In response to various mandates related to ESG factors and ESG risks comprised in several EU pieces of legislation (CRR2 and CRD5, new IFR and IFD, notably), the EBA issued the Action Plan to highlight certain messages on sustainable finance and to clarify for certain financial institutions the policy direction and expectations regarding ESG risks. The EBA noted three areas where institutions should consider affirmative actions: strategy and risk management, disclosure, and scenario analysis.
According to the EBA, the Action Plan is part of a broader effort to "connect finance with the needs of the European and global economy related to sustainable developments." The three main objectives of the Action Plan are to: (i) reorient capital flows to sustainable investment to attain sustainable and inclusive growth; (ii) manage financial risks resulting from climate change, resource depletion, environmental degradation, and social issues; and (iii) encourage transparency and long-term commitment in financial and economic activity.
The Action Plan sets forth the legislative sources of the EBA mandates and specifies what each mandate requires of the EBA. It describes, for example, three mandates related to sustainable finance. The first such mandate requires the EBA to "assess the potential inclusion of ESG risks in the supervisory review and evaluation process performed by competent authorities" and sets forth the factors that the EBA's assessment must include. The second such mandate requires the EBA to develop a technical standard that will implement disclosure requirements related to ESG risks, and the third mandate requires the EBA to make assessments as whether "a dedicated prudential treatment of exposures related to assets or activities associated substantially with environmental and/or social objectives" is justified. The deliverable related to achieving each mandate also is noted.
As noted above, the EBA expects to issue a number of pieces in the next five years to address the mandates in this area. In the meantime, the Action Plan sets forth key policy messages and expectations with respect to mandates on sustainable finance. In short, the EBA notes that financial institutions will need to have in place metrics, strategies, and risk management to deal with potential consequences of climate change and the related physical and transition risks. Although this effort is at an early stage, institutions should begin now to consider how they will take action with respect to these areas prior to the EBA completing its mandates.
The EBA encourages institutions to incorporate ESG considerations into business strategy and risk management to mitigate the impact of environmental and social risks, based in particular on the currently built EU taxonomy. In addition, institutions can begin to incorporate ESG risks into other aspects of their operations (e.g., business plans, internal control framework, and decision-making processes) while continuing to work on and participate in other related initiatives (e.g., the Non-Financial Reporting Directive). These approaches and practices implemented by institutions now can be used to assist the EBA in addressing the mandates and will give market participants time to become familiar with the application of, for example, ESG disclosure metrics, prior to a more formal requirement.