The European Banking Authority (EBA) has published an action plan on sustainable finance, which outlines its approach and timeline for delivering mandates related to environmental, social and governance (ESG) factors.
The action plan (22 page / 1.5MB PDF) sets out policy messages on sustainable finance as well as the EBA’s approach to the issue. Under EU regulation the EBA is required to set standards and assess risks associated with sustainable business models and ESG factors.
The EBA said it would start with a focus on strategy and risk management and associated metrics and disclosure. It then plans to develop a dedicated climate change stress test, followed by analysis into the evidence around the prudential treatment of ‘green’ exposures.
The authority said it would carry out a significant amount of work between 2019 and 2025, starting with the development of a uniform definition of ESG risks, criteria and methods for understanding their impact on institutions, strategies which firms could implement to evaluate and manage ESG risks, and finally the potential inclusion of ESG risk in its supervisory review and evaluation process.
The EBA is also to develop technical standards, a climate change stress test and carry out a sensitivity analysis for a sample of volunteering banks to provide a first estimate of their exposure to ESG risk.
According to the action plan, the rationale for taking actions in this order was the need to first understand institutions’ current business mix from a sustainability perspective in order to measure and manage it in relation to their chosen strategy. This understanding can then be used for scenario analysis and later for the assessment of an appropriate prudential treatment.
The EBA said ESG factors were becoming increasingly relevant for financial markets, and it was essential that financial institutions were able to measure and monitor ESG risks to enable them to deal with both transition and physical risks.
It suggested that banks and other financial institutions should incorporate ESG factors into their business strategies and measure risks using simple metrics. Scenario analysis could be used as a tool to understand the relevance of exposures affected by ESG and how significant ESG risks might be for a particular institution.
EBA chair Jose Manuel Campa 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.”
Sustainable financing is becoming increasingly popular. Earlier this year a trio of banks advised by Pinsent Masons, the law firm behind Out-Law, provided a £450 million credit facility to real estate investment trust (REIT) Derwent London, which included a £300m ‘green’ tranche available to fund activities that satisfy the criteria set out in Derwent’s ‘Green Finance Framework’. The loan was the first provided to a UK REIT meeting the Loan Market Association Green Loan Principles. Meanwhile in October 2019 a group of 130 banks from 46 countries signed up to a set of United Nations principles designed to promote a responsible, sustainable banking system, in line with global climate change and sustainable development goals.