Sustainable Finance implies that financial actors should consider Environmental, Social, and Governance (ESG) factors in their decision making with the aim of having long term sustainable, fair and environment friendly activities and projects.  The European Commission is making it clear that Sustainable Finance is a top priority, with a number of legislative and regulatory initiatives being issued, and also lately, the unveiling of a new strategy for financing the transition to a sustainable economy.

Very much related, the European Commission communication, identified areas where action is needed to support the necessary transition to a sustainable economic landscape.  Amongst others, the Commission identified the need to take further steps on accounting, credit ratings, micro-prudential and macro-prudential regulation.  The importance of ESG risk is in fact demonstrated in the proposed amendments to the Capital Requirements Directive (CRD6) and the Capital Requirements Regulations (CRR3) through the inclusion of the phrase “environmental, social and governance risks” in the title of the Directive. The topic is covered both directly and indirectly in the new proposals and banks will have to demonstrate significant improvement in their approaches to ESG issues:

• Pillar 3 disclosure requirements for ESG risks are extended from only large, listed banks to all banks in scope of CRR
• ESG considerations are to be included as a specific component of management responsibilities
• Supervisors have also been given new powers allowing them to require banks to reduce the risk of misalignment with relevant policy objectives of the EU over the short, medium and long term (including through adjustments to their business models, governance strategies and risk management)
• Banks are given new, formal requirements systematically to identify, measure and manage ESG risks, and their supervisors need to be able to assess risks at both bank and systemic levels

In its recent publication on the state of climate and environmental risk management in the banking sector, the ECB notes that from the banks which are under its direct supervision, none of such banks are close to fully aligning their practices with the ECB’s expectations and though banks have developed plans, progress is deemed too slow.

This is an area regarding which the MFSA similarly sees the need for further effort.  Being a relatively new area, banks will need to adapt to this new landscape and implement changes, not only to comply with the legislation but also to meet consumer and society expectations in the ESG field.

Banks are expected to holistically assess how ESG factors impinge on their operations and a dedicated strategy of how to manage the emanating risks should be in place.  This must be reviewed on an ongoing basis and appropriately enhanced.  It is essential that a sound data framework is in place, which besides being a pre-requisite for the necessary disclosure also serves to enhance the same risk management decisions.  Clear lines of responsibilities for such area need to be coherently established within an institution and the necessary reporting lines to the Board need to be set up. Moreover, such ESG risks will be assessed during the SREP process, and banks shall be expected to conduct internal stress tests against climate change risks.

Banks are encouraged to monitor ongoing developments in this area and plan ahead in order to effectively meet the ensuing requirements.

Banks should also be aware of the proposal for a Corporate Sustainability Reporting Directive, launched in April 2021, which will extend such reporting requirements to a greater number of entities, including all large companies, whether listed or not, without the 500-employee requirement.  Furthermore, and subject to a three-year transition period, the proposal extends the scope to also include SME’s that are listed.  Operationally, the actual proposal will amend other existent legislation. In addition to the environmental factors, the proposal also includes specific social factors and governance factors that would need to be disclosed.