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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The ongoing pandemic crisis has inter alia sped up digitalization efforts and altered the perception of working from home – two fundamental changes that are likely to have a lasting impact and which also affect social factors such as e.g. workers rights and work conditions. Most institutions were able to adapt within a short period of time, which warrants a positive outlook on possible future needs for adapting spontaneously to ESG factors/risks.
As for including public policies in these assessments, we believe that it is for governments and political actors to suppress or foster certain behaviours, products or services by e.g. creating new legislation in this regard – this is neither the task nor in the remit of supervisory authorities who are only to implement and interpret existing legislation , taking into account the legislator’s wishes and aims. Introducing the assessment of long term resilience of institutions in accordance with relevant public policies would therefore overstep a certain boundary and blur the lines between political and supervisory decisions, unless these public policies clearly form the basis or backdrop for supervisory legislation and are therefore part of the supervisory assessment.
2. Please provide your views on the proposed definition of ESG factors and ESG risks.
The definition of ESG risks encompasses the risk of any negative financial impact to the institution stemming from the current or prospective impacts of ESG factors on the institution’s counterparties – this is a very, in some cases too wide definition as it also covers any minor negative financial impact which may well be neglectable, both in the short as well as in the long run.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.
As ESG factors and risks may not only have an impact on institutions directly or through their counterparties, but also through general economic developments resulting from ESG risks, this approach/angle seems quite narrow, also considering that the title of the discussion paper implies that the EBA wishes to cover the management and supervision of all ESG risks. Also, the concept of “counterparties” is not explained further: It can mean only (legal or natural) persons who have direct contact with the institution, e.g. customers or business partners with which an institution has contractual relationships or employees of the institution, or it can mean all (natural and legal) persons who have some kind of impact on the institution, thus including also e.g. the suppliers of contractual partners. The relevance of such indirect effects have become apparent also in the current pandemic crisis, but the limited influence institutions have on such indirect contacts needs to be taken into account. In order to raise awareness for ESG factors and ESG risks, all ESG factors and risks should be explained, even though not all these ESG factors and risks need to be considered in the (existing) risk management and internal governance framework of institutions. Raising this kind of awareness of risks should be the focus of the EBA’s work, as assessment and management of risks follows awareness of risks.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?
Unless the social and governance factors are not portrayed more clearly and fleshed out by further explanations and examples in future EBA publications, the definitions of social and governance risks presented in the discussion paper (paras. 79 and 85) are not self-explanatory and provide little help in raising awareness for and thus promoting the assessment and management of these risks.The ongoing pandemic crisis has inter alia sped up digitalization efforts and altered the perception of working from home – two fundamental changes that are likely to have a lasting impact and which also affect social factors such as e.g. workers rights and work conditions. Most institutions were able to adapt within a short period of time, which warrants a positive outlook on possible future needs for adapting spontaneously to ESG factors/risks.
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.
Even though liability risks may very well arise from inter alia social and governance factors, the definition of liability transmission channels/liability risks in the discussion paper (para. 90) are also closely connected to reputational risks, which are not per se liability risks – the risk of e.g. being sued for damages in court is different from the risk of public opinion assessing certain behaviours, business connections, etc. negatively.8. Please provide your views on the relevance and use of qualitative and quantitative indicators related to the identification of ESG risks.
Taxonomies can give a good insight into what factors and risks are to be taken into account, they can help raise awareness. However, taxonomies cannot cover all possible cases and hence neither can they cover all factors/risks. It is important to take special heed of the proportionality principle in this context and leave enough room for institutions to identify and manage these risks in an individually appropriate and adequate way.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.
As stated before, taxonomies, etc. provide good insights, but cannot cover all possible cases and circumstances. Hence, institutions should be granted a high level of flexibility when deciding which ESG indicators to use, including any self-developed indicators or standards.15. 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.
The question of vulnerability to ESG risks is very likely less related to the size of an institution as such, but more to e.g. the extent it has specialized in serving clients from certain sectors or industries. Smaller institutions with fewer employees may e.g. have the advantage of having a better “at a glance” perception of their portfolio and hence their risks while larger institutions with a greater number of employees may require more analysis and exchange of internal information before reaching that perception/overview. The proportionality principle focuses not only on the size of an institution, but also on e.g. the nature, scope and complexity of the institution’s activities – this should also be reflected widely in the EBA’s publications on ESG risk management and supervision, inter alia by allowing a high level of flexibility to institutions in their risk management and supervision choices. Moreover, a thorough and sound implementation of ESG risk management and supervision requires time, so that any time frames for the application and implementation of any EBA guidelines, etc. on ESG risks ought to be liberal and extensive.16. Through which measures could the adoption of strategic ESG risk-related objectives and/or limits be further supported?
As with many risk-related issues, awareness is the key: The EBA (alongside with other EU institutions) should promote awareness of ESG risks by providing information about them and the different approaches to managing such risks. From awareness, risk assessment and management will follow where relevant and necessary.17. Please provide your views on the proposed ways how to integrate ESG risks into the business strategies and processes of institutions.
Integrating ESG risks into business strategies and institutions’ processes involves long-term progressive assessments and planning. These in turn require reliable information and data to base these assessments and plans on. Hence, any time frames for the application and implementation of any EBA guidelines, etc. on ESG risks ought to be liberal and extensive.18. Please provide your views on the proposed ways how to integrate ESG risks into the internal governance of institutions.
Again, awareness is key: The EBA (alongside with other EU institutions) should promote awareness of ESG risks by providing information about them and the different approaches to managing such risks. Raised levels of awareness quite naturally lead to the proportionate and adequate integration of these risks in the institutions’ internal governance - from awareness, risk assessment and management will follow where relevant and necessary. Suggestions on e.g. allocating corresponding responsibilities to certain members of management bodies or specialized committees should not be binding or prescriptive.19. Please provide your views on the proposed ways how to integrate ESG risks into the risk management framework of institutions.
ESG risks can be integrated in the already existing and known risk categories and their management framework in institutions to the best advantage . Again, raised awareness of such ESG factors/risks will naturally lead to the proportionate and adequate integration of these risks in the institutions’ risk management - from awareness, risk assessment and management will follow where relevant and necessary.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.
There is a risk that the current particular focus on the E in ESG, i.e. environmental factors and risks, may lead to imbalances in implementation. The right calibration should be sought for in order to achieve the common goal of sustainable financing. It is therefore important to maintain a balanced approach to all kinds of ESG risks, both from the institutions’ as well as from the regulators’ point of view, and to avoid binding or prescriptive rules and instead allow for flexible measures and solutions which are risk adequate.22. Please provide your views on the incorporation of ESG factors and ESG risks considerations in the business model analysis of credit institutions.
In addition to adhering to the principle of proportionality, supervisory authorities also need to keep in mind that ESG risks are elements of a range of risks which institutions need to take into consideration – they are by no means the most important ones or at the top of a (non-existent) hierarchy of risks, but rather, this risk assessment and analysis should continue to be made on the level of the individual financial institution. The specific focus and current emphasis on the management and supervision of ESG risks should therefore not result in ultimately ousting or excluding certain sectors and industries from access to affordable finance , as this is a matter for political or individual entrepreneurial but not supervisory decision-making. Also, binding or prescriptive rules should be avoided and instead flexible measures and solutions which are risk adequate should be allowed for.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.
Although an extension of the time horizon of the supervisory assessment of an institution’s business model including its long term resilience can certainly give the supervisory authorities an even better grasp of an institution’s situation and standing, ESG factors and risks should not play a more prominent role in this assessment than other factors and risks. Also, the over time decreasing accuracy of such long term assessments needs to be taken into consideration.As for including public policies in these assessments, we believe that it is for governments and political actors to suppress or foster certain behaviours, products or services by e.g. creating new legislation in this regard – this is neither the task nor in the remit of supervisory authorities who are only to implement and interpret existing legislation , taking into account the legislator’s wishes and aims. Introducing the assessment of long term resilience of institutions in accordance with relevant public policies would therefore overstep a certain boundary and blur the lines between political and supervisory decisions, unless these public policies clearly form the basis or backdrop for supervisory legislation and are therefore part of the supervisory assessment.