EU Financial Institutions Will Need to Assess and Integrate ESG Risks Across Entire Strategy

Financial institutions will be required to adhere to minimum standards and reference methodologies for the identification, measurement, management, and monitoring of ESG risks under guidelines for ESG risk management released by the European Banking Authority (EBA).

They are designed to implement the provisions of the Capital Requirement Directive (CRD6), the implementation date for which has not been announced, which will require the monitoring and mitigation of financial risks stemming from ESG factors, including those arising from the adjustment process towards the objective of achieving climate neutrality in the EU by 2050.

The draft guidelines set out requirements for institutions for the identification, measurement, management and monitoring of ESG risks, including through plans aimed at addressing the risks arising from the transition towards an EU climate-neutral economy.

Key provisions - financial institutions will be required to: 

* develop a Capital Requirements Directive (CRD)-based prudential climate transition plans to address the risks arising from the transition;

* adhere to minimum standards and reference methodologies for the identification, measurement, management, and monitoring of ESG risks;

* prepare plans with specific timelines, quantifiable targets, and milestones to monitor and mitigate ESG financial risks;

* use qualitative and quantitative criteria to assess the impact of ESG risks on their risk profile and solvency in the short, medium, and long term;

* integrate ESG risks into their broader risk management framework, including funding strategies, risk appetite, profitability impact assessments, and internal capital needs;

* make sure plans are consistent with business strategy, regularly reviewed, and documented with clear criteria, methodologies, assumptions, and targets;

* report to the EBA as to whether they comply or intend to comply with the guidelines, or otherwise provide reasons for non-compliance. 

The guidelines also include minimum reference methodologies to be developed and used by institutions to measure ESG risks.

The EBA points out that the guidelines don’t require CRD-based plans to set out an objective of fully aligning with Member States or EU sustainability objectives or one specific transition trajectory. Instead, they aim at make sure institutions comprehensively assess and embed forward-looking ESG risks considerations into their strategies, policies and risk management processes.

The goal of prudential plans, the EBA says, is “not to force institutions to exit or divest from carbon intensive sectors but rather to stimulate institutions to proactively reflect on technological, business and behavioral changes driven by the sustainable transition, the risks and opportunities they entail, and prepare or adapt accordingly through structured transition planning, including by engaging with and where needed supporting their clients, notwithstanding other mitigation actions consistent with sound risk management”.

It is envisioned that the guidelines will be finalised by the end of 2024 and apply from the date the CRD6 is incorporated into EU law. 

The guidelines are also part of the EBA’s planned actions under its roadmap on the implementation of the EU banking package. 

The consultation runs until 18 April 2024.