Global: EU Banking Regulator Proposes Stringent Guidelines for Banks Addressing ESG, Climate Transition Risks

The European Banking Authority (EBA), the EU banking supervisor, has initiated a consultation on comprehensive guidelines designed to establish requirements for banks in identifying, measuring, managing, and monitoring Environmental, Social, and Governance (ESG) risks. The proposed guidelines also encompass planning strategies to mitigate risks arising from the EU’s transition to a climate-neutral economy.

Key stipulations in the proposed guidelines involve banks conducting regular materiality assessments of ESG risks. This includes ensuring the capability to identify risks through diverse data processes and methodologies, encompassing exposure-based, portfolio-based, and scenario-based approaches. Additionally, banks are required to integrate ESG risks into their routine risk management frameworks, considering their impact across various risk categories, such as credit, market, operational, reputational, liquidity, business model, and concentration risks, spanning short, medium, and long-term time horizons.

Institutions would also be mandated to formulate Capital Requirement Directive-based (CRD) transition plans, addressing risks associated with the climate transition and financial risks linked to ESG factors and regulatory objectives.

The EBA emphasizes that these guidelines are aligned with its sustainable finance roadmap, initiated in late 2022. The roadmap outlines the EBA’s objectives in sustainable finance, focusing on integrating ESG risk considerations into the banking framework through risk management, supervision, treatment of exposures, and sustainable finance monitoring.

The rationale behind these guidelines stems from observed shortcomings in managing the impacts of ESG factors over recent years. The EBA notes that these shortcomings, particularly in incorporating ESG risks into business strategies and risk management frameworks, could pose challenges to institutions’ safety and soundness as the EU transitions towards a more sustainable economy.

Distinguishing its approach from other sustainability-focused regulations like the Corporate Sustainability Reporting Directive (CSRD) and the proposed Corporate Sustainability Due Diligence Directive (CSDDD), the EBA’s guidelines concentrate on ensuring the assessment and integration of ESG risks in strategies and policies. This approach differs from requiring banks to align with specific sustainability goals or transition pathways.

While the guidelines clarify that the intention is not to compel institutions to exit or divest from carbon-intensive sectors, they aim to stimulate proactive reflection on technological, business, and behavioral changes driven by sustainable transition. This includes focusing on related risks and opportunities, transition planning, and engagement.