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As the CRR3/CRDVI package is a very rich set of texts, several NLs will be written to decipher it. This third NL of the CRDVI series focuses on ESG risk

1.  Possibility for competent authorities to use the systemic risk buffer to cover banks’ ESG exposures

CRR3 and CRDVI provide several clarifications to address the significant risks that banks will face as a result of climate change and the profound economic transformations required to manage these ESG risks.

The systemic risk buffer framework can already be used to address various types of systemic risks, including climate change risks. Competent authorities may require banks to maintain a systemic risk buffer to address risks that have the potential to have serious consequences for the EU financial and economic system. In this case, the imposition of a systemic risk buffer rate is considered effective and proportionate to mitigate the risk.

The framework for the application of the systemic risk buffer provides that the buffer may be applied to certain sets or subsets of exposures, for example those subject to physical and transitional risks related to climate change.

The adequacy of the macroprudential framework to deal with such risks will be assessed in a comprehensive and structured way in the review of the macroprudential framework scheduled for 2022.

2.  The requirements for banks’ internal strategy and governance around ESG risk

The CRDVI requires that the short-, medium- and long-term horizons of ESG risks be included in banks’ strategies and processes for assessing internal capital needs as well as adequate internal governance. It also introduces a reference to current and future impacts of ESG risks. Besides, banks’ senior management will have to develop effective plans to address these risks .

The CRDVI introduces a sustainability dimension into the supervisory framework to ensure a better management of ESG risks and to encourage a better allocation of bank funding to sustainable projects. This will support the transition to a more sustainable economy. The CRDVI also allows competent authorities to examine the alignment of banks with the EU’s ESG objectives. The expectations are for a better understanding of ESG risks. Thus, competent authorities will address financial stability issues that may arise from banks continuing to misjudge ESG risks.

To ensure consistency in ESG risk assessments, EBA will  further clarify the criteria for assessing ESG risks, including how they should be identified, measured, managed, and monitored. EBA will also provide details on how banks should develop effective plans to address and test internally the bank’s resilience and the long-term negative impacts of ESG risks.

3.  Formalisation by EBA of ESG risk assessment criteria in the SREP

In the context of the SREP, EBA will have to draft guidelines to ensure a harmonized inclusion of ESG risks in the SREP. It is important to have a forward-looking stress test to assess ESG risk in the SREP. Therefore, the CDRVI mandates EBA and the other ESAs to develop stress tests methodologies for ESG risks, with a focus on environmental risks.

In order to facilitate the proper consideration of governance and ESG risk management in the SREP, the CRDVI requires competent authorities to assess :

  • The adequacy of banks’ exposures.
  • The strategies, processes and mechanisms in place to manage these risks.

An additional supervisory power is added in the CRDVI to address ESG risks. This will enable  competent authorities to address ESG risks affecting the prudential position of the bank in the short, medium, and long term, and to reflect the specificities of this category of risk.

 

4.  References

https://ec.europa.eu/finance/docs/law/211027-proposal-crd-5_en.pdf

 

Abbreviations and glossary

EBA: European Banking Authority