factors on its counterparties’). However, since the term “prospective” impacts of an ESG factor could be rather ambiguous, we consider that it would be helpful to clarify the meaning offering, at the same time, also a clearly defined timeframe. Since ESG factors are by definition neutral, their potential positive impact on the financial performance or solvency of an entity, sovereign or individual should also play a role from a risk assessment perspective.
As regards ESG risks it is important to have a consistent and coordinated definition across the regulatory framework; definitions of ESG risks have to be in line with the Taxonomy Regulation, the Disclosure Regulation, the approach outlined in the ECB Guide on climate-related and environmental risks and also the EBA GL on Loan origination.
With reference to the definitons of ESG risks we would like to point out the importance of a concerted approach over all relevant regulations, guidelines etc. We see the paper as an attempt for a broad and common definition for ESG risiks that can be applied to all existing and coming requirements. It is important to pay attention to the fact that it must be in line with the Taxonomy Regulation, the Disclosure Regulation, the ECB Guide on climate risks, the EBA GL on Loan origination etc.
We have noticed that the definition in the discussion paper is slightly different from the definition in the Disclosure Regulation. According to the discussion paper, ESG risks mean the risks of any negative financial impact to the institution stemming from the current or prospective impacts of ESG factors on its counterparties’. The Disclosure Regulation (EU/2019/2088) instead refers to sustainability risk as ‘an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment’. On one hand, the Disclosure Regulation focuses on material negative impacts while on the other hand the Discussion paper includes every negative impact in the definition. Moreover, the Disclosure Regulation has the value of an individual investment in mind whereas the Discussion Paper focuses on the counterpart as a whole.
What seems to be neglected is the fact, that ESG factors could have positive effects as well. Regarding the positive side we want to point out to Par. 113 and 114 of the discussion paper, where the alignment of the portfolio with globally agreed climate targets is mentioned. To incentivise and compensate banks' efforts and additional costs for promotion of sustainability and investments in sustainable activities and counterparties, there is a strong need for a green supportive factor. As the EBA uses the discussion paper as a basis for the mandate according to Article 501c CRR2, this should be considered in this context as well.
We would like to point out that the availability of data is the biggest problem in this area. Reliable, adequate, recent, and low-cost data is not available at the moment. The availability of these data will be a key factor for adequate banks’ risk management, for the development of new financial products and for helping consumer and businesses to transition. They are a prerequisite for the development of quantification methodologies.
3. Do you agree that, for the purpose of assessing their inclusion in institutions’ and supervisors’ practices from a prudential perspective, ESG risks should be approached primarily from the angle of the negative impacts of ESG factors on institutions’ counterparties? Please explain why.
While defining the ESG factors as “environmental, social or governance characteristics that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign or individual” is logical and aligned with existing regulatory framework, the definition of ESG risks as “the risks of any negative financial impact to the institution stemming from the current or prospective impacts of ESG factors on its counterparties” can be improved to avoid confusion with the concept of “inside-out” risks.As the ECB “Guide on climate-related and environmental risks” and TEG “Taxonomy: Final report of the Technical Expert Group on Sustainable Finance” cover the differences between “outside-in” and “inside-out” understanding of ESG risks, it is clear, that the latter is mostly relevant for industrial enterprises whose impact on environment can be tangible and grave. Financial institutions are on the receiving end of ESG risks exposure, not as much causing climate change as facing ESG factors as additional risk components within their credit risk, counterparty risk, market risks and other risk types. The definition may be adjusted in the following way: “ESG risks mean the risks of any negative financial effect to the institution stemming from its exposure to counterparties, who suffer or may suffer the impact of ESG factors”.
Limiting the scope of the problem according to item 39. seems justified, as direct exposures to ESG factors are already covered within management arrangements. Indirect exposure to ESG factors should be understood and measured as additional volatility factor to the price of assets and additional counterparty risk component.
4. Please provide your views on the proposed definitions of transition risks and physical risks included in section 4.3.
The proposed definition of transition risks and physical risks included in section 4.3. is clear and comprehensive. However, we consider that a definition of the time horizon could be useful in the context of aligning the bank strategy planning (usual 3 to 4 years) with the ESG time horizon (10 years or more).5. Please provide you views on the proposed definition of social risks and governance risks. As an institution, to which extent is the on-going COVID-19 crisis having an impact on your approach to ESG factors and ESG risks?
The discussion paper also describes the social and governance risk perspective (in line with the EBA mandate according to Article 98(8) CRDV and Article 35 IFD).The proposed definitions of social risks and governance risks seem clear and comprehensive, though one must be aware of difficulties in estimating social and governance factors of counterparties.
The COVID-19 crisis is changing the approach to ESG factors and risks in the following ways:
1. introduction of home office and the necessity to deal with personal information about employees (health status, family arrangements, contact tracing, vaccination) exacerbate the problem of data protection;
2. efficient organization of home office work, especially during global lockdown, requires additional support for some categories of employees (families with children, larger households, single parents, women);
3. particular attention is required in labour rights protection areas – necessary changes in work organization should not harm employees.
On customers side, the COVID-19 impact on ESG risks is not straightforward and it is too early to identify any negative impact, especially on client engagement. At this point of time, ECB is focusing on climate related risks (for example in the ECB Guide on climate-related and environmental risks). It seems unclear, how the industry should deal with the two other risk components in the meanwhile, especially to avoid a double counting in case the “S” and “G” risks have already been taken into consideration when assessing other existing risks (e.g. operational or credit risks).
Furthermore, we ask ourselves, what the indicative weighting should be between E, S and G.
It is important that governance risk considerations are aligned with the current EC (European Commission) consultation on sustainable corporate governance. Finally, a unified and standardised approach towards the financial materiality of social and governance factors is necessary.
6. Do you agree with the description of liability transmission channels/liability risks, including the consideration that liability risks may also arise from social and governance factors? If not, please explain why.
In principle, we agree with EBA’s considerations included in the discussion paper that legal/liability risks can arise in relation to Environmental, Social and Governance when clients are held accountable for the negative impact though their activities. We also understand the need to point out that such risks may rise also in relation to social and governance factors. However we do not see the need to specify explicitly this as a separate transmission channel in relation to environmental factors as in the proposal included in the current discussion paper. As EBA states in point 61, legal risks in the context of the climate change are sometimes considered as part of either physical or transition risks. We would recommend to clarify in the future guidelines that these risks do not have to be treated as a separate risk category / transmission channel and exclusively assessed for each of the E/S/G risk categories separately. One could even argue that the consequent liability / legal risks, even if they arise in the context of the client’s activities related to environmental are subset of the governance (transparency or strategy and risk management) or social (i.e. workplace health and safety) risk category. We believe that due to the already quite established risk management frameworks and categorization to prudential risks at credit institutions, it should be allowed to treat Liability Risk as inherent part of any of the risk categories in relation to ESG. Such explicit separation and exclusive assessment for each of ESG categories may be more meaningful only for investment companies but not for financial institutions. The description of liability risks does not make a qualitative contribution to the understanding of ESG factors and their influence on a company. Liability risks exposure is in any case a derivative of general exposure to ESG factors and the company’s inability to meet the ESG-related challenges. Making a separate category of risks seems excessive and not necessary.7. Do the specificities of investment firms compared to credit institutions justify the elaboration of different definitions, or are the proposed definitions included in chapter 4 also applicable to them (in particular the perspective of counterparties)? Please elaborate on the potential specificities of investment firms in relation to ESG risks and on how these specificities, if any, could be reflected in this paper.
The specificities of investment firms compared to credit institutions do not justify a separate definition of ESG risks. General definitions should be used, while the exact implementation of such definitions would naturally differ from institution to institution depending on its size, complexity and type of business activity.8. Please provide your views on the relevance and use of qualitative and quantitative indicators related to the identification of ESG risks.
Qualitative indicators are hard to compare and tend to be non-transparent. They can be used by companies, yet definite qualitative indicators should be set by regulators. There should be clear understanding of parameters and thresholds to aim for. Taking into consideration the different restraints/ challenges regarding lack of data, time horizon mismatches and methodological constrains.According to the discussion paper (para. 105) ‘The impact of ESG factors on institutions materializes through different channels that affect the entire value chain of the activities of any counterparty to which institutions are exposed. ESG indicators must therefore incorporate information about the transmission channels as well’. It seems unclear what this requirement that ESG indicators should incorporate information about the transmission channels mean in concrete.
Assuming that this question refers to counterparty credit risk, ESG indicators are relevant to the extent they provide an indication of the counterparty’s ability to service their debt. The examples in the paper do not show a sufficiently concrete nexus between the counterparty and the ESG factors. At this point in time, this is probably to some extent due to the lack of relevant data (as opposed to forecasts and models).
9. As an institution, do you use or plan to use some of the ESG indicators (including taxonomies, standards, labels and benchmarks) described in section 5.1 or any other indicators, inter alia for the purpose of risks management? If yes, please explain which ones.
Using TEG “Taxonomy: Final report of the Technical Expert Group on Sustainable Finance” would be preferable yet relying on certificates and labels seems a more realistic approach until the Taxonomy method is fully implemented.10. As an institution, do you use or plan to use a portfolio alignment method in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.
Some small, non-complex financial institution do not intend to use a portfolio alignment method in their approach to measuring and managing ESG risks. While it might be suitable for large market players, it is too complicated and hard to implement for a smaller institutions (also due to limits of the balance sheet).11. As an institution, do you use or plan to use a risk framework method (including climate stress testing and climate sensitivity analysis) in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.
Some small, non-complex financial institution do not intend to use a risk framework method in their approach to measuring and managing ESG risks. Stress testing is particularly challenging, as it requires extensive resources, is connected to a problem of finding a full set of scenarios to cover both probable and rare yet possible outcomes. Climate sensitivity analysis, being a simpler form of integrating climate risks into financial modelling, could be a working solution even for smaller banks, yet there is not enough experience at the market within this method.12. .As an institution, do you use or plan to use an exposure method in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.
ESG ratings provided by (specialized) rating agencies are the best way to secure industry-wide, coordinated understanding of ESG risks connected to various counterparties. The solution of Sustainalytics seems particularly promising. Yet, until a higher degree of method transparency and consistency is achieved by ratings providers, or until specific ratings are approved by regulators, some institutions would rely on ESG evaluation models developed in-house. The financial load of investing into external data without being certain they meet regulatory approval is too high for small institutions.There are also other approaches that could be considered by financial institutions that do not strictly align with the categorization and definitions of methods provided by EBA (portfolio, risk framework or exposure method). We agree that the exposure method as described in 5.2.3 is a good fit for the origination compared to the other methods listed (some small, non-complex financial institution consider exposure method to be the best approach to measuring and managing ESG risks), but only for larger companies, where the relevant information and underwriting processes support a more in-depth assessment at client level (even through the relevant data is still scarce, and if available then rather at the level of group of connected clients, although it is expected to improve over time in line with the non-financial disclosure requirements). However, it is not deemed to be appropriate for smaller clients (i.e. SME and micro companies), where a more automated approach to underwriting is applied. For the latter client segments a form of an aggregated exposure approach may be more adequate, i.e. the ESG factors and relevant risks are assessed at the industry segment / sub-segment and not individual clients and any risks are addressed through lending strategies and standards (i.e. exclusion criteria, risk parameters, etc). We recommend to reflect this also in any future guidelines as an acceptable approach. Any other listed approaches are not seen as meaningful for the purpose of underwriting / origination due to data availability issues and thus from the point of view of automation and digitalization of the origination process, which are critical for financial institutions in a long-term.
13. As an institution, do you use or plan to use any different approaches in relation to ESG risk management than the ones included in chapter 5? If yes, please provide details.
The discussion paper describes three different types of methodological approaches for assessing and evaluating ESG risks (portfolio alignment method, risk framework method and exposure method). Considering their limited personal/financial resources and their non-complex business models for small and non-complex institutions these three approaches seem inappropriate.The discussion paper takes this into account to a certain extent and explicitly states that ‘The decision on which methodological approach to choose will also depend on the size, the complexity and the business model of the respective institution and consequently the approach taken by a small, non-complex institution will likely differ from the one taken by a large institution’ (para. 109).
However, it should be explicitly clarified that small and non-complex institutions as defined in Article 4(1)(145) CRR II can apply simplified approaches (other than the three approaches laid down in the discussion paper) for the assessment and evaluation of ESG risks. Additionally, EBA should grant some time flexibility in implementing a certain approach, as choosing a specific methodology has significant investment implications for the ICT system development.
15. Please provide your views on the extent to which smaller institutions can be vulnerable to ESG risks and on the criteria that should be used to design and implement a proportionate ESG risks management approach.
Smaller institutions cause fewer „inside-out“ risks but experience full scope of „inside-in“ ESG risks. We do not see the need to develop special criteria to design and implement a proportionate ESG risk management approach for smaller institutions; methods that can be realistically implemented by such institutions should provide adequate treatment of ESG risks.E, S and G factors manifest themselves in existing risk categories [E.g. hard coal or lignite plant operators], particularly as many ESG factors do not manifest themselves in increased risk overnight (this is ultimately true even of the COVID 19 pandemic).
16. Through which measures could the adoption of strategic ESG risk-related objectives and/or limits be further supported?
By “strategic ESG risks objectives” the financial institutions main goal is to reduce the financial risk, rather than reducing the actual climate risk (as defined within the Paris Agreement).A measure in this context could be to set incentives for institutions to provide capital for the transition. This could be achieved (for example) through the introduction of a balanced green supporting factor for special exposures (green mortgage loans). Since there are studies that come to the conclusion that those exposures are also less risky, by incentivizing the granting of such exposures this measure could generally support the adoption of strategic ESG risk-related objectives and/or limits.
An important contribution to the adoption of strategic ESG-risks-related objectives can come from regulators in the form of recommended practices and methods. That would help all institutions and exacerbate the general effort to face ESG risks.
As regards ESG data it would be important to know, what ESG data the supervisors consider important/relevant to be collected by banks. Currently available scoring attempts differ substantially in terms of quantitative but also qualitative data that are taken into consideration for the assessment of ESG profiles of clients. ESG data is broadly considered to be relevant in the future, but it is hard to decide on assessment methodologies and eventually impossible to quantify and measure ESG profiles (due to a lack of standardized and unified data, lack of clear methodologies and materiality maps). Hence, a measure in this regard would be to clarify which data the supervisors consider important/relevant to be collected by banks.
Furthermore, (notwithstanding the need to specify and unify the data demand) it is also well known that ESG relevant data is broadly not available currently. There is no publicly available data source and most companies do not yet disclose relevant non-financial data. A publicly available ESG data hub on EU level would be favorable for fostering transparency and avoiding greenwashing. Hence, we support the envisaged initiative for a single access point in the EU (ESAP) for non-financial data. The availability of reliable, adequate, recent, and low-cost data is the major issue which has to be solved.
By getting better data allowing institutions to better understand the mechanics by which ESG factors translate into risk. Further, the models supporting ESG factors and their development are complex. Smaller institutions would be better served if they were able to purchase such supporting models. However, such models must then also be understood in-house, in order to properly use the output data purchased.
17. Please provide your views on the proposed ways how to integrate ESG risks into the business strategies and processes of institutions.
We approve of the suggested ways of integrating ESG risks into the business strategies and particularly welcome the proposed incorporation of ESG-related considerations to CRD and CRR.While we recognize that the engagement/dialogue with clients is an important tool to transition and transform economies towards a more sustainable trajectory (para. 180f), the discussion paper should contain a clarification that the engagement with customers and other relevant stakeholders should be performed on a best effort basis.
As EBA requests that institutions should be able to generate on a timely basis aggregated data “to meet a broad range of on-demand request” (page 114), banks cannot invest in developing the ICT systems as long as Taxonomy is incomplete and the revised NFRD is not implemented. This makes it difficult to fulfill this request.
18. Please provide your views on the proposed ways how to integrate ESG risks into the internal governance of institutions.
We generally approve of Conclusions and policy recommendations listed in EBA discussion paper, though item b. “Ensuring that the relevant committees or working groups meet regularly to follow up on implications from an ESG risks perspective <…> and review if there is an adverse impact in relation to the relevant ESG limits of the institution” should be scaled down in case of small, non-complex institution. Also, the lack of data availability and data access that is necessary to develop ESG risk monitoring metrics, management practices are one of the main challenges in developing the expertise needed to assign the responsibilities.Specialized ESG-Committees (para. 203ff)
Institutions should not be obliged to set up specific organizational structures (e.g. a specialized committee in charge of ESG risks/sustainability). It should be up to supervisors to assess whether the established governance arrangements are efficient. Hence, it should be left for institutions discretion whether there is a need to establish a specialized committee in charge of ESG risks/sustainability within the management body (since the governance structures of the institutions vary). Centralized or decentralized network/group structures may require different solutions.
Skills and experience of the management body (Para 204)
Regarding Paragraph 204 we want to point out that the skills and expierence in this context have to be removed. („It is equally important that the members of the management body are collectively and key function holders who are individually suitable including that they have sufficient knowledge, skills and experience with regard to ESG factors.“). On one hand, skills and experience are individual requirements that can´t be fulfilled on the level of the consolidated management board. On the other hand it is yet not possible to have sufficient experience with ESG factors at this stage as the experience in this field has to be built up gradually. Skills are personal and individual and need not to be analysed in the light of ESG factors as they are sustainable per se.
Remuneration (para. 213ff)
Remuneration policies currently are in focus as a tool for various different purposes (ESG risks, sustainable corporate governance, etc.). In this regard it has to be underlined that the integration of ESG risks into risk-management will automatically make remuneration more ESG-risk related. The EBA GL on sound remuneration practices stipulate explicitly that: ‘The institution should define the objectives of the institution, business units and staff. These objectives should be derived from its business and risk strategy, corporate values, risk appetite and long-term interests and consider also the cost of capital and the liquidity of the institution.’ Thus, as the current regulatory framework for remuneration practices is very risk-oriented, the integration of ESG in the risk management and risk strategy will automatically provide also a focus on ESG-risks.
Beyond this, (as regards the linkage between variable remuneration and sustainability objectives) we are of the view that it must remain the responsibility of the financial institution to decide what share of variable remuneration relates to non-financial performance. Furthermore, we think that this linkage between the non-financial performance and the remuneration does already exist in the current supervisory framework (CRD IV, GLs on sound remuneration policies). CRD IV, the EBA GL on sound remuneration policies and the ECB Guide on climate-related and environmental risks take a holistic approach regarding remuneration and in our view stimulate sustainability-oriented behaviours in banks. We are of the view that the current framework ensures that sustainability targets will be reflected in the banks’ objectives and business strategy and those aspects would have to be considered as company values in variable remuneration.
19. Please provide your views on the proposed ways how to integrate ESG risks into the risk management framework of institutions.
The recommendations for integrating ESG risks considerations into the risk management framework of institutions are clear, well structured and practical. The two major challenges of dealing with ESG risks (classifying green and non-green exposures; developing stress tests) are identified correctly and should be addressed by regulators. We recommend a phase-in approach that would be necessary to include ESG risks in the Risk Appetite Frameworks of the banks as this will have a cascading effect through all risk management processes and reporting. Additionally, we suggest a careful consideration of paragraph 253, requesting financial institutions to adjust their pricing, could create a competitive disadvantage for those banks with activities outside the EU in case Regulators from those jurisdictions do not adopt the same measures (or for commodities as they are funded in US dollars).20. The EBA acknowledges that institutions’ approaches to environmental, and particularly climate-related, risks might be more advanced compared to social and governance risks, and gives particular prominence in this report to the former type of risks. To what extent do you support this approach? Please also provide your views on any specificities associated with the management of social and governance risks.
While analysing social and governance risks stemming from the institution itself is relatively easy, doing this analysis for counterparties is borderline impossible, especially for smaller institutions. Even for larger companies who publish ample information about their corporate responsibility programs, social policies and governance principles no standardised, easily accessible information exists. Identifying SG risks of a counterparty is only possible after a thorough due diligence, which is not suitable for all counterparties and all issuers in a portfolio. It could be helpful if EBA could provide more clarity and a timeline on when it expects financial institutions to make progress on governance and social risks.22. Please provide your views on the incorporation of ESG factors and ESG risks considerations in the business model analysis of credit institutions.
The suggested steps for incorporating ESG factors and ESG risks considerations in the business model analysis of credit institutions are well structured and cover major aspects of the problem.However, since some EU banks are operating in the CEE Market with several geographies facing a different environment, we see the following problem: in some of those regions there are unequal levels of policy incentives for a green transition, there are fewer reporting and disclosure requirements and typically lower regulatory standards of environmental protection, etc.; this might make it significantly harder for banks operating in these markets to fulfill the supervisory requirements towards sustainable finance. A future SREP process, which includes ESG criteria, should guarantee a level playing field in Europe independent of the geographical scope a banking group is working in.
It is not sufficiently clear how the ESG risks will be included in SREP, especially if they will be embedded in the business model analysis (or in each existing element) or if there will be a seperate element in SREP. This especially in the view of the fact, that ESG risks materialize in prudential risks and should be included in existing risk categories. So clarification would be needed here. In this context it also needs to be resolved how "a new area of analysis in the supervisory assessment" is meant regarding the long term resilience of the business model.
In general we also want to point out that new SREP Guidelines should not become applicable before all underlying acts have been published and a sufficient period for implementing the new requirements has been ensured.
23. Do you agree with the need to extend the time horizon of the supervisory assessment of the business model and introduce as a new area of analysis the assessment of the long term resilience of credit institutions in accordance with relevant public policies? Please explain why.
The nature of ESG issues, particularly climate-related ones, requires a longer time horizon of business model planning. The regulatory need to assess long-term resilience of credit institutions is also understandable. In this context, it should be taken into account, that long term planning by financial institutions requires more guidance and input information from regulators.24. Please provide your views on the incorporation of ESG risks considerations into the assessment of the credit institution’s internal governance and wide controls.
The proposed ways of incorporating ESG risks considerations into the assessment of the credit institution’s internal governance and wide controls seem clear and well structured.25. Please provide your views on the incorporation of ESG risks considerations in the assessment of risks to capital, liquidity and funding.
The explicit considerations listed in point 339 with regard to the specialized lending, requiring regulators to ensure that the use of project financing does not circumvent the assessment of how much counterparties are exposed to ESG factors, for instance by granting particularly favourable terms on a project facility with low ESG risks, while the counterparty as such is heavily exposed to ESG factors, is seen as counterproductive to the nature of the project finance. Project finance transactions focus on the object being financed and hence the ESG assessment should definitely take place in relation to this object of the project and include relevant considerations. Such transactions are usually structured in a way that there is a special purpose company (SPC) being financed on a nonrecourse basis to other SPC of the client. Each SPC represents a closed risk group and neither the SPC’s sponsor(s) nor other members of the client group are liable for repayment of the SPC’s debt in case of default. Due the nature of such transactions any assessment on the client level, even if the client is exposed to higher ESG risk on other projects but on the project financed by the financial institution (s)he is not, is seen as counterproductive to the EU and regulatory expectations for banks to help and support ESG friendly undertakings. Therefore, EBA should clarify if this paragraph covers only specialized lending in the form of project financing or all specialized lending, including asset financing.We welcome the idea of legally and undoubtedly incorporating ESG risks into CRD. The ways of addressing ESG considerations in the assessment of risks to capital, liquidity and funding seem appropriate and clearly defined.
26. If not covered in your previous answers, please provide your views on whether the principle of proportionality is appropriately reflected in the discussion paper, and your suggestions in this respect keeping in mind the need to ensure consistency with a risk-based approach.
We strongly endorse the application of the principle of proportionality and would like to highlight that it should not be limited to the size of the bank, but should also result from the evaluation of other criteria such as business model, geographical location etc.27. Are there other important channels (i.e. other than the ones included in chapter 7) through which ESG risks should be incorporated in the supervisory review of credit institutions?
We consider chapter 7 of this discussion paper to cover the relevant channels, through which ESG risks should be incorporated in the supervisory review of credit institutions.28. As an institution, do you use or plan to use some of the indicators and metrics included in Annex 1? If yes, please describe how they are used in relation to your ESG risk management approach.
Most institutions are still in the process of choosing appropriate ESG indicators and metrics.29. If relevant, please elaborate on potential obstacles, including scope of applicability, granularity and data availability, associated with the indicators and metrics included in Annex 1.
The potential obstacles about the non‐exhaustive list of ESG factors, indicators and metrics, mainly point at the issue of data availability. The availability of ESG data is a prerequisite for the development of quantification methodologies.Since ESG factors are defined as (neutral) environmental, social or governance characteristics that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign or individual, the ESG factors listed in Annex 1 should have the potential to materialize in a positive or a negative way.
However, some of the listed ESG factors have a strong negative connotation. It is hardly imaginable, how these factors can have a positive impact on the financial performance (for example heatwaves, floods, biological hazards etc.). Hence, we are of the view that some of those ESG factors should be formulated in a more neutral way in order to be in line with the definition of ESG factors.