The European Commission’s landmark Action Plan on Sustainable Finance called upon Europe’s ‘supervisory trinity’ to support the implementation of its vision.
Specifically, in the short-term, it sought “guidance” from the trio – the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) – on how sustainability could be incorporated into existing legislation.
Now incoming amendments to capital requirements legislation – all but approved by the European Parliament – will see the London-based EBA take up that mantle and grapple with some of the Commission’s key proposals, including scenario analysis, stress testing and the prudential treatment of green assets.
Among the proposed amendments to the Capital Requirement Regulation II/ Capital Requirement Directive V (CRR II/CRD V) legislation, which has been under review since 2016, are several significant sustainability issues for Europe’s banking supervisory body to work through and report back to the Commission on in the coming years.
One refers directly to action eight of the Commission’s plan, namely, the prudential treatment of green assets. The other two relate to the consideration and disclosure of ESG risks more broadly by Europe’s banking sector.
A plenary vote at the European Parliament in April is all that now stands in the way of the formal adoption of the text, a mere “formality” according to a spokesperson for German MEP Peter Simon. It was Simon, a member of the Group of the Progressive Alliance of Socialists and Democrats, who introduced a draft report in 2017 proposing that ESG risks be included among the amendments to the legislation.
The spokesperson for Simon’s office told RI that the mandates handed to the EBA are the result of negotiations with the Council. There had been, he said, a “reluctance” among some parliamentary parties to “adopt ambitious proposals” without the EBA investigating them first. That hesitancy, he added, mainly came from centre-right groupings the European People’s Party (EPP), the European Conservatives and Reformists (ECR) and liberal centrists, the Alliance of Liberals and Democrats for Europe (ALDE).
Last month, both the Council of the EU and the parliament’s Committee on Economic and Monetary Affairs (ECON) approved the negotiated amendments.
Over the next two years the EBA – pending final adoption of the text – will assess the “potential inclusion” of ESG risks in the “review and evaluation” of member state “competent authorities”. Those 28 “authorities” – which (currently) include the Bank of England and the Netherland’s DNB – make up the EBA’s Board of Supervisors, the body that makes policy decisions.
The EBA’s assessment will cover:
(a) Definitions of ESG risks (physical, transition, and regulatory)
(b) The development of appropriate qualitative and quantitative criteria for the assessment of the impact of such risks on the financial stability of institutions (including stress testing and scenario analysis).
© The strategies, processes and mechanisms implemented by institutions to identify, assess and manage ESG risks
(d) The analysis methods and tools used to assess the impact of ESG risks on lending and financial intermediation activities of institutions.Slavka Eley, Head of Banking Markets, Innovation and Products at the EBA, told RI that this mandate [on ESG risks] is “quite broad”, but that it basically looks at how sustainability “can be incorporated into risk management of banks and supervisory review process”.
Definitions arrived at by this report will then inform another draft amendment, which when adopted, will require “large institutions” operating in EU member states to disclose their ESG risk exposure.
Such disclosures, which will take place “annually the first year and biannually the second year and thereafter”, according to the draft, will come into effect in three years’ time when the regulation comes in force.
Eley told RI that there would be a focus on “pillar three disclosure”, which is “more on prudential disclosure on ESG related risks than general non-financial disclosure”.
For the mandate on prudential treatment of green assets, the EBA has been given significantly longer, six years, to explore the justification for considering prudential risk through a sustainability lens.
The EBA will consult with the European Systemic Risk Board, an independent EU body responsible for the macroprudential oversight of the financial system, on the mandate.
It will, the draft regulation adds, base its report on “available data and the findings of the High Level Expert Group on Sustainable Finance [HLEG] of the Commission”.
The Commission will use the EBA’s findings to determine if it is “appropriate” to submit a legislative proposal to the European Parliament and the Council on the topic.
Denisa Avermaete, Senior Policy Advisor at the European Banking Federation (EBF) expressed her disappointment at the length of this mandate, she told RI: “If you think six years for the report and I don’t know how many more years to get something agreed in parliament…it is quite a long way [off]”.
Avermaete added it is important for the capital framework to remain risk sensitive. She gave the example of green mortgages where there is emerging evidence of a lower risk of default compared to conventional mortgages.
The EBF is also co-hosting an event next month with the EBA to discuss the mandates, attended by both central and private bankers.
Another mandate, explicitly mentioned in the Action Plan but not in the CRR II /CRD V legislation, was put to all three of Europe’s supervisory authorities in January by the Commission.
It called on them to each collect evidence of “potential undue short-term pressure from capital markets on corporations” and consider what role, if any, regulators can play in addressing them. They have been asked to report their findings by the end of the year.
Eley also told RI that it is “likely” that a specific reference to sustainability considerations in the mandate of the ESAs will be included in a review of the “founding regulations of all three ESAs” that is currently on-going.
EBA is also a member of the Commission’s Technical Expert Group (TEG) on sustainable finance, which was appointed in June 2018 to build upon the work of the HLEG and the Commission’s Action Plan. Eley told RI that as part of that working group the EBA “actively contributed” on the TEG’s report on climate related disclosures, which was the basis for the update of the Commission’s non-binding guidelines on non-financial reporting published in February 2019 for consultation.
The EBA, she said, also “directly participated” on the preparation of the draft EU green bond standard also published this month by the TEG.