|
|
Climate change and the response to it by the public sector and society in general have led to an increasing relevance of ESG factors for financial markets. It is, therefore, essential that financial institutions are able to measure and monitor the ESG risks in order to deal with transition and physical risks.
As the exact manifestation of transition and physical risk remains uncertain, the EBA encourages financial institutions to act now to incorporate ESG factors into their business strategies, and to identify measure and monitor ESG risks including simple metrics, such as a green asset ratio. To this end, they can then use scenario analysis as an explorative tool to understand the relevance of the exposures affected by and the potential magnitude of the ESG risks.
Jose Manuel Campa, the EBA Chairperson, highlighted the importance of acting now on sustainable finance and said: “The urgent need to act explains why we have also set out early expectations for interim measures, including the identification of simple metrics that can foster market discipline and allow banks to set clear green strategies”
To support this, the EBA’s work will follow the sequencing reflected in its legal mandates and start with a focus on strategy and risk management and associated key metrics and disclosure. In the second stage, the EBA aims to develop a dedicated climate change stress test. The third stage of the work will look into the evidence around the prudential treatment of “green” exposures. The rationale for this sequencing is the need firstly to understand institutions’ current business mix from a sustainability perspective in order to measure and manage it in relation to their chosen strategy, which can then be used for scenario analysis and later for the assessment of an appropriate prudential treatment.