Climate and ESG risks: the next big challenge for the banking sector

ABBL Published 30.06.2021

Climate and environmental risks could lead to significant financial losses and, as with other types of risk, need to be integrated into banks’ risk management. Many initiatives aim at giving banks the tools and guidance to better assess these risks:

  • The CSSF published in June 2021 a circular on the management of these risks applicable to all credit institutions designated as smaller institutions under the single supervisory mechanism, and to all branches of non-EU credit institutions.
  • The European Banking Authority (EBA) has also published its final report on the management and supervision of ESG risks, which provides common definitions and guidance on their integration into risk governance and management. The report also provides guidance to supervisors on how to take ESG into account in their supervisory reviews, thus laying the foundation for EBA guidelines on the topic.
  • The Task Force on Climate-related Financial Disclosures (TCFD) is seeking comments on its proposed guidance on climate-related metrics, targets and transition plans and the associated technical supplement on measuring portfolio alignment.
  • The Luxembourg Sustainable Finance Initiative (LSFI) has launched a climate scenario analysis for Luxembourg financial institutions to assess their trajectory against the Paris Agreement’s climate goals.
  • Beyond the EU’s borders, policymakers and stakeholders in other countries are getting in on the act.

Climate is only the first step in greater disclosure of ESG risks. On 18 June, the Network for Greening the Financial System (NGFS) published a paper which sets out the links between biodiversity loss and the risk to the stability of macroeconomic systems, highlighting in particular the financial sector’s dependence on ecosystem services and its impact on further degradation of natural systems.

Whilst the above are all good initiatives, the complexity of other ESG issues, the lack of harmonised regulations and policy guidance, and the limited tools and data for identifying, measuring, managing and disclosing ESG-related financial risks pose many challenges for financial institutions.

Next steps

Banks within the scope of CSSF Circular 21/773 are expected to review the extent to which their current climate and ESG risk management framework is robust and compliant with the expectations set out in the Circular, and if necessary, they are expected to adapt their practices. In 2022, the European Central Bank (ECB) will conduct a full prudential review of banks’ practices and take concrete follow-up action if necessary.

Large institutions with publicly listed issues will also be required to disclose information on ESG risks from June 2022, in accordance with Article 449a of CRR2.

As the topic of climate and ESG risks is increasingly on the banks’ agenda, the ABBL has launched an ESG Risk Task Force to help its members understand developments in this area and how they affect the banking sector. Risk and ESG experts share their views and concerns, advocate common positions (e.g. by providing information on ESG risks) and make recommendations.

By Julien Froumouth and Gilles Pierre

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