Report
In its response to the EBA consultation on the draft guidelines for the management of ESG risks, Finance Watch encourages developing consistent rules for transition plans under both the CSDDD (the Corporate Sustainability Due Diligence Directive) and the prudential rules.
On 18 April 2024, Finance Watch responded to the EBA consultation on the draft guidelines setting out requirements for institutions for the identification, measurement, management and monitoring of ESG risks. The draft guidelines propose, among others, provisions for the development of plans aimed at addressing the risks arising from the transition towards an EU climate-neutral economy. They follow the mandate provided to the EBA in point 5 of Article 87a of the amended Capital Requirements Directive (CRD).
Finance Watch welcomes the early work from the EBA on the guidelines to clarify the current expectations on the management of ESG risks and how prudential transition plans should interact with CSDDD-based transition plans, which aim at ensuring that the business model and the strategy of companies is compatible with the objectives of the Paris Agreement. However, Finance Watch highlighted specific attention points, including:
- It is important that CRD-based and CSDDD-based transition plans share common foundations and be consistent in terms of criteria, methodologies, assumptions and targets, as proposed by the EBA. Considering both plans as distinct exercises would undermine the comparability of the transition plans and result in duplicative efforts for financial institutions.
- CRD-based and CSDDD-based transition plans should still respond to distinct purposes and be designed accordingly. In their design, CSDDD-based transition plans should be seen as a prerequisite for the design of CRD-transition plans. While we understand that not all financial institutions subject to CRD are in scope of CSDDD transition plans, they still need to understand how their business model, their portfolio and their exposures should look to be considered as consistent with the objectives of the Paris Agreement.
- The time horizon for the management of ESG risks should be extended. A 10-year time horizon for strategic planning and managing ESG risks remains insufficient to take into account the transition risk perspective and the necessary transformations that need to happen to meet the objectives of the Paris Agreement.
- Currently, EBA guidelines illustrate that exposures to concerned companies showing a high level of taxonomy-alignment may not be considered material. This leads to the false impression that taxonomy alignment entails the absence of ESG risks.
- GHG emissions should be considered both in absolute and intensity values. GHG intensity, whether based on the enterprise value or the revenue, is not the right metric to measure decarbonisation results. EBA should therefore not give the flexibility for the institutions to use one or the other metric.
As the draft guidelines refer to the materiality assessment for ESG risks, Finance Watch reiterates that there is lack of clarity on the performance of materiality assessment for ESG risks and the robustness of the assessment varies between the institutions. Additional guidelines and clearer expectations on the materiality assessment, with references to qualitative and quantitative thresholds, will be key to ensure that institutions develop their risk management approach on an equivalent basis. Further, the consideration of exposures towards sectors that highly contribute to climate change as material by default is welcome but the list of sectors highly contributing to climate change should be more granular.
Finally, Finance Watch reiterates that there needs to be a radical rethinking of the approach to climate scenario modelling. The results of scenario analyses conducted have predicted only benign impacts of climate change or disorderly transition on the financial system, giving a false sense of security to policymakers. Such results are in stark contrast with climate science, which predicts major macroeconomic disruptions at the warming levels above 2C. The reason for this paradox lies in the economic models used for climate scenario analyses. These models rely on historical data and make assumptions about economic equilibrium that may no longer apply, as climate-related impacts will be disruptive, unpredictable and permanent. Tipping points and feedback mechanisms are not modelled, whereas they could accelerate losses to levels far above those from recent financial crises.
