The European Central Bank (ECB) will expect banks to assess and disclose climate and environmental risk as early as this year, it has revealed, as it invites feedback from the industry on new guidelines.
The EU banking supervisor has launched a consultation on its expectations for how banks should manage climate-related and environmental risks and disclose such risks transparently under the current prudential framework.
The new Guide on Climate and Environmental Risks reveals that the ECB will expect lenders to disclose financially material climate-related risks in alignment with European Commission guidelines on non-financial reporting, the TCFD recommendations, and the Non-Financial Reporting Directive, the latter of which is currently under review.
Disclosure is one of a raft of expectations that will be confirmed when the final guide is published, and focuses on five aspects: business model, policies and due diligence processes, outcomes, risks and risk management and KPIs.
Institutions will also have to disclose their group-wide Scope 1, 2 and 3 greenhouse gas emissions, the amount or percentage of carbon-related assets in each portfolio, and the weighted average carbon intensity of each portfolio.
The draft guide says: “Institutions are encouraged to adopt a granular approach to measuring carbon emissions. This could, for instance, entail a project-by-project approach to measuring the carbon intensity of large corporate portfolios and the property-by-property measurement of actual energy consumption or energy efficiency classification for real estate portfolios.”
The ECB wants banks to comply with the new guidelines as soon as they are finalised towards the end of the year, and from next year will ask banks to explain any deviation, although non-compliance will not initially trigger sanctions, it said.
The guide outlines 13 expectations for lenders in the areas of business models and strategy, governance and risk appetite, risk management and disclosure.
It says institutions are expected to “conduct a rigorous programme of stress testing” with a view to incorporating them into their baseline and adverse scenarios.
It says scenario analysis and stress testing should consider physical risk and transition risk, how risks may develop under various scenarios, “taking into account that these risks may not be fully reflected in historical data” and in the short, medium and long term.
Institutions are expected to consider adopting a longer time horizon than the ICAAP’s recommended three years, “given the likelihood that [climate-related and environmental risks] will mostly materialise in the medium to long term”.
It warns that institutions associated with social or environmental controversies could face reputational risk “as a result of changing market sentiment” and says institutions are expected to consider evaluating the compliance of their investment products with international or EU best practices, such as the EU Green Bond Standard, to avoid reputational risks arising from controversy in connection to their products.
Institutions are also “encouraged to monitor on an ongoing basis the effect of climate-related and environmental factors on their current market risk positions and future investments”.
The consultation on the guidelines closes on September 25, 2020.
It is the latest in a flurry of activity by central banks on sustainability and climate risk.
Last week, the Bank of Canada made reporting climate risks a condition for firms to receive its Covid-19 bailout, and has also published climate scenario analysis of the global economy, as RI reported yesterday. It is currently working on developing Canada-specific scenarios to conduct its own climate stress test of the country’s financial sector and to inform monetary policy.
In Mexico, the central bank said this week it wanted to help lead a taskforce to mobilise climate and SDG finance and create a sustainable finance taxonomy in a new report produced in collaboration with UNEP Inquiry.
Meanwhile, on Wednesday next week, the Network for Greening the Financial System will release two reports: a guide for supervisors on integrating climate-related and environmental risks in prudential supervision, and a status report on financial institutions’ practices from working with green, non green and brown financial assets.