Supervisory pressure is on as ECB publishes guide on climate-related and environmental risk

in Industry Insights, 09.12.2020

ESG – The acronym that’s taken the corporate world by storm as it continues to gain serious ground. It’s at the top of most corporate agendas, and financial institutions are no exception.

In its recent guide on climate-related and environmental risk (published in November 2020), the European Central Bank (ECB) declares that approaching the topic of ESG from a primarily CSR perspective is just not enough… Financial institutions need to take it up a notch and “develop a comprehensive risk management approach.”

Unexplained fears surrounding the number 13 (or triskaidekaphobia) can be traced back to ancient times… Thirteen also happens to be the number of high-level expectations covering the entire risk management universe. Make of that what you will!

A wake-up call for banks

Most bank risk management criteria will need to be revised in order to incorporate environmental risks. That means including all levels of policies and procedures, not to mention methodologies and infrastructure.

Banks must have processes to identify and integrate material emerging risks which are already subject to a wide range of regulations. The key assumption made by the ECB is that climate-related and environmental risks are material to banks, therefore all requirements are already in place.

A word of warning: Divergence from the ECB guide is equivalent to non-compliance with existing standards. As no transitional period is required, the guide is instantaneously applicable.

What needs to be done?

ESG is evolving at breakneck speed, and institutions are expected to keep up. But how can they stay ahead of the game? By regularly evaluating the “appropriateness and quality of the data sources and methods in place and to take into account up-to-date scientific insights.” Easier said than done, however, given that developing the tools needed to assess climate-related and environmental risks requires new data sources and models not typically used in bank risk management yet.

And let’s not forget that climate-related scenarios need a much longer time horizon to analyze the impact. Extending the scenario horizon requires dynamic balance sheet modeling and a significant overhaul of many firms’ scenario capabilities and infrastructure.

The ECB guide also examines the importance of integrating climate-related risks into credit risk management and processes, notably by evaluating the client’s vulnerability to climate-related aspects, as well as their approach to managing these risks. The ECB also mentions the possibility of offering “discounts on the interest rate of an environmentally sustainable loan.” This integration will require changes along the entire credit process in addition to the development of new tools, new methodologies and access to underlying data.

A starting point

While analyzing the ECB guide, KPMG identified actions on all time horizons. So, what are short-term priorities? Define the risk appetite and strategy as well as enhance transparency towards stakeholders. And a longer-term objective? The deployment of an adequate and mature methodology supporting long-term scenario analysis.

We have the resources and expertise you need

At KPMG, we have developed tools and methodologies to help you conduct an initial gap analysis for climate-related and environmental risk. Thanks to our international footprint, you’ll also have access to insight and benchmarking.

Even though all eyes are currently on climate-related and environmental risk, at KPMG we apply a holistic approach to the broader ESG topics impacting not just your processes, but also the expectations of your existing and future clients.