ESG Risk Alert: Stay in pole position with the European Banking Authority’s navigation system!

It may require some imagination on your part, but the current environmental, social and governance (ESG) landscape could be compared to the early years of Formula One (F1) racing. Back then, the rapid and revolutionary changes in racing technology brought on an era where drivers frequently raced in a blaze of glory. However, they routinely perished in sometimes horrific crashes. 

With the fast and frequent regulatory changes that have come about in the name of ESG these past few years, it’s prudent to tread carefully to avoid the same fate as the early days of F1 drivers. To this end, the European Commission called on the European Banking Authority (EBA) for support in ensuring synergy in the execution of its Sustainable Action Plan.

Don’t have time to read the whole blog entry? Then watch our “Blog in 1 minute” video for a quick summary of its main points:

The sea of regulatory—and accompanying market overhaul—stemming from Europe’s sustainability agenda alone asks for flexibility and adaptability when it comes to implementing sustainability policy agendas. 

The financial sector is undoubtedly a crucial lynchpin in its potential to facilitate the transition to a robust, stable and sustainable future. For one, in terms of financing the transition towards a low-carbon, more resource-efficient and sustainable economy, but also when it comes to managing financial risks stemming from ESG factors.

Hence, the European Commission’s Action Plan on sustainable finance is aimed at addressing these challenges to ensure the robustness of financial institutions in financing the economy’s sustainable transformation.

In this blog, we steer you through the delivery of the roadmap of the EBA’s mandates. We explain the reasoning behind it as well as the EBA’s key objectives and approach. To help you with the framing, we also provide an overview of the relevant milestones that have been delivered so far and the ones that are still to come, according to the EBA’s sequenced approach. Are you wondering what that means? We explain that too.

Whether you feel prepared for the regulatory expectations or find you could use a helping hand, it’s time for you to buckle up and start your engines. But don’t you worry, we can be your pit team on your journey.

The race is on: An introduction to the EBA’s policy agenda on ESG factors and risks

ESG risks are changing the risk picture for the financial sector, including banking, calling all stakeholders to take assertive actions. Their cross-cutting nature necessitates a holistic approach, to which end, the European Commission’s Action Plan on sustainable finance called on the EBA to provide direct support in its execution, primarily through mandates that cover ESG factors and ESG risks. 

As a response, the EBA published their first action plan on sustainable finance in 2019, specifying four areas of focus: 

  • strategy and risk management; 
  • key metrics and disclosure; 
  • stress testing and scenario analysis; 
  • and prudential treatment.

Nevertheless, finance, much like the sustainability agenda in recent years, keeps on racing, and while large parts of the actions envisaged under the 2019 action plan have already been finalised, the work continues. 

In the past years, the EBA’s policy agenda has grown significantly, in line with the policy developments at the European Union (EU) and international levels. 

Building on the work of the initial action plan, the EBA’s new roadmap brings continuity to the steps already taken while also adding new areas of focus. On the road to fulfilling the EU’s sustainability strategy, the EBA’s mandates and tasks now expand to the labelling of sustainable products, greenwashing, while continuing to strengthen its supervisory reporting and enhanced risk monitoring framework.

EBA’s mandates and tasks in the area of sustainable finance and ESG risks
Click to enlarge | Source: PwC Luxembourg

Hands on the steering wheel and follow the navigation system for consistent ESG regulatory actions

After World War II, motor racing was revamped. The minimum race distance was reduced, which in turn, allowed for the race time to decrease from the previous 48 hours to only a few, making it more exciting for both the drivers and the spectators.

Such changes led to the creation of the Monaco Grand Prix and the announcement of plans for a World Championship in 1950, dubbed the “International Formula One” race. A month later, Silverstone, home of the British Grand Prix, hosted the first sanctioned championship race for Formula One Grand Prix cars. The F1 World Championship was born, and the rest is history.

To bring synergy to sustainability ambitions in business and develop a cohesive sustainable banking framework, the Commission’s mandate to the EBA has stressed the need for ensuring a consistency of regulatory actions across the EU financial sector. 

As a key objective, the EBA will contribute to the development of an adequate regulatory and supervisory framework regarding ESG risks by analysing how such risks are embedded in the current prudential regulation, and how institutions and competent authorities address them. 

The primary role of the prudential framework is to facilitate a stable and resilient financial sector that will be able to provide the financing for the needed economic and social transition. But that’s not enough. Managing ESG challenges calls for the implementation of a range of new, as well as updates to old, public policies.

Eight stop-overs on the roadmap: what activities are already planned?

With the “race towards sustainability” in full swing, the EBA has envisioned a sequenced approach by progressively updating and enhancing the integration of ESG risks in the supervisory and regulatory framework. Work on ESG risks will primarily cover the three pillars of the banking framework—prudential requirements, supervision and market discipline—along with other related areas and the monitoring and assessment of risks.

To begin, fostering transparency and market discipline on ESG issues through enhanced disclosures, such as Pillar 3 disclosure requirements, remains a key priority for the sequenced approach. Similarly, efforts will continue to ensure that ESG factors and risks are adequately integrated in institutions’ risk management frameworks and in their supervision, including through further developments on climate stress tests.

In the area of prudential regulation, the EBA is assessing whether amendments to the existing prudential treatment of exposures to incorporate environmental and social considerations would be justified. Furthermore, the development of green standards and labels will carry on along with measures to address emerging risks in this field, such as greenwashing

Finally, developments in sustainable finance and institutions’ ESG risk profile will be monitored and assessed on an on-going basis, including on account of the expected supervisory reporting.

The phases of the EBA’s sequenced approach

Achieving speed: key milestones in the EBA’s implementation phases

With the basis for the sequenced approach formulated, the EBA has taken off with full speed to implement its mandates. As the scope of its policy agenda has significantly expanded, however, the regulatory overhaul in the related policy areas has also been numerous. Below is a brief extract of key milestones in the EBA’s implementation phases. 

Click to enlarge 

How to prepare for the journey

Already feeling the exhilaration of the “race towards sustainability”?

Continuing with the F1 racing analogy, the most crucial tool of a driver, and most decisive in their victory, is the quality of their car. Among the best of the early F1 manufacturers were Bugatti and Fiat, which introduced the supercharger for the first time in 1923.

In this case, as preparation and foundation for your journey, we recommend laying down a basis for a robust ESG programme that signals to investors and regulators that your company is “forward-looking” and “risk-conscious”. 

For example, you can start with ensuring your institution’s resilience to the potential financial impact of ESG risk by accounting for ESG factors in risk management, including credit risk policies and procedures. Additionally, developing credit classification systems, including green lending policies and procedures, sets a precedent for integrating ESG factors and risks into your firm’s business strategy. 

Conclusion of the journey

F1 as it’s known today has its roots in the European Grand Prix championships, but this sport’s history is in part about the evolution of its technical regulations, which has allowed for the standardisation of rules that birthed the first World Championship. 

To round out the comparison with F1, a sound framework for sustainable banking products is also necessary to allow for the emergence of a robust sustainability framework for banking. Moreover, the ESG risks’ cross-cutting nature necessitates a holistic approach that entails enhancing their measurement, management, disclosure, and monitoring as well as effective supervision of institutions.

The past EBA initiative was focused on understanding market practices related to ESG aspects, investigating existing regulatory concepts from the ESG point of view, and formulating common definitions and terminology to be applicable in the regulatory framework. 

However, as the framework for sustainable finance became more developed, it was necessary to review the initial action plan to add new areas of focus that related to the labelling of products, greenwashing as well as supervisory reporting and enhanced risk monitoring framework.

Our last piece of advice is to not overlook the importance of pit stops. Along the lengthy, winding roads on which F1 races were initially held, there were the “pits”, whose first iteration was shallow emplacements dug by the side of the track where mechanics could fix the detachable rims on early car tires. Later, the pit stops started sending signals to the drivers  to indicate that work needed to be done on their cars. 

Ready for the disclosure requirements to come, or maybe you need some help? Our Financial Services Core team is the perfect pit stop along your ESG disclosure journey to help you meet the regulatory expectations. Visit our “Sustainable Finance” web page to find out more about the specific business needs that you might have and how we can support you.  

What we think
Jörg Ackermann
Jörg Ackermann, Partner at PwC Luxembourg

The challenge with ESG reporting is that currently it feels like a fragmented landscape, with many different groups and regulations implicated. The mission is to engage all of them and create a holistic vision for ESG reporting and impact.

Jean Philippe Maes, Risk Management Partner at PwC Luxembourg
Jean-Philippe Maes, Risk Management Partner at PwC Luxembourg

Demand for ethical and sustainable investments is now on the rise and increasingly being adopted by a wide range of investors. Thus, greater clarity about ESG regulations will enable banks to more effectively fund companies and projects that promote a sustainable future.

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