Response to discussion Paper on management and supervision of ESG risks for credit institutions and investment firms (EBA/DP/2020/03)
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• “ESG factors are environmental, social or governance characteristics that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign or individual”
• “ESG risks mean the risks of any negative financial impact to the institution stemming, from the current or prospective impacts of ESG factors on its counterparties’. ESG risks materialise themselves through their impact on prudential risk categories.”
We note that these definitions include both the environmental (or climate) and social impact itself, as well as the consequences they might have for the financial performance and thus the financial risk for us as a bank.
In our point of view the distinction should be clearer. ESG risks refer to the actual ESG impacts on people and planet. ESG related financial risks concern the related potential negative impacts on the client and the bank. This is also in line with statements elsewhere in this paper that ESG risk management includes managing both the ESG impact (ESG materiality) and the financial consequences thereof (financial materiality).
The fact that both are included in this definition begs the question: what if there is an ESG risk that does not negatively impact financial performance or in other words: how this definition addresses the question of double materiality (what prevails, mitigating ESG risks in itself, or mitigating the potential financial impacts resulting from that. What is there is a negative ESG impact that does not (yet) have a negative financial impact)? And what if there is a negative “S” impact and a positive “E” impact (or the other way around) – what prevails? We would like to understand EBA point of view on this. And how should we reconcile the purpose of prudential supervision (focusing on limiting negative financial impacts on institutions) with this focus on/introduction of ES impacts as part of the scope and mandate of EBA? Also, we would like to understand if the EBA poses these definitions as binding, or whether institutions remain to have some room for own definitions. As these definitions for example are slightly different than the ones recently shared by ECB in their draft guide.
• “Environmental risks are the risks posed by the exposure of institutions to counterparties that may potentially be negatively affected by environmental factors, including factors resulting from the climate change and factors resulting from other environmental degradation.’
• “Physical transmission channels/physical risks are the risks posed by the exposure of institutions to counterparties that may potentially be negatively affected by the physical effects of climate change or other environmental factors, including:
a) acute physical effects, which arise from particular events, especially weather-related events such as storms, floods, fires or heatwaves, that may damage production facilities and disrupt value chains; and
b) chronic physical effects, which arise from longer-term trends, such as temperature changes, rising sea levels, reduced water availability, biodiversity loss and changes in land and soil productivity.””
• Transition transmission channels/transition risks are the risks posed by the exposure of institutions to counterparties that may potentially be negatively affected by the transition to a low carbon, climate-resilient or environmentally sustainable economy, including:
o climate and environment related policy changes, for example as a result of energy efficiency requirements, carbon-pricing mechanisms that increase the price of fossil fuels, or policies to encourage sustainable use of environmental resources;
o technological changes, for example if a technology with a less damaging impact on the climate or the environment replaces a technology that is more damaging, hence making it obsolete;
o behavioural changes, for example if the choices of consumers and investors shift towards products and services that are more sustainable; or if difficulties to attract and retain customers, employees, business partners and investors arise when a counterparty has reputation for damaging the climate and the environment.”
With regards to transition and physical risk definition: our interpretation under point 47, all risks are grouped under environmental risks, and physical, transition and liability are named as transmission channels/risks under that. The definition is a slightly distinct set up than the ECB used in its draft guide, but essentially, we believe it touches on all the same risks and risk factors.
Liability risk in our view is a risk type. ESG risks (climate risks, environmental risks, social risks) are drivers - or EBA your terms: transmission channels - of potential reputation, liability and financial risk.
Regarding physical risks (point 54): this is explained as physical effects of climate change or other environmental factors, including A) acute physical effects and B) chronic physical effects. Given that ‘other environmental factors’ are mentioned, to us it would make sense if EBA added a category ‘C’ here, explaining these other environmental factors (we presume related to environmental degradation, in part because of the business of clients/counterparties).
Definition physical risk: Both ECB and EBA have added “chronic physical effects, which arise from longer-term trends, such as temperature changes, rising sea levels, reduced water availability, biodiversity loss and changes in land and soil productivity” to their definition of physical risk. Banks can currently only assess this in a qualitative way. Quantifying these risks (and other environmental risks like biodiversity) is very difficult as we don’t have data or models to do so.
The transition risk definition under point 68 makes sense to us.
Again we suggest to make the distinction clear between the social risk itself (risk to people) and its potential financial consequences for clients and financial institutions. We also suggest including in this definition what is meant with the social factors that are mentioned. From point 72 we understand that EBA refers to social factors as related to ‘the rights, well-being and interests of people and communities’ and they include for example ‘(in)equality, health, inclusiveness, labour relations, and investing in human capital and communities. Perhaps EBA could expand on how these risk factors relate to what is part of the UNGP’s and the Declaration on Human Rights. The definition as it is now is quite high level and thus does not provide much guidance or detail. We understand from the paper that the primary focus of the EBA for now is on climate and environmental risks, but we would expect the EBA over time to come with a more comprehensive definition of social risks, as ESG risks are introduced here as part of the mandate of EBA. When developing clearer guidance with regards to social risk, we suggest that EBA takes into account that social risk is difficult to determine in advance. Social norms may differ per culture or country and are moreover constantly changing. In our view, social risk can only appropriately be taken into account if the risk is limited to unmistakable violations of social norms that seriously damage confidence in the financial institution or the financial markets. This definition is currently already embedded in Dutch national law.
Governance risks definition: as with social risks, for clarity’s sake, we suggest to add to this definition what is meant by governance factors.
COVID-19 impact on approach to ESG: although Covid can result in additional questions in specific client engagements in sectors that appear seriously impacted, our overall ESG approach has not changed based on the crisis. It has always been our approach to address material ESG topics in our ESR management and in client engagement. If Covid is particularly material in a specific sector, we thus take it into account.
• Investment firms are most often able to change their portfolio composition very swiftly.
• The due diligence process for an investment by an investment manager is often more limited in scope then a bank does for its lending. The limitations come from the ability to change the composition of the portfolio but also from a different fee structure which makes it harder to do the same due diligence.
• Investment firms can more easily add investment instruments for diversification or hedging purposes, which will influence the risk perspective.
These differences between the two institutions lead to different perspectives on risk, financial and ESG risk. While defining ESG risks, one should take account of these different perspectives.
On a client level in certain cases there is more quantitative information, depending on its reporting and transparency, on specific indicators. That does not mean there is a methodology quantitively estimating what those datapoints mean in terms of future (financial) risks for that client.
Other standards like ISO are of course known to us and promoted with our clients through our ESR Policy Framework. That does not mean we have quantitative information on how our clients are doing compared to these standards or how many of them have aligned their business practice with these standards.
Generally we clearly acknowledge the many fast developments in this area. We welcome concrete guidance from EBA on this question, that is which taxonomies, standards, labels and benchmarks does EBA consider useful for risk management, and what would integration into risk look like exactly?
“Whilst this [portfolio alignment] approach allows for the identification of risk related to sustainable development (i.e. the sectors and exposures which are not aligned), it does not make an explicit link between sustainability targets and portfolios’ (changing) risk characteristics (in the form of PDs or LGDs, for instance), does not take into account the relative transition abilities of industries and is sometimes found to be disconnected from banks’ actual strategy and risk management.”
The quote above is recognizable, in the sense that connecting our alignment steering/sustainability goals with our financial risk steering, goals and strategy is challenging. Yes, we do work on alignment methods. Our Terra approach includes PACTA and PCAF for example. This is not linked to or aligned with risk management or steering via risk management yet. Which, notably, goes beyond just limit setting etc. Engagement via ESR management with companies can help clients steer in the right direction and help de-risk their profile.
We note this comes back to the matter of double materiality. Our Terra approach (like other steering tools that aim to meet the Paris goals) works towards achieving sustainability goals, whereas credit risk management is aimed at minimizing financial risk. We welcome further insights from EBA on this point, including suggestions about how to integrate these approaches.
With regards to stress testing (as published in our Climate Risk report): to assess the effect of climate change on the bank’s financial position, in 2019 ING carried out an internal climate risk stress test. As there is no standard for climate change stress testing yet, ING has adapted its regular stress testing models while leveraging on insights from supervisory climate stress tests and internal climate (risk) experts.
We assumed that ING will be confronted with both transition and physical risk. Using the 2018 DNB transition risk stress test as a starting point, we added our own elements, such as the physical risk of flooding. Whereas for transition risk we assessed the impact on a global scale, for physical risk we restricted the scope of the stress test to the Dutch mortgage portfolio only. ING’s stress test models were used to assess the severity of the four scenarios (see ‘scenario analysis’), in which we developed stress test overlays for the more long-term transition risk and the above-mentioned flooding event. For example, the additional physical risk is based on the flooding areas ‘Kromme Rijn’ and ‘Rivierenland’, as identified in the DNB’s Waterproof? report.
The stress test showed that climate risk is material and could have a significant impact. It also confirmed the potential impact on asset classes that are deemed particularly vulnerable, such as residential and commercial real estate (in regions sensitive to flooding), oil & gas-related industry and the automotive and shipping sectors.
We strive to undertake further climate change stress tests that incorporate and adopt the yet to be defined industry standards. ING will also aim to further enhance data gathering to better assess exposures that are vulnerable to physical and transition risks. In addition, ING will need to start exploring ways and methodologies to cover the Society and corporate governance related risks such that the full ESG risks are part of the Stress Test Framework. ING is of the opinion that this can best be done in close cooperation with regulators, supervisors and the banking industry. In this way the financial sector can collectively work on e.g. enhancing the data on ESG events (in a similar way as is done via OR-X for Operational Risk events) or developing industry standards for quantifying ESG risks
Yes. ING has an established ESR management approach in place for years. We work with both our own in-house evaluation model (consisting of an ESR client and an ESR transaction assessment) and (for highrisk transactions) we use external databases like Sustainalytics and Reprisk. Our approach is integrated into the client onboarding (KYC) process and into the Credit Approval process. This based on the assumption that ES risks, and impact on people and planet, lead to potential reputational, liability and thus credit risks. We do not however quantify that potential credit risk. More information about ING’s approach to ESR can be found here: https://www.ing.com/Sustainability/Sustainable-business/Environmental-and-social-risk-policies.htm
Relevant regulations concerning ESG are incorporated in the Compliance Framework. The relevant ESG risks are therefore included in policies and controls. Governance related financial crime risks are covered in multiple (Compliance) policies, like the Anti Bribery and Corruption (ABC) policy, the Anti Money Laundry (AML) policy and the Know Your Customer (KYC) policy. Social and Governance related conduct risks are currently covered in the ESR Framework, for example on controversial weapons and animal welfare. Next to Compliance owned policies the Remuneration policy covers part of the governance related risks. The Remuneration policy is owned by HR. New regulations which concern ESG risks, like the SFDR and MiFID II/IDD amendments, will also be incorporated in the compliance framework.
ING, like many large credit institutions, has focused its business model on sustainability to varying degrees, starting with philanthropic focus and moving towards integrated business strategy along the way. Promoting sustainability through green bonds, social bonds, sustainability-linked financings and sustainable improvement loans are good examples of how niche-financings spurred industry-wide competition (via league tables etc). We believe it to be necessary – and perhaps good industry practice – to have prudential management of ESG risk of our general products as well as our Green / Sustainable products.
The section on engaging with customers and other relevant stakeholders, 180-184, is an important concept that we have started implementing. Client engagement on ESG risks has become an important (and still growing) aspect of our business. ING has piloted an internal client engagement tool covering human rights impacts, where we rank them in terms of risk and opportunity in order to identify which relationships should be prioritized for growth, and which should be consider for divestment unless improvement is demonstrated. With the increased focus on ESG risks we may have to consider expanding this tool to cover the full spectrum of ESG risks.
Nevertheless, ING – like many large institutions – is concerned about the increasing role and responsibility for ESG risk management and the responsibility that is being placed on them. The suggestions advocated in this EBA Discussion Paper effectively push credit institutions further away from their basic function as credit intermediaries, apply more hurdles for investment firms when investing the pooled capital of investors in financial securities, and potentially move Regulators away from their mission of safeguarding the financial system. While this is for a good cause, improving the ESG and sustainability profiles across the market, it’s not entirely risk-free even when responsibly implemented.
We should point out the important role that Regulators should play in this, and the importance of giving capital relief or some other regulatory benefit for the prudential management of ESG risks. Effectively if the concepts contained within this EBA Discussion Paper are put into full force and effect, then institutions will need another significant capital outlay within a short time in order to comply with the ‘spirit’ and the letter of these proposals. Hence, institutions ask for clear guidance, a pragmatic approach, and some manner of benefit for their achievement herein.
At ING, we have already done this to a large extent, although we acknowledge that further refinement will be necessary in order to comply with the recommendations and new requirements contained within this EBA Discussion Paper, should it come into force. ING integrates sustainability considerations and objectives into its business strategy and actively manages social and environmental risks associated with its business engagements, which is embedded in our ESR Framework – also publicly available. The scope of our ESR Framework reflects the materiality of the potential ESR impacts on society and is integrated into ING’s business processes based on existing client segmentation and the type of business engagement. The ESR Framework is owned by ING’s ESR team, which falls within Credit Risk Management and ultimately under the CRO. In addition, ING has a Climate Change Committee and Global Credit and Transfer Risk Committee which help determine risk appetite on specific ESG related elements.
We remain concerned about the availability of ESG data that will be necessary in order to develop ESG related risk monitoring metrics and management practices, and eventually to model and/or stress test them. This represents a complicated new frontier which at present still lacks appropriate definition and guidance from regulators.
Lastly regarding the allocation of responsibility for ESG risks to ‘a’ board member: we agree that companies should follow a holistic approach and take ESG risks into account, as already required by for example the Dutch Corporate Governance Code but also by other Corporate Governance Codes. As appropriate norms have already been laid down in national codes, there is no need for harmonisation and therefore no basis or need for EU legislation/requirements on this point.
If there would nonetheless be new obligations at EU level, they should:
- Be for the company, not the (individual) board members;
- Be in line with international commitments,
- Be proportionate; and
- Create legal certainty
What has not been widely established yet is the assessment and forward looking quantification of those ESG risks, in other words: the potential financial implications. The EBA Discussion paper now asks for banks to 1) formalize their ESG [financial] risk appetite, 2) set out appropriate policies and procedures, 3) collect data related to ESG risks [and financial impacts], 4) develop risk monitoring metrics and management practices, and 5) stress test them. Much of this is , over time, achievable, but the availability of data (and several other challenges mentioned in this paper) will be a major issue for all institutions. This is already the case for climate change risks and will be even more of a challenge for social and governance risks and their financial impacts.
We take particular note of paragraph 253, which calls on institutions to adjust their pricing “which should reflect also the risks driven from the ESG factors. Institutions should account for ESG risks in their pricing strategies.” This is an important step forward which needs very careful consideration given that pricing is already dependent on global market forces, namely an institution’s borrowing rate and a risk premium. Larger institutions who are active outside of Europe may therefore face a pricing, and hence competitive disadvantage if regulators outside of the EU do not adopt the same measures. Particular attention should be on the US, as most commodities are funded in USD which usually means European based institutions start at a disadvantage.
However, there are consequences for institutions of not managing these risks, as can be seen through the activities of Business at OECD (BIAC) and increased use of the National Contact Point for the resolution of issues that arise from the alleged non-observance of the OECD Guidelines for MNEs in specific instances. We believe that the potential negative financial impacts of social (human rights) and governance risks can be just as large as the financial impacts of environmental and climate change risks. As stated above, we would expect EBA to formulate a clearer point of view on this so that institutions know what is exactly expected of them. It is important that any EU initiative is aligned with national rules in this respect.
On the second part of the question, regarding “Please also provide your views on any specificities associated with the management of social and governance risks”: Institutions would welcome the EBA to define what is expected of institutions with the management of social and governance risks. An EU Taxonomy covering these risks (definitions, concepts, and expectations) would be a good start.
More clarification is needed for the introduction of requirements for E, S and G before all stakeholders can have certainty on what is expected of them.
We strongly endorse the application of the principle of proportionality but consider it helpful to have more detail on how proportionality can be achieved both with regard to requirements imposed on institutions’ risk controls as with regard to supervisors’ assessment of these control frameworks. In our view institutions and supervisors can only take into account the principle of proportionality in practice, if there is a clear and precise framework that is proportionate itself. Rules on the quantification of ESG risks should not go beyond the legitimate objectives pursued by the legislation at issue and should not exceed the limits of what is appropriate and necessary to achieve those objectives. We reiterate that any framework developed by EBA should be consistent with the ECB’s framework. We also repeat our call for the maintenance of a level playfield, both among different institutions as well as on an EU and global level.
1. Please provide details of other relevant frameworks for ESG factors you use.
Examples of other relevant Frameworks we use include: Equator Principles, IFC Performance Standards, United Nations Guiding Principles, Sustainalytics, Reprisk, TCFD etc.2. Please provide your views on the proposed definition of ESG factors and ESG risks.
Definitions:• “ESG factors are environmental, social or governance characteristics that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign or individual”
• “ESG risks mean the risks of any negative financial impact to the institution stemming, from the current or prospective impacts of ESG factors on its counterparties’. ESG risks materialise themselves through their impact on prudential risk categories.”
We note that these definitions include both the environmental (or climate) and social impact itself, as well as the consequences they might have for the financial performance and thus the financial risk for us as a bank.
In our point of view the distinction should be clearer. ESG risks refer to the actual ESG impacts on people and planet. ESG related financial risks concern the related potential negative impacts on the client and the bank. This is also in line with statements elsewhere in this paper that ESG risk management includes managing both the ESG impact (ESG materiality) and the financial consequences thereof (financial materiality).
The fact that both are included in this definition begs the question: what if there is an ESG risk that does not negatively impact financial performance or in other words: how this definition addresses the question of double materiality (what prevails, mitigating ESG risks in itself, or mitigating the potential financial impacts resulting from that. What is there is a negative ESG impact that does not (yet) have a negative financial impact)? And what if there is a negative “S” impact and a positive “E” impact (or the other way around) – what prevails? We would like to understand EBA point of view on this. And how should we reconcile the purpose of prudential supervision (focusing on limiting negative financial impacts on institutions) with this focus on/introduction of ES impacts as part of the scope and mandate of EBA? Also, we would like to understand if the EBA poses these definitions as binding, or whether institutions remain to have some room for own definitions. As these definitions for example are slightly different than the ones recently shared by ECB in their draft guide.
3. Do you agree that, for the purpose of assessing their inclusion in institutions’ and supervisors’ practices from a prudential perspective, ESG risks should be approached primarily from the angle of the negative impacts of ESG factors on institutions’ counterparties? Please explain why.
Yes, we agree that ESG risks should be approached primarily from the angle of the negative impacts of ESG factors on institutions’ counterparties.4. Please provide your views on the proposed definitions of transition risks and physical risks included in section 4.3.
Definitions:• “Environmental risks are the risks posed by the exposure of institutions to counterparties that may potentially be negatively affected by environmental factors, including factors resulting from the climate change and factors resulting from other environmental degradation.’
• “Physical transmission channels/physical risks are the risks posed by the exposure of institutions to counterparties that may potentially be negatively affected by the physical effects of climate change or other environmental factors, including:
a) acute physical effects, which arise from particular events, especially weather-related events such as storms, floods, fires or heatwaves, that may damage production facilities and disrupt value chains; and
b) chronic physical effects, which arise from longer-term trends, such as temperature changes, rising sea levels, reduced water availability, biodiversity loss and changes in land and soil productivity.””
• Transition transmission channels/transition risks are the risks posed by the exposure of institutions to counterparties that may potentially be negatively affected by the transition to a low carbon, climate-resilient or environmentally sustainable economy, including:
o climate and environment related policy changes, for example as a result of energy efficiency requirements, carbon-pricing mechanisms that increase the price of fossil fuels, or policies to encourage sustainable use of environmental resources;
o technological changes, for example if a technology with a less damaging impact on the climate or the environment replaces a technology that is more damaging, hence making it obsolete;
o behavioural changes, for example if the choices of consumers and investors shift towards products and services that are more sustainable; or if difficulties to attract and retain customers, employees, business partners and investors arise when a counterparty has reputation for damaging the climate and the environment.”
With regards to transition and physical risk definition: our interpretation under point 47, all risks are grouped under environmental risks, and physical, transition and liability are named as transmission channels/risks under that. The definition is a slightly distinct set up than the ECB used in its draft guide, but essentially, we believe it touches on all the same risks and risk factors.
Liability risk in our view is a risk type. ESG risks (climate risks, environmental risks, social risks) are drivers - or EBA your terms: transmission channels - of potential reputation, liability and financial risk.
Regarding physical risks (point 54): this is explained as physical effects of climate change or other environmental factors, including A) acute physical effects and B) chronic physical effects. Given that ‘other environmental factors’ are mentioned, to us it would make sense if EBA added a category ‘C’ here, explaining these other environmental factors (we presume related to environmental degradation, in part because of the business of clients/counterparties).
Definition physical risk: Both ECB and EBA have added “chronic physical effects, which arise from longer-term trends, such as temperature changes, rising sea levels, reduced water availability, biodiversity loss and changes in land and soil productivity” to their definition of physical risk. Banks can currently only assess this in a qualitative way. Quantifying these risks (and other environmental risks like biodiversity) is very difficult as we don’t have data or models to do so.
The transition risk definition under point 68 makes sense to us.
5. Please provide you views on the proposed definition of social risks and governance risks. As an institution, to which extent is the on-going COVID-19 crisis having an impact on your approach to ESG factors and ESG risks?
“Social risks are the risks posed by the exposure of institutions to counterparties that may potentially be negatively affected by social factors.”Again we suggest to make the distinction clear between the social risk itself (risk to people) and its potential financial consequences for clients and financial institutions. We also suggest including in this definition what is meant with the social factors that are mentioned. From point 72 we understand that EBA refers to social factors as related to ‘the rights, well-being and interests of people and communities’ and they include for example ‘(in)equality, health, inclusiveness, labour relations, and investing in human capital and communities. Perhaps EBA could expand on how these risk factors relate to what is part of the UNGP’s and the Declaration on Human Rights. The definition as it is now is quite high level and thus does not provide much guidance or detail. We understand from the paper that the primary focus of the EBA for now is on climate and environmental risks, but we would expect the EBA over time to come with a more comprehensive definition of social risks, as ESG risks are introduced here as part of the mandate of EBA. When developing clearer guidance with regards to social risk, we suggest that EBA takes into account that social risk is difficult to determine in advance. Social norms may differ per culture or country and are moreover constantly changing. In our view, social risk can only appropriately be taken into account if the risk is limited to unmistakable violations of social norms that seriously damage confidence in the financial institution or the financial markets. This definition is currently already embedded in Dutch national law.
Governance risks definition: as with social risks, for clarity’s sake, we suggest to add to this definition what is meant by governance factors.
COVID-19 impact on approach to ESG: although Covid can result in additional questions in specific client engagements in sectors that appear seriously impacted, our overall ESG approach has not changed based on the crisis. It has always been our approach to address material ESG topics in our ESR management and in client engagement. If Covid is particularly material in a specific sector, we thus take it into account.
6. Do you agree with the description of liability transmission channels/liability risks, including the consideration that liability risks may also arise from social and governance factors? If not, please explain why.
In our view liability risks (just like reputation risks) may arise from environmental, social and governance issues. In turn reputation and liability risks may potentially lead to financial risks for clients and financial institutions, depending on the circumstances at hand.7. Do the specificities of investment firms compared to credit institutions justify the elaboration of different definitions, or are the proposed definitions included in chapter 4 also applicable to them (in particular the perspective of counterparties)? Please elaborate on the potential specificities of investment firms in relation to ESG risks and on how these specificities, if any, could be reflected in this paper.
It would indeed be good if the different definitions would be aligned for banks and investment firms. But there are some differences between the two institutions why risks can be different:• Investment firms are most often able to change their portfolio composition very swiftly.
• The due diligence process for an investment by an investment manager is often more limited in scope then a bank does for its lending. The limitations come from the ability to change the composition of the portfolio but also from a different fee structure which makes it harder to do the same due diligence.
• Investment firms can more easily add investment instruments for diversification or hedging purposes, which will influence the risk perspective.
These differences between the two institutions lead to different perspectives on risk, financial and ESG risk. While defining ESG risks, one should take account of these different perspectives.
8. Please provide your views on the relevance and use of qualitative and quantitative indicators related to the identification of ESG risks.
Ideally, we would be able to assess the ESG risks we are exposed to both qualitatively and quantitatively. At the moment, given the different restraints or challenges described in chapter 5 (incl. uncertainty, lack of data, methodological constraints, time horizon mismatch etc) it is not yet possible to have many quantitative indicators indicating financial implications of ESG risks, certainly not over all sectors of our full portfolio over the short, medium and long term. This remains a work in progress for us and other institutions (as well as supervisors).On a client level in certain cases there is more quantitative information, depending on its reporting and transparency, on specific indicators. That does not mean there is a methodology quantitively estimating what those datapoints mean in terms of future (financial) risks for that client.
9. As an institution, do you use or plan to use some of the ESG indicators (including taxonomies, standards, labels and benchmarks) described in section 5.1 or any other indicators, inter alia for the purpose of risks management? If yes, please explain which ones.
Currently the EU taxonomy is being used for the categorization of our sustainable finance product offering. That is not (yet) linked to risk management, although our expectation is that steering towards sustainable product offering will help de-risk our portfolio.Other standards like ISO are of course known to us and promoted with our clients through our ESR Policy Framework. That does not mean we have quantitative information on how our clients are doing compared to these standards or how many of them have aligned their business practice with these standards.
Generally we clearly acknowledge the many fast developments in this area. We welcome concrete guidance from EBA on this question, that is which taxonomies, standards, labels and benchmarks does EBA consider useful for risk management, and what would integration into risk look like exactly?
10. As an institution, do you use or plan to use a portfolio alignment method in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.
As described on the EBA paper:“Whilst this [portfolio alignment] approach allows for the identification of risk related to sustainable development (i.e. the sectors and exposures which are not aligned), it does not make an explicit link between sustainability targets and portfolios’ (changing) risk characteristics (in the form of PDs or LGDs, for instance), does not take into account the relative transition abilities of industries and is sometimes found to be disconnected from banks’ actual strategy and risk management.”
The quote above is recognizable, in the sense that connecting our alignment steering/sustainability goals with our financial risk steering, goals and strategy is challenging. Yes, we do work on alignment methods. Our Terra approach includes PACTA and PCAF for example. This is not linked to or aligned with risk management or steering via risk management yet. Which, notably, goes beyond just limit setting etc. Engagement via ESR management with companies can help clients steer in the right direction and help de-risk their profile.
We note this comes back to the matter of double materiality. Our Terra approach (like other steering tools that aim to meet the Paris goals) works towards achieving sustainability goals, whereas credit risk management is aimed at minimizing financial risk. We welcome further insights from EBA on this point, including suggestions about how to integrate these approaches.
11. As an institution, do you use or plan to use a risk framework method (including climate stress testing and climate sensitivity analysis) in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.
Yes, we are currently drafting a Climate Risk Framework, in addition to our already existing Environmental and Social Risk Framework.With regards to stress testing (as published in our Climate Risk report): to assess the effect of climate change on the bank’s financial position, in 2019 ING carried out an internal climate risk stress test. As there is no standard for climate change stress testing yet, ING has adapted its regular stress testing models while leveraging on insights from supervisory climate stress tests and internal climate (risk) experts.
We assumed that ING will be confronted with both transition and physical risk. Using the 2018 DNB transition risk stress test as a starting point, we added our own elements, such as the physical risk of flooding. Whereas for transition risk we assessed the impact on a global scale, for physical risk we restricted the scope of the stress test to the Dutch mortgage portfolio only. ING’s stress test models were used to assess the severity of the four scenarios (see ‘scenario analysis’), in which we developed stress test overlays for the more long-term transition risk and the above-mentioned flooding event. For example, the additional physical risk is based on the flooding areas ‘Kromme Rijn’ and ‘Rivierenland’, as identified in the DNB’s Waterproof? report.
The stress test showed that climate risk is material and could have a significant impact. It also confirmed the potential impact on asset classes that are deemed particularly vulnerable, such as residential and commercial real estate (in regions sensitive to flooding), oil & gas-related industry and the automotive and shipping sectors.
We strive to undertake further climate change stress tests that incorporate and adopt the yet to be defined industry standards. ING will also aim to further enhance data gathering to better assess exposures that are vulnerable to physical and transition risks. In addition, ING will need to start exploring ways and methodologies to cover the Society and corporate governance related risks such that the full ESG risks are part of the Stress Test Framework. ING is of the opinion that this can best be done in close cooperation with regulators, supervisors and the banking industry. In this way the financial sector can collectively work on e.g. enhancing the data on ESG events (in a similar way as is done via OR-X for Operational Risk events) or developing industry standards for quantifying ESG risks
12. .As an institution, do you use or plan to use an exposure method in your approach to measuring and managing ESG risks? Please explain why and provide details on the methodology used.
Exposure method is explained as: ‘The basic principle of this approach is to directly evaluate the performance of an exposure in terms of the E, the S and the G.’Yes. ING has an established ESR management approach in place for years. We work with both our own in-house evaluation model (consisting of an ESR client and an ESR transaction assessment) and (for highrisk transactions) we use external databases like Sustainalytics and Reprisk. Our approach is integrated into the client onboarding (KYC) process and into the Credit Approval process. This based on the assumption that ES risks, and impact on people and planet, lead to potential reputational, liability and thus credit risks. We do not however quantify that potential credit risk. More information about ING’s approach to ESR can be found here: https://www.ing.com/Sustainability/Sustainable-business/Environmental-and-social-risk-policies.htm
Relevant regulations concerning ESG are incorporated in the Compliance Framework. The relevant ESG risks are therefore included in policies and controls. Governance related financial crime risks are covered in multiple (Compliance) policies, like the Anti Bribery and Corruption (ABC) policy, the Anti Money Laundry (AML) policy and the Know Your Customer (KYC) policy. Social and Governance related conduct risks are currently covered in the ESR Framework, for example on controversial weapons and animal welfare. Next to Compliance owned policies the Remuneration policy covers part of the governance related risks. The Remuneration policy is owned by HR. New regulations which concern ESG risks, like the SFDR and MiFID II/IDD amendments, will also be incorporated in the compliance framework.
13. As an institution, do you use or plan to use any different approaches in relation to ESG risk management than the ones included in chapter 5? If yes, please provide details.
No.14. Specifically for investment firms, do you apply other methodological approaches, or are the approaches described in this chapter applicable also for investment firms?
n/a15. Please provide your views on the extent to which smaller institutions can be vulnerable to ESG risks and on the criteria that should be used to design and implement a proportionate ESG risks management approach.
Rather than size to determine vulnarability to ESG risks, one should take into account other criteria and drivers. The extent to which institutions (either small or large) may be vulnerable to ESG risks varies, and is a function of the institution’s business model, internal organisation and nature and complexity of its activities. In addition, one might look at the markets they operate in (how regulated they are) as well as their investment strategy (private banking focused, mortgage lending, or an investment fund focused on fossil fuels) as indicators of their vulnerability to ESG risks. The principle of proportionality is also important.16. Through which measures could the adoption of strategic ESG risk-related objectives and/or limits be further supported?
We suggest EBA provide further guidance on this question. What is meant with ‘strategic’ ESG risk objectives for example? Does that mean goals aimed at reducing financial risk, or also goals aimed at reducing actual climate risks (i.e. aligning with the Paris goals)? We note that if ‘strategic ESG risk-related objectives’ were to include non-financial risks as well, this would fall outside the scope of (i) prudential supervision, and (ii) EBA’s mandate which is to contribute to a single set of harmonised prudential rules for financial institutions throughout the EU.17. Please provide your views on the proposed ways how to integrate ESG risks into the business strategies and processes of institutions.
This section advocates that institutions adjust their business strategy to incorporate ESG risks as drivers of prudential risks, which EBA sees as a progressive risk management tool to mitigate the potential impact of ESG risks: namely through extending the time horizon for strategic planning, including ESG risk scenarios, setting and disclosing ESG KPIs, offering sustainable products, and adjusting business processes to reflect ESG risk-related strategic objectives and/or limits in the engagement with borrowers, investee companies and other stakeholders in order to lower the ESG risks associated with those exposures. Much of this section is explaining or evidencing trends in the marketplace, such as how the Principles for Responsible Banking, Equator Principles, Sustainable Development Goals and EU Taxonomy have shaped ESG risk management and led to sustainability linked products. In this respect, we agree.ING, like many large credit institutions, has focused its business model on sustainability to varying degrees, starting with philanthropic focus and moving towards integrated business strategy along the way. Promoting sustainability through green bonds, social bonds, sustainability-linked financings and sustainable improvement loans are good examples of how niche-financings spurred industry-wide competition (via league tables etc). We believe it to be necessary – and perhaps good industry practice – to have prudential management of ESG risk of our general products as well as our Green / Sustainable products.
The section on engaging with customers and other relevant stakeholders, 180-184, is an important concept that we have started implementing. Client engagement on ESG risks has become an important (and still growing) aspect of our business. ING has piloted an internal client engagement tool covering human rights impacts, where we rank them in terms of risk and opportunity in order to identify which relationships should be prioritized for growth, and which should be consider for divestment unless improvement is demonstrated. With the increased focus on ESG risks we may have to consider expanding this tool to cover the full spectrum of ESG risks.
Nevertheless, ING – like many large institutions – is concerned about the increasing role and responsibility for ESG risk management and the responsibility that is being placed on them. The suggestions advocated in this EBA Discussion Paper effectively push credit institutions further away from their basic function as credit intermediaries, apply more hurdles for investment firms when investing the pooled capital of investors in financial securities, and potentially move Regulators away from their mission of safeguarding the financial system. While this is for a good cause, improving the ESG and sustainability profiles across the market, it’s not entirely risk-free even when responsibly implemented.
18. Please provide your views on the proposed ways how to integrate ESG risks into the internal governance of institutions.
The EBAs proposed ways on how to integrate ESG risks into the internal governance of institutions are broad – covering 1) risk committees or creating specialised committees such as sustainability finance committees or ethics committees, 2) allocating the responsibility related to ESG risks to a board member, 3) involving risk when integrating ESG risks into the risk appetite, 4) considering ESG risks when implementing risk policies, 5) having internal audit function include ESG risks, 6) encouraging staff behaviour to be consistent with the institutions’ ESG risks appetite, 7) remuneration policy including ESG KPIs, and 8) managing conflict of interest which may incentivise short-term-oriented undue ESG-related risk-taking.We should point out the important role that Regulators should play in this, and the importance of giving capital relief or some other regulatory benefit for the prudential management of ESG risks. Effectively if the concepts contained within this EBA Discussion Paper are put into full force and effect, then institutions will need another significant capital outlay within a short time in order to comply with the ‘spirit’ and the letter of these proposals. Hence, institutions ask for clear guidance, a pragmatic approach, and some manner of benefit for their achievement herein.
At ING, we have already done this to a large extent, although we acknowledge that further refinement will be necessary in order to comply with the recommendations and new requirements contained within this EBA Discussion Paper, should it come into force. ING integrates sustainability considerations and objectives into its business strategy and actively manages social and environmental risks associated with its business engagements, which is embedded in our ESR Framework – also publicly available. The scope of our ESR Framework reflects the materiality of the potential ESR impacts on society and is integrated into ING’s business processes based on existing client segmentation and the type of business engagement. The ESR Framework is owned by ING’s ESR team, which falls within Credit Risk Management and ultimately under the CRO. In addition, ING has a Climate Change Committee and Global Credit and Transfer Risk Committee which help determine risk appetite on specific ESG related elements.
We remain concerned about the availability of ESG data that will be necessary in order to develop ESG related risk monitoring metrics and management practices, and eventually to model and/or stress test them. This represents a complicated new frontier which at present still lacks appropriate definition and guidance from regulators.
Lastly regarding the allocation of responsibility for ESG risks to ‘a’ board member: we agree that companies should follow a holistic approach and take ESG risks into account, as already required by for example the Dutch Corporate Governance Code but also by other Corporate Governance Codes. As appropriate norms have already been laid down in national codes, there is no need for harmonisation and therefore no basis or need for EU legislation/requirements on this point.
If there would nonetheless be new obligations at EU level, they should:
- Be for the company, not the (individual) board members;
- Be in line with international commitments,
- Be proportionate; and
- Create legal certainty
19. Please provide your views on the proposed ways how to integrate ESG risks into the risk management framework of institutions.
ESG risks (impacts on people and planet) are already well-integrated into the risk management of most (large) credit institutions, and have been for over a decade. For instance, there are 45 (mainly) credit institutions from Europe (and 110 worldwide) who are signatories of the Equator Principles, which is a “risk management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in projects and is primarily intended to provide a minimum standard for due diligence and monitoring to support responsible risk decision-making.” EPFIs have a large number of guidance documents, best practices, roundtables and members-only forums available to members to discuss the management of ESG Whereas the Equator Principles focus on ESG risk management on a transactional basis, the EBA paper also advocates a portfolio approach at the institution level which will take time and resources for institutions to implement and develop.What has not been widely established yet is the assessment and forward looking quantification of those ESG risks, in other words: the potential financial implications. The EBA Discussion paper now asks for banks to 1) formalize their ESG [financial] risk appetite, 2) set out appropriate policies and procedures, 3) collect data related to ESG risks [and financial impacts], 4) develop risk monitoring metrics and management practices, and 5) stress test them. Much of this is , over time, achievable, but the availability of data (and several other challenges mentioned in this paper) will be a major issue for all institutions. This is already the case for climate change risks and will be even more of a challenge for social and governance risks and their financial impacts.
We take particular note of paragraph 253, which calls on institutions to adjust their pricing “which should reflect also the risks driven from the ESG factors. Institutions should account for ESG risks in their pricing strategies.” This is an important step forward which needs very careful consideration given that pricing is already dependent on global market forces, namely an institution’s borrowing rate and a risk premium. Larger institutions who are active outside of Europe may therefore face a pricing, and hence competitive disadvantage if regulators outside of the EU do not adopt the same measures. Particular attention should be on the US, as most commodities are funded in USD which usually means European based institutions start at a disadvantage.
20. The EBA acknowledges that institutions’ approaches to environmental, and particularly climate-related, risks might be more advanced compared to social and governance risks, and gives particular prominence in this report to the former type of risks. To what extent do you support this approach? Please also provide your views on any specificities associated with the management of social and governance risks.
It is a matter of fact that Regulators and Governments, particularly in the EU, have thus far primarily shown interest in climate-related and as of late Environmental-related risks. This is evidenced through the many climate related questionnaires that have been sent to institutions over the past 3-4 years, the attention given to TCFD, and even the recently published EU Taxonomy on Sustainable Finance. As to social and governance risks, there’s no TCFD-like initiative or EU Taxonomy prioritizing these risks.However, there are consequences for institutions of not managing these risks, as can be seen through the activities of Business at OECD (BIAC) and increased use of the National Contact Point for the resolution of issues that arise from the alleged non-observance of the OECD Guidelines for MNEs in specific instances. We believe that the potential negative financial impacts of social (human rights) and governance risks can be just as large as the financial impacts of environmental and climate change risks. As stated above, we would expect EBA to formulate a clearer point of view on this so that institutions know what is exactly expected of them. It is important that any EU initiative is aligned with national rules in this respect.
On the second part of the question, regarding “Please also provide your views on any specificities associated with the management of social and governance risks”: Institutions would welcome the EBA to define what is expected of institutions with the management of social and governance risks. An EU Taxonomy covering these risks (definitions, concepts, and expectations) would be a good start.
21. Specifically for investment firms, what are the most relevant characteristics or particularities of business strategies, internal governance and risk management that should be taken into account for the management of the ESG risks? Please provide specific suggestions how could these be reflected.
n/a22. Please provide your views on the incorporation of ESG factors and ESG risks considerations in the business model analysis of credit institutions.
As noted in our response to question 17, we generally agree to reflect on the incorporation of ESG risks in the business model analysis. Noting that the developing regulatory calendar should be followed to avoid inconsistent introduction of requirements that are based on a still developing internal methodology and both internal and external data environment.More clarification is needed for the introduction of requirements for E, S and G before all stakeholders can have certainty on what is expected of them.
23. Do you agree with the need to extend the time horizon of the supervisory assessment of the business model and introduce as a new area of analysis the assessment of the long term resilience of credit institutions in accordance with relevant public policies? Please explain why.
Benefit lies in looking at a variety of time horizons to manage the impact of climate change as different risks could materialize and inform strategic choices as well as risk appetite setting. Whereas classic stress testing models focus on quantifying the near term impact that corresponds with the financial planning horizon, we recognize that for climate the impact is predominantly noticeable in the long term (reaching up to 2050). The key hurdle on assessing either of these time horizons is around the access to adequate data and convergence of methodologies that can support the quantification of the impact. This is clearly an example where banks, regulators and supervisors should team up to collectively determine approaches for this.24. Please provide your views on the incorporation of ESG risks considerations into the assessment of the credit institution’s internal governance and wide controls.
We support the EBA approach that ESG risks are drivers of existing risks and as such should be integrated in the existing governance framework. This is consistent with the ECB Guide, where the EBA DP provides more granular guidance. However, a proportionate approach to the implementation requires a more robust / mature process for the identification and assessment of ESG risks. Similar to the need for generic approaches to long-term scenarios / stress testing, the notion of a proportionate incorporation of ESG risks into the assessment of the credit institution’s internal governance and wide controls requires a solid basis of measurement of these risks in order to establish objective supervision. This is also depending on / related to the introduction of more complete taxonomy and finalization of the EC NFRD. We call for consistency between consistency and alignment between an EBA framework and the ECB Guide on Climate Risk. We also call for a level playing field e.g. as regards when new rules will apply.25. Please provide your views on the incorporation of ESG risks considerations in the assessment of risks to capital, liquidity and funding.
Liquidity and funding seem less pressing as the ESG risks are also largely considered to have a longer-term impact. While we support the use of scenarios and stress testing to assess the potential impact of ESG risks on capital and liquidity buffers, this underpins the need for base-line scenarios with the associated definitions of ESG risks. This is in line with EBA's conclusion (page 139), where we consider that a staged approach of translation into Pillar 2 requirements should be taken.26. If not covered in your previous answers, please provide your views on whether the principle of proportionality is appropriately reflected in the discussion paper, and your suggestions in this respect keeping in mind the need to ensure consistency with a risk-based approach.
Based on the principle of proportionality, EBA considers it is important that both institutions and supervisors are able to distinguish and form a view on the relevance of ESG risks, following a proportionate, risk-based approach that takes into account the likelihood and the severity of the materialisation of ESG risks. Institutions are to proportionately incorporate ESG risks in their internal governance arrangements. Supervisors are to proportionately incorporate the ESG factors and considerations into the business model analysis in order to reflect the ESG risks in the supervisory evaluation.We strongly endorse the application of the principle of proportionality but consider it helpful to have more detail on how proportionality can be achieved both with regard to requirements imposed on institutions’ risk controls as with regard to supervisors’ assessment of these control frameworks. In our view institutions and supervisors can only take into account the principle of proportionality in practice, if there is a clear and precise framework that is proportionate itself. Rules on the quantification of ESG risks should not go beyond the legitimate objectives pursued by the legislation at issue and should not exceed the limits of what is appropriate and necessary to achieve those objectives. We reiterate that any framework developed by EBA should be consistent with the ECB’s framework. We also repeat our call for the maintenance of a level playfield, both among different institutions as well as on an EU and global level.