The European Banking Authority (EBA) has suggested that existing assessments used by supervisors are not fully able to capture investment firms’ vulnerability to longer-term ESG risks and recommended that time horizons be extended to “at least 10 years”.
In a report published this week on incorporating ESG risks in the supervision of investment firms, the EU banking regulator wrote: “It is reasonable to assume that the existing assessment would not sufficiently enable competent authorities to understand the longer-term breadth and magnitude of the impact of ESG risks on future performance and longer-term vulnerabilities of the investment firm.”
It added: “It would be beneficial to extend the analysis to a longer-term resilience of the investment firm over a period of at least 10 years.”
Dorota Siwek, head of the EBA’s ESG risk unit, told Responsible Investor that the new report complements one published by the regulator in June 2021 which focused on the risk management of banks and investment firms, and the supervision of banks and only the largest investment firms.
The new guidance addresses the “missing element” of supervision of small and medium-sized investors, she added.
This work could not be undertaken until the EBA had set out the framework for the Supervisory Review and Evaluation Process (SREP), which came out in July. The SREP framework is used by supervisors to annually assess the risks financial institutions face and check that they are equipped to manage them properly.
Siwek told RI that the EBA’s report is not an extension of the SREP guidelines, but a tool designed to help the supervisors “identify areas where the incorporation of ESG elements is necessary”.
On the EBA’s suggested extension to the assessment horizon, she explained that traditionally the analysis of financial institutions’ business model would be short to medium-term focused. For the EBA, this means means a one-year time horizon for short-term viability and three to five years for mid-term sustainability.”
A shift to a 10-year assessment would be “quite significant” and would bring challenges, Siwek said.
“This is not an easy task and that is also why we are suggesting supervisors focus their long-term assessments on larger investment firms first, which have more significance for the markets, and also do it – at least in the first place – in a qualitative manner, based on specific considerations, such as how the strategy is being constructed, how the investment firm is planning to react or manage the risks that they are facing over a longer term.”
The EBA’s report was published the same week as the EU’s financial markets regulator and supervisor ESMA revealed plans to prioritise ESG disclosures over the next few years.
As part of that push, financial regulators in EU member states will be asked to ramp up scrutiny on ESG disclosures.
ESMA is required to identify a limited number of high-priority areas where “higher-intensity supervisory tools” and resources are needed to achieve effective supervision as part of its union strategic supervisory priorities (USSPs). These have no fixed term.
“We will foster transparency and comprehensibility of ESG disclosures across key segments of the sustainable finance value chain such as issuers, investment managers or investment firms and hence tackle greenwashing,” said ESMA, which makes up one third of the EU financial regulatory trio.
“The USSPs are an important tool through which ESMA coordinates supervisory action with [national regulators] on specific topics.”
EU financial institutions are due to start reporting ESG fund information under the SFDR regime from next year, and alignment KPIs against the EU green taxonomy from 2024.
ESG disclosures replace a previous USSP focused on costs and performance for retail investment products, which was adopted in 2020.