New regulatory expectations on ESG: what does that mean for banks?


In brief

Regulatory authorities are tightening their grip on ESG issuing recent publications calling banks to start setting and implementing their ESG strategy and risk appetite in a timely manner. 

In the last few months, competent authorities have published a list of guides and requirements, stating their expectations for banks to start integrating Environment, Social and Governance (ESG) risks into their business strategies, risk management framework and disclosures. 

While the European Central Bank (ECB) finalised their expectations on the climate and environmental dimension, the European Banking Authority (EBA) shed more light on the EU’s ESG taxonomy and how it would apply to the banking sector more specifically. Locally, the update of the Commission de Surveillance du Secteur Financier’s (CSSF) Circular 12/552 calls for banks to consider ESG risks into their strategy and risk appetite with the objective to ensure viability of the bank’s business model. 

This leads to risk and operations officers moving forward in their management of ESG risks: there is a need to present the banks’ ESG considerations, document them into the 2020 ICAAP report and develop a roadmap starting from today.

In detail

Supervisors and regulators are setting the tone for ESG risks
  • ECB: In November 2020, the ECB published a guide on climate-related and environmental risks setting out 13 supervisory expectations for ECB-directly supervised banks to consider climate-related and environmental risks in their business strategy, governance, and risk management frameworks. The ECB is asking significant institutions to submit their plan on integrating against these expectations by the end of February 2021, and will challenge them in the course of its supervisory dialogue with these banks.

The 13 expectations set by ECB cover the areas of business model and strategy, governance & risk appetite, risk management as well as disclosures. 

  • EBA: In October 2020, the EBA published the discussion paper EBA/DP/2020/03 to propose a definition of ESG risks and related factors and indicators to monitor. It also shed light on the  potential expectations for banks to include ESG in their Pillar 1, 2 and 3 regulatory and capital requirements and disclosures. The paper:

    • Defines ESG risks and proposes ESG factors and indicators to monitor

    • Calls for banks to formalise their ESG risk appetite and set out appropriate policies and procedures

    • Invites banks to collect data related to ESG risks, develop their ESG risk monitoring metrics and stress test them. 

The perspective as seen in the EBA paper is to monitor the banks’ counterparties against the proposed ESG factors as follows:

15 ESG factors
  • CSSF: In December 2020, CSSF revised their Circular 12/552 on internal governance and stated that banks’ management bodies need to adjust and embed their business strategy and risk appetite to cover ESG risks. CSSF also announced that an ESG-specific Circular is to be expected in 2021.

In practice, what does that mean for you? Our recommended steps for banks are:
  1. Set the right ESG risk culture, starting with the education part

  2. Monitor and navigate within the changing regulatory space

  3. Identify exposure levels and perform gap analyses

  4. Finalise an ESG strategy within relevant time horizons

In conclusion

As supervisors tighten their grip on ESG, it is essential for banks to take that timely and decisive action to start integrating them in their strategy arrangements and risk management frameworks. Where many banks still think of ESG or environmental risks only in terms of potential “physical risk”, they often underestimate or overlook the so-called “transition risk” and how the letter will impact all banks, regardless of their business model. And that realisation is a call for action now.

We will continue to inform you on further developments in this area. For more information, please visit our page "ESG in banking: what it means for Risk Managers".

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Jean-Philippe Maes

Risk & Regulatory Partner, PwC Luxembourg

Tel: +352 49 48 48 2874

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