EA Discussion paper

1 30 October 2020. EBA/DP/2020/03. EBA Discussion paper On management and supervision of ESG risks for credit institutions and investment firms EBA Discussion paper ON MANAGEMENT AND SUPERVISION OF ESG RISKS FOR CREDIT INSTITUTIONS AND INVESTMENT FIRMS. Contents Contents 2. List of figures 4. List of tables 5. Abbreviations 6. 1. Responding to this consultation 7. Submission of responses 7. Publication of responses 7. Data protection 7. 2. Executive Summary 8. 3. Background and rationale 11. Structure of the Discussion paper 15. Questions for consultation 17. 4. Common definitions of ESG factors, ESG risks and their transmission channels 20. Definition and general features of ESG factors 23.

2 Definition of ESG risks 27. Environmental factors and environmental risks 29. Environmental factors 29. Environmental risks 30. Physical transmission channels/physical risks 31. Transition transmission channels/transition risks 33. The interaction of physical and transition risks 38. Social factors and social risks 39. Liability transmission channels/liability risks 46. 5. Quantitative and qualitative indicators, metrics and methods to assess ESG risks 48. Quantitative and qualitative indicators for the identification of ESG risks 54. Methodological approaches for assessing and evaluating ESG risks 59. Portfolio Alignment Method 60. Risk Framework Method 63. Exposure Method 68. Comparison of methods and their application 72.

3 6. The management of ESG risks by institutions 78. Current status of integrating ESG risks into business strategies, risk management and governance of institutions 79. Business strategies and business processes 85. Integrating ESG risks considerations into business strategies and processes 85. Internal governance 95. 2. EBA Discussion paper ON MANAGEMENT AND SUPERVISION OF ESG RISKS FOR CREDIT INSTITUTIONS AND INVESTMENT FIRMS. Management body and committees 95. Internal control framework 97. Remuneration 99. Risk management framework 101. Risk appetite, risk policies and risk limits 102. Data and methodology 104. Risk monitoring and mitigation 108. The climate risk stress testing framework for banks and supervisors 109.

4 (i) Main challenges of a climate risk stress test framework 109. (ii) Main practices for climate risk stress test 110. Investment firms-specific considerations 115. 7. ESG factors and ESG risks in supervision 118. Scope of supervisory review in the CRD and the IFD 119. Main links between ESG factors, ESG risks and supervisory review 120. ESG risks in business model analysis 122. Business environment and long-term resilience 123. Understanding the current business model from a ESG risks perspective 124. Analysis of the strategy and financial plans 125. Assessing business model viability and sustainability 126. ESG risk-related considerations as longer term resilience of the credit institution's strategy 127.

5 Internal governance and institution wide controls 129. Overall internal governance framework 129. Management body, corporate and risk culture 130. Remuneration policies and practices 131. Internal control framework 131. Risk management framework 131. Information systems 132. Assessment of risks to capital 132. Assessment of credit and counterparty risk 133. Assessment of the portfolio credit quality (with focus on loan origination) 135. Assessment of market risk 136. Assessment of operational risk 137. Risk identification, measurement, monitoring and reporting of social and governance risks 137. Assessment of risks to liquidity and funding 137. Annex 1 Non-exhaustive list of ESG factors, indicators and metrics 141.

6 3. EBA Discussion paper ON MANAGEMENT AND SUPERVISION OF ESG RISKS FOR CREDIT INSTITUTIONS AND INVESTMENT FIRMS. List of figures Figure 1 Main content of this Discussion paper 16. Figure 2 Commonalities of ESG factors 24. Figure 3 Theoretical example on the ESG cycle: impact of environmental factors through physical risk on the institutions' balance sheet 33. Figure 4 Theoretical example on the ESG cycle: impact of environmental factors through transition risks on the institutions' balance sheet 36. Figure 5 Theoretical example on the ESG cycle: impact of social factors on the institutions' balance sheet 44. Figure 6 Challenges of incorporating ESG risks 50. Figure 7 Comprehensive approach to the assessment of ESG risks 52.

7 Figure 8 Overview of the three methodological approaches 73. Figure 9 ESG in business strategies and processes 87. Figure 10 Incorporation of ESG risks at the point of loan origination 98. Figure 11 Links between ESG factors and supervisory review 120. 4. EBA Discussion paper ON MANAGEMENT AND SUPERVISION OF ESG RISKS FOR CREDIT INSTITUTIONS AND INVESTMENT FIRMS. List of tables Table 1 Examples of ESG factors included in the most commonly used frameworks 22. Table 2 The three methodological approaches in the context of loan origination and portfolio management 74. Table 3 The three methodological approaches: Pro's and Con's 76. Table Environmental factors 145. Table Examples of physical risks with environmental and social impacts 147.

8 Table Social factors 149. Table Governance factors 152. 5. EBA Discussion paper ON MANAGEMENT AND SUPERVISION OF ESG RISKS FOR CREDIT INSTITUTIONS AND INVESTMENT FIRMS. Abbreviations CET 1 Common Equity Tier 1. CRR Capital Requirements Regulation CRD Capital Requirement Directive CSR Corporate Social Responsibility IFD Investment Firm Directive EBA European Banking Authority ECB European Central Bank EIOPA European Insurance and Occupational Pensions Authority ESG Environmental, Social and Governance ESMA European Securities and Markets Authority EU European Union GDP Gross Domestic Product GHG Green House Gases ICAAP Internal Capital Adequacy Assessment Process ILAAP Internal Liquidity Adequacy Assessment Process NGFS Network for Greening the Financial System SREP Supervisory Review and Evaluation Process SDG Sustainable Development Goals TCFD Taskforce on Climate-Related Financial Disclosures USD USA dollar 6.

9 EBA Discussion paper ON MANAGEMENT AND SUPERVISION OF ESG RISKS FOR CREDIT INSTITUTIONS AND INVESTMENT FIRMS. 1. Responding to this consultation The European Banking Authority (EBA) invites comments on all the proposals put forward in this paper and, in particular, on the specific questions included in this Discussion paper . Comments are most helpful if they: respond to the question stated;. indicate the specific point to which a comment relates;. contain a clear rationale;. provide evidence to support the views expressed/ ationale proposed; and describe any alternative regulatory choices the EBA should consider. Submission of responses To submit your comments, click on the send your comments' button on the consultation page by 3 February 2021.

10 Please note that comments submitted after this deadline or submitted via other means may not be processed. Publication of responses Please clearly indicate in the consultation form if you wish your comments to be disclosed or to be treated as confidential. A confidential response may be requested from us in accordance with the EBA's rules on public access to documents. We may consult you if we receive such a request. Any decision we make not to disclose the response is reviewable by the EBA's Board of Appeal and the European Ombudsman. Data protection The protection of individuals with regard to the processing of personal data by the EBA is based on Regulation (EC) No 45/2001 of the European Parliament and of the Council of 18 December 2000.