ECB Issues Guide for Banks on Climate-Related and Environmental Risk Management

Steven Lofchie Commentary by Steven Lofchie

The European Central Bank ("ECB") issued a guide for banks on climate-related and environmental risk management practices and disclosures under the current prudential framework. The guide, which is not binding, is designed to facilitate supervisory dialogue, and adheres to (i) applicable European Union and national law, (ii) the European Commission Action Plan on financing sustainable growth, and (iii) the European Banking Authority ("EBA") Action Plan on sustainable finance.

The guide outlines (i) the ECB's understanding of climate-related and environmental risks, (ii) the ECB's expectations for banks when establishing their business strategy and governance and risk management frameworks, and (iii) how the ECB expects banks to enhance transparency in their climate-related and environmental disclosures.

First, the guide describes its approach by providing several articles from the Capital Requirements Directive ("CRD"), the Capital Requirements Regulation ("CRR"), and further EBA technical guidance relating to those CRD/CRR articles. Second, the ECB outlined its supervisory expectations of banks, which include:

  1. understanding the short-, medium- and long-term impact of climate-related and environmental risks to make informed strategic and business decisions;
  2. climate-related and environmental risks that will affect their business in the short, medium or long term in their business strategy;
  3. practicing effective climate-related and environmental risk oversight when creating a general business strategy, in addition to objectives and risk management frameworks;
  4. climate-related and environmental risks in their risk appetite framework;
  5. designating the internal management of climate-related and environmental risks "in accordance with the three lines of deference model";
  6. reporting aggregated risk data on exposures to climate-related and environmental risks to help the management body and relevant sub-committees make informed decisions;
  7. incorporating into their current risk management infrastructure climate-related and environmental risks as "drivers of established risk categories";
  8. considering climate-related and environmental risks at every stage of the credit-granting process in addition to overseeing such risks in their respective portfolios;
  9. examining (i) the potential adverse effects of climate-related events on business continuity and (ii) how business activities may "increase reputational and/or liability risks";
  10. assessing the potential impact of climate-related and environmental factors on market risk positions and future investments and developing stress-testing scenarios;
  11. evaluating the benefit of including stress testing into baseline and adverse scenarios for those institutions with material climate-related and environmental risks;
  12. examining whether material climate-related and environmental risks could result in cash outflows or a reduction in liquidity buffers and using these factors in their liquidity risk management and liquidity buffer calibration; and
  13. publishing information and key metrics in line with the "European Commission's Guidelines on Non-Financial Reporting: Supplement on Reporting Climate-Related Information."

Comments on the guide - which is effective immediately - may be submitted until 12:00 a.m. (midnight) Central European Time (CET) on September 25, 2020.

Commentary

There have been many recent efforts by European regulators to recognize climate change. For example, the EBA has said that it would assess whether a special prudential treatment of exposures related to assets/activities associated with environmental and/or social objectives would be justified. Christine Lagarde, the President of the ECB, wants climate change to be part of a strategic review of the ECB's purpose. The European Commission is exploring a proposal to ease EU banking rules in an effort to motivate green investment in Europe. The European Parliament announced a climate emergency.

Against that background, the guide makes environmental considerations part of the credit risk assessment and management of regulated institutions. However, for some observers, the concern remains as to whether supervisory tools should be used to reach political goals.

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Commentary

What does this mean in practice? Don't lend to ski resorts or buyers of beach properties? Lend to air conditioner manufacturers?

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