The Situation: The European Banking Authority ("EBA") issued its Action Plan on Sustainable Finance ("Action Plan") on December 6, 2019, setting forth an outline for its deliverables and activities related to environmental, social, and governance ("ESG") factors and risks. The Action Plan explains the EBA's approach and timelines for issuing the reports, advice, guidelines, and technical standards mandated to it by the European Commission ("EC") through various banking-oriented legislation, and in coordination with the EC's global action plan issued in March 2018 on "Financing Sustainable Growth."
The Result: The EBA expects to issue and produce materials in response to its specific mandates over the next five years, including a general mandate on ESG risk monitoring that fits into the main goal of improving the stability of the banking sector. In addition, the EBA expects to participate in the work of the European Union platform on sustainable finance.
Looking Ahead: The EBA encourages institutions to be proactive in adopting ESG considerations into their business strategies, risk management plans, and financial disclosure. While the EBA works to meet its mandates, financial institutions can begin creating forward-looking processes to address ESG risks, responding to client expectations in this respect.
In response to various mandates related to ESG factors and ESG risks comprised in several EU pieces of legislation (CRR2 and CRD5, new IFR and IFD, notably), the EBA issued the Action Plan to highlight certain messages on sustainable finance and to clarify for certain financial institutions the policy direction and expectations regarding ESG risks. The EBA noted three areas where institutions should consider affirmative actions: strategy and risk management, disclosure, and scenario analysis.
According to the EBA, the Action Plan is part of a broader effort to "connect finance with the needs of the European and global economy related to sustainable developments." The three main objectives of the Action Plan are to: (i) reorient capital flows to sustainable investment to attain sustainable and inclusive growth; (ii) manage financial risks resulting from climate change, resource depletion, environmental degradation, and social issues; and (iii) encourage transparency and long-term commitment in financial and economic activity.
The Action Plan sets forth the legislative sources of the EBA mandates and specifies what each mandate requires of the EBA. It describes, for example, three mandates related to sustainable finance. The first such mandate requires the EBA to "assess the potential inclusion of ESG risks in the supervisory review and evaluation process performed by competent authorities" and sets forth the factors that the EBA's assessment must include. The second such mandate requires the EBA to develop a technical standard that will implement disclosure requirements related to ESG risks, and the third mandate requires the EBA to make assessments as whether "a dedicated prudential treatment of exposures related to assets or activities associated substantially with environmental and/or social objectives" is justified. The deliverable related to achieving each mandate also is noted.
As noted above, the EBA expects to issue a number of pieces in the next five years to address the mandates in this area. In the meantime, the Action Plan sets forth key policy messages and expectations with respect to mandates on sustainable finance. In short, the EBA notes that financial institutions will need to have in place metrics, strategies, and risk management to deal with potential consequences of climate change and the related physical and transition risks. Although this effort is at an early stage, institutions should begin now to consider how they will take action with respect to these areas prior to the EBA completing its mandates.
The EBA encourages institutions to incorporate ESG considerations into business strategy and risk management to mitigate the impact of environmental and social risks, based in particular on the currently built EU taxonomy. In addition, institutions can begin to incorporate ESG risks into other aspects of their operations (e.g., business plans, internal control framework, and decision-making processes) while continuing to work on and participate in other related initiatives (e.g., the Non-Financial Reporting Directive). These approaches and practices implemented by institutions now can be used to assist the EBA in addressing the mandates and will give market participants time to become familiar with the application of, for example, ESG disclosure metrics, prior to a more formal requirement.
Three Key Takeaways
- There are a number of mandates the EBA must address over the next few years in consideration of ESG factors and risks. Financial institutions should begin now to consider what metrics, strategies, and risk management they should implement to address the changes associated with climate change, including ESG risks.
- Access to clear data on ESG risks is a challenge. The EBA welcomes the sharing of data and various initiatives directed at collecting related data to contribute to understanding the impact of ESG risks.
- By starting now to include ESG risks into the different aspects of their business (e.g., reporting, capital requirement, and risk policy, among others), not only will financial institutions become familiar with these considerations, but they will be able to assist the EBA in understanding the challenges ahead and the most efficient way to address them for the industry.