On January 18th, the European Banking Authority (EBA) launched a public consultation on draft Guidelines on the management of Environmental, Social, and Governance (ESG) risk. The Guidelines outline requirements for the identification, measurement, management, and monitoring of ESG risks by institutions and prudential transition plans to address the risks arising from the transition to a climate-neutral economy. Sustainable Finance Lab drafted a response to this consultation.
There is a crucial need to speed up banks’ assessment and management of ESG risks. The ECB thematic review on climate and environmental risks concludes banks still lack sophisticated methodologies and granular information on climate and environmental risks. Moreover, a recent ECB report on misalignment states that “the euro area banking sector shows substantial misalignment and may, therefore, be subject to increased transition risks”. The Dutch Central Bank performed an analysis of transition plans of the Dutch financial sector and concluded that many of the transition plans lack concrete plans and strategies. These insights show the risks are building up and underline the crucial need to accelerate the assessment and management of ESG risks and transition plans by financial institutions.
In response to the Guidelines, SFL especially stresses the importance of (1) sufficiently ambitious, robust, and reliable transition plans, (2) the need for prompt action given imperfect data, and (3) the need to not only focus on climate but specifically also focus on nature degradation and its link with climate change.
Ambitious, robust and reliable transition plans
SFL strongly supports EBA’s inclusion of prudential transition plans in the guidelines. Transition plans are powerful tools for institutions to manage transition risks and steer financed activities towards greener outcomes. Following the so-called double materiality approach, there is a need for a stronger link between the management of ESG risks and the financing of the transition. It is the tool for strategic planning and decision-making on steering activities to finance the transition – aiming to achieve climate neutrality in 2050. Prudential transition plans should not only focus on managing environmental risk but also on subsequent impacts as a source of financial risks and a threat to financial stability in the long term. Including environmental impacts would also improve consistency with the Corporate Sustainability Reporting Directive (CSRD) and Corporate Sustainability Due Diligence Directive (CSDDD) requirements. Additionally, clear requirements need to be defined for robust transition plans and to allow for comparability.
Despite insufficient data: act now
SFL also welcomes the inclusion of guidance on ESG-related data points and data processes in the guidelines. There is radical uncertainty and significant potential harm associated with ESG-related financial risk. A more precautionary approach is thus necessary, despite institutions’ general ESG risk management and the treatment of imperfect or missing data. Undoubtedly there are shortcomings of data availability and quality and risk assessment methodologies. This however does not justify limited progress in integrating ESG risks. Financial institutions should work proactively and act with incomplete information, starting with a focus on the most harmful activities. It’s better to be roughly right than exactly wrong.
Climate change can not be halted when nature degrades further
SFL supports the broader focus on ESG, including environmental topics beyond climate. Climate goals cannot be achieved in a world where nature continues to degrade. That is why an integrated approach is needed, for example, for transition plans. Moreover, exposure to activities harmful to nature should be disclosed and managed. Even though the nature topic is not as mature as climate, and the data from underlying companies might not be fully available yet, much can already be analysed and managed qualitatively.
For more details on SFL’s position on the EBA’s Guidelines on the management of ESG risk, and for an overview of other responses, visit the EBA consultation page or see our detailed response below.
