Last Thursday the European Central Bank (ECB) published a consultation on its Guide on climate‑related and environmental risks. The consultation runs until 25 September, with the Guide currently expected to apply from the end of this year, a rapid implementation by any standards and certainly in the current circumstances.
We have published a blog that summarises the ECB’s expectations for how the banks which it directly supervises should manage climate‑related and environmental risks. Here I set out four aspects of the ECB’s proposed Guide which strike me as particularly interesting.
First, the ECB’s expectations are detailed, considerably more do than, say, the material on climate risk from the PRA. (It is also noteworthy that the ECB’s Guide covers environmental risks, including biodiversity risks, a subject on which supervisors have so far said relatively little.) The ECB sets out 13 expectations, with a series of more granular observations underpinning each. This means a significant challenge for banks to assess how their current practices match the ECB’s expectations and to be ready to explain any divergence from them as part of the supervisory dialogue from the end of this year.
Second, despite the detail, the language of the Guide is very clear and, at times, deceptively simple, especially for such a complex subject area. For example, Expectation 7.4 states that “Institutions are expected to conduct a proper climate-related and environmental due diligence, both at the inception of a client relationship and on an ongoing basis”. When you contemplate the work involved in meeting this one‑sentence expectation, the magnitude of the compliance task becomes clear. In this respect the Guide reminds me of the Basel Committee on Banking Supervision’s Principles for effective risk data aggregation and risk reporting (or BCBS 239 as they are often known). These too are disarmingly simple in how they are expressed, but - as banks have discovered - fiendishly difficult and costly to comply with in practice.
Third, the Guide sets out very clearly the expectations of the Management Body for ensuring that climate-related and environmental risks are integrated into every aspect of decision-making, including strategy, business model, risk appetite and risk management. Banks will need both resources (human and financial) and data (KPIs, KRIs etc) to support this. In places the ECB’s approach brings to mind the UK’s Senior Managers Regime in the way that it seeks to allocate responsibility, although the emphasis is on allocation to functions rather than to individuals. For example: “Institutions are expected to explicitly assign responsibilities for climate-related and environmental risks within their institution. These responsibilities are also expected to be duly documented in the relevant governance documents”. There is no doubt that the ECB wants to pin down responsibility for climate and environmental risks very precisely across the three lines of defence.
Fourth, while the ECB makes it clear that the expectations in the Guide are not legally binding, we know from banks’ Brexit experiences that the ECB can make its expectations stretch a long way. Banks should be in no doubt about the impact of the ECB’s Guide and that it will use its supervisory dialogue with individual banks as means of levelling up the risk management practices across the population of banks it supervises directly.
The very clear message from the Guide is that the ECB is intent on setting a brisk pace for euro area banks on climate and environmental risks. It has set a demanding baseline and has signalled that it will hold the Management Body to account for meeting it. Although banks’ immediate priority will be on responding to the consultation, they also need to mobilise the resources to begin assessing their current practices against the ECB’s Guide so as to inform the supervisory dialogue with the ECB from the end of this year.
“Institutions are expected to ensure that their remuneration policy and practices stimulate behaviour consistent with their climate-related and environmental (risk) approach, as well as with voluntarily commitments made by the institution.”