Context

On 27 October the European Commission published the two proposals to amend Regulation 575/2013 on prudential requirements for credit institutions and investment firms (CRR) and Directive 2013/36 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms (CRD).

Objectives

These proposed amendments have two main overarching objectives, 1⃣ to ensure financial stability and 2⃣ to contribute to the financial recovery of the economy after the COVID-19 crisis. As recognised by the Commission, achieving these objectives requires a transformation of the EU economy towards a more resilient, competitive and sustainable one that can combat the consequences of climate change. To this end, the intermediation of financial institutions that direct capital flows towards economically sustainable activities is essential. However, the transition towards a more resilient economy implies a series of risks that these institutions must face, and for which the role of the supervisor and the establishment of a prudential framework that integrates ESG risks play a fundamental role, not only for the management of these risks by organisations, but also as a guarantee of the stability of the European financial system. Thus, these new proposals for amendments are aimed at building a context that promotes an adequate understanding and management of ESG risks, given that the current requirements are insufficient for the challenges presented by the ESG field.

ESG Risks

The proposed CRR amendment thus introduces new sustainability concepts by providing harmonised definitions of ESG, environmental, physical, transitional, social and governance risks in the financial supervision framework. The proposed CRD requires the incorporation of ESG risks in the internal capital assessment strategies and processes, as well as in the internal governance arrangements in the short, medium and long term of credit institutions through specific plans for managing these risks. Furthermore, consistent with the importance of the role of supervisory bodies, both proposals empower competent authorities to review the alignment of banks with the ESG objectives and policies set by the European Union ????????, as well as the supervision of their ESG risk exposures in the short, medium and long term through regular stress tests.

Prudential treatment of ESG exposures

A further sign of the urgency and centrality of green and sustainable finance for the European regulator is the EBA’s prudential reporting requirements in the ESG area. Thus, they require an advance from 2025 to 2023 for the EBA to publish a report on the prudential treatment of these exposures, with an analysis of the risks associated with assets and activities in the energy ⚡, infrastructure and transport sectors. In addition, they should address the possibility of a calibration of the risks associated with a particularly high exposure to climate risk, including assets or activities in the fossil fuel sector and in sectors with high climate impact in order to consider the possibility of applying a specific prudential treatment for these types of exposures.

In the same vein, the proposed amendment of the CRD requires the EBA to develop ESG risk assessment criteria, in terms of identification, measurement, management and monitoring, as well as plans to be developed by credit institutions on their resilience in stress tests and the negative impacts of ESG risks. It also empowers the EBA to develop uniform guidelines for the inclusion of ESG risks in the Supervisory Review and Evaluation Process (SREP), as well as to develop and include methodological standards for the incorporation of these risks in stress tests, giving priority to environmental risks as these are more evolved both at the regulatory level and in the availability of information in the market.

Date of implementation

The implementation of these proposals has been projected by the Commission in January 2025 ????, subject to possible modifications as this proposed legislative package will be discussed in the European Parliament and in the Council, although the Commission has opened the period for comments for a period of 8 weeks with the aim of enriching these documents.

Conclusion

The European Commission continues to push for the incorporation of ESG factors in the risk management of institutions, as evidenced by the advance in the timetable of the report required in this respect from the EBA. The differential prudential treatment of exposures aligned with the objectives of the Green Pact ♻ seems unstoppable and it is therefore essential for institutions to adapt their data, processes, methodologies and tools to respond with guarantees to this new reality.