ESG risks - new methods and old problems
On January 18, the European Banking Authority (EBA) announced a new consultation on the requirements for banks to identify, measure, manage and monitor ESG risks. A now familiar topic with new guidelines - but a recently published study by the European Central Bank shows that a revision of the methodology and objectives of ESG risks is necessary: according to the study, only 10% of the banks surveyed are pursuing a net zero strategy in their lending by 2050, meaning that a full 90% have misguided lending with increased transformation risk. Transformation risks that can certainly be avoided through appropriate risk management.
EBA Consultation
Climate change, which is already having a noticeable impact on the environment and society, poses significant challenges for the economy, particularly in the financial sector. The risk profile and business model of institutions can be significantly affected by ESG risks, which manifest themselves primarily in transition and physical risks. Appropriate and holistic risk management is therefore essential to ensure the safety and soundness of companies in the short, medium and long term.
The EBA is planning new guidelines including procedures and methodologies to avoid the climate risks described. These are to include plans for managing the risks arising from the transition to a climate-neutral economy in the EU. The guidelines are intended to encourage companies to proactively make technological and business changes that are triggered by climate change and adaptation to climate change.
The requirements for banks under the proposed guidelines include carrying out regular materiality assessments of ESG risks, ensuring the ability to identify risks through data processes and integrating ESG risks into regular risk management. All effects of the risk categories defined by the EBA should always be taken into account, including credit, market, operational, reputational, liquidity, business model and concentration risks. In addition, the guidelines now presented would oblige companies to develop transitional plans on the basis of the Capital Requirements Directive (CRD). Article 76 of the CRD stipulates that companies must develop specific plans to monitor and manage the financial risks arising from adapting to climate change and the transition to a climate-neutral economy.
According to the EBA, the new guidelines were developed in line with the published roadmap for sustainable finance. The roadmap, published at the end of 2022, sets out the EBA's priorities and plans in the areas of sustainable finance and supporting and monitoring the integration of ESG risks into the banking framework. The consultation process on the EBA's new guidelines runs until April 18.
ECB study
In parallel with the development of guidelines to strengthen the integration of ESG risks into corporate processes, the ECB published a study in January 2024 that examines the potential risks in the banking sector in connection with the EU climate targets. For the study, the ECB quantified the transition risks in the loan portfolios of 95 banks in the euro area by measuring and assessing the deviations between the production forecasts and the decarbonization targets of the companies in the banks' portfolios. Companies from six major carbon-intensive sectors with increased transformation risk were analyzed: energy, automotive, oil and gas, steel, coal and cement. These sectors are responsible for around 70% of global CO2 emissions.
The study shows that the majority of the banks surveyed (90%) have not yet adapted their lending process to the net zero targets by 2050, which significantly increases their vulnerability to transition risks. In this context, the ECB points out that transition risks arise primarily from larger loans to poorly aligned companies and represent a significant risk for the banks concerned. The average risk level for mismanaged companies is more than twice as high as for companies that operate in line with EU climate targets. In addition, the ECB identified an increased risk in loans to companies that are too slow to phase out carbon-intensive production or lag behind in the expansion of renewable energies. In addition to transition risks, the study also points to potential reputational risks, which affect around 70 percent of banks.
Conclusion
Although ESG risks are by no means new and are already taken into account in various regulations, the current procedures and applications for integrating these risks into risk management appear inadequate. The ECB also comes to this conclusion, pointing in particular to the lack of suitable processes in the lending process. It is therefore not surprising that the EBA is developing new guidelines on the integration of ESG risks, which will initially be put out for consultation until April 18.
We support you with all requirements relating to ESG risks in the corporate context. Do you have questions about the integration of sustainability-related data or the identification of ESG risks? Please contact us personally at https://curentis.com/consulting/regulatory-reporting/
About the author: Fabian Brandt has been with CURENTIS AG since 2023. During his work in management consultancies in the field of CSR reporting and sustainable banking, he was able to gain extensive project experience. In addition, he has specialized in sustainable finance with a focus on the EU taxonomy.
