A week ago, during a Sustainable Finance Deep Dive on ESG Data Reporting & Banking Compliance, organized by TechQuartier, we had the opportunity to present our views and ESG Impact solutions to a panel of major German banks and financial institutions. Beyond ESG Data, the workshop emphasis was on the incoming ECB Stress Tests related to Environmental and Climate Change risks, which are planned in 2022.
ECB Stress Tests
In November 2020, the European Central Bank (ECB) indeed published a non-binding Guide on climate-related and environmental risks, providing clear supervisory expectations relating to risk management and disclosure. The ECB identified environmental and climate-related risks as a key risk driver for the euro area banking system and expect thus institutions to take a “strategic, forward-looking and comprehensive approach” to considering these risks, and to understand their impact on the business environment in which they operate, in the short, medium and long term.
Consequently, the ECB expects financial institutions operating in the euro zone to start performing self-assessment on the supervisory expectations in early 2021, whereas supervisory stress tests of climate-related risks will be performed by the ECB in 2022.
Banks or financial institutions should thus be able to measure the exposure of their different kind of activities to environmental and climate-related risks. Then key metrics must be published and reported, for regulatory and disclosure purpose.
Two main risk drivers are considered by the ECB, regarding the climate-related and environmental risks:
- Physical risk — refering to the financial impact of climate change,
- Transition risk — refering to the potential financial loss resulting, directly or indirectly, from the transition towards a lower-carbon and more environmentally sustainable economy.
All the supervisory expectations linked to the disclosure of the climate-related and environmental risks are then listed in the detail in the ECB’s guide. We summarized these 13 supervisory expectations in the table here below.
Are financial institution prepared ?
The very same month, in November 2020, the ECB also released the results of an assessessment perfomed on 125 institutions. This assessment demonstrated that only 3% of the financial instutions studied were disclosing all the expected basic climate-related information, and 39% were disclosing less than half of this information. A situation confirmed by a study from UBS Group AG, exposing that European banks are unprepared to disclose their exposure to climate change and other ESG issues, as reported by Bloomberg.
Enablers and solutions for the ECB Stress Tests
The ECB expectations are pushing the financial institutions in the good direction, but the required level of Environmental and Climate-related risks assessment and reporting is indeed quite high, vis-à-vis the current situation: the gap is huge for the banks. But enablers exists, to be able to meet these ECB expectations—such as our Investors Solutions.
On the following table, and for the 1st expectation on the Business Environment, we listed many of our solutions which can be leveraged in the environmental and climate-related risk assessment and reporting process for the banking activities.
Expectation 1 : “Institutions are expected to understand the impact of climate-related and environmental risks on the business environment in which they operate, in the short, medium and long term, in order to be able to make informed strategic and business decisions.“
For instance our Sectoral ESG Risks Mapping solution provides a list of the main Environmental risks (plus Social and Governance risks) for 158 sub-industries. This mapping can thus be used to assess the exposure to specific Environmental and Climate-related risks depending of the exposure in specific sub-industries.
We also provide both Climate Change and Physical Risk rating datasets (for countries, territories, and companies) and SDG, ESG Impact, and Climate-Change and Physical Risk scorecards, which can both be used to assess the materiality of risk linked to the investment portfolios (geographies, nature of activities). As example, our Climate-Change Climate-Change and Physical Risk scorecard, displayed in the following figure, provides, for a sepcific Fixed Income fund:
- the Physical Risk exposure of the fund to Cyclones, Drought, Flood, Tsunami, and Earthquake;
- The Energy Mix related to the fund (shares of Fossil fuels, Nuclear, Coal, Renewable);
- Climate Change and Physical Risk scores: Climate-Change score, Mitigation Score, Adaptation score, Physical risk score, Transition score.
- The Climate Change and Physical Risk scores for every issuer in the portfolio,
Are the financial institution ready to meet the supervisory expectations of the ECB Stress Tests on climate-related and environmental risks ? Probably not. Some hard work is required to meet the required quality and level of transparency of information disclosure and reporting expected by the ECB, but the good news is that solutions exist to help—and we are proud to be part of them!
- European Central Bank, Guide on climate-related and environmental risks, Supervisory expectations relating to risk management and disclosure, November 2020.
- European Central Bank, ECB report on institutions’ climate-related and environmental risk disclosures – Disclosure frameworks, November 2020.
- Alastair Marsh, European Banks Unprepared for Growing ESG Disclosures, UBS Says, Bloomberg, 18 January 2021.