Guide on climate-related
and environmental risks
Supervisory expectations relating torisk management and disclosure

November 2020

Contents
1

Introduction

3

2

Scope and application

6

2.1

Application to significant institutions

6

2.2

Date of application

7

2.3

Application to less significant institutions

7

2.4

General prudential framework

7

3

4

Climate-related and environmental risks

10

3.1

Definitions

10

3.2

Characteristics of climate-related and environmental risks

10

3.3

Observations from stocktakes

14

Supervisory expectations relating to business models and strategy
16

5

6

4.1

Business environment

16

4.2

Business strategy

18Supervisory expectations relating to governance and risk appetite

21

5.1

Management body

21

5.2

Risk appetite

24

5.3

Organisational structure

26

5.4

Reporting29

Supervisory expectations relating to risk management

31

6.1

Risk management framework

31

6.2

Credit risk management

35

6.3

Operational risk management

38

6.4

Market risk management

40

6.5

Scenario analysis and stress testing

42

6.6

Liquidity risk management

43

Guide on climate-related and environmental risks1

7Supervisory expectations relating to disclosures

45

7.1

Disclosure policies and procedures

45

7.2

Content of climate-related and environmental risk disclosures

48

References

51

Guide on climate-related and environmental risks21

Introduction
Following the adoption of the Paris Agreement on climate change 1 and the UN 2030
Agenda for Sustainable Development in 2015, governments are making strides totransition to low-carbon and more circular economies on a global scale. On theEuropean front, the European Green Deal sets out the objective of making Europe thefirst climate-neutral continent by 2050. The financial sector is expected to play a keyrole in this respect, as enshrined in the Commission action plan on financing
sustainable growth.
Transitioning to a low-carbon and more circular economy entails both risks andopportunities for the economy and financial institutions, 2 while physical damage
caused by climate change and environmental degradation can have a significant
impact on the real economy and the financial system. For the second year in a row, theEuropean Central Bank (ECB) has identified climate-related risks as a key risk driverin the SSM Risk Map for the euro area banking system. The ECB is of the view that
institutions should take a strategic, forward-looking and comprehensive approach toconsidering climate-related and environmental risks.
The ECB is closely following developments that are likely to affect euro area
institutions. The Commission action plan on financing sustainable growth aims toredirect financial flows to sustainable investments, to mainstream sustainability in risk
management and to enhance transparency and long-termism. Specifically for thebanking sector, the European Banking Authority (EBA) was given several mandates toassess how environmental, social and governance (ESG) risks can be incorporated
into the three pillars of prudential supervision. Based on this, the EBA published an
Action Plan on sustainable finance and a Discussion Paper on the integration of ESG
risks into the regulatory and supervisory framework.
This guide outlines the ECB’s understanding of the safe and prudent management ofclimate-related and environmental risks under the current prudential framework. It
describes how the ECB expects institutions to consider climate-related andenvironmental risks – as drivers of existing categories of risk – when formulating andimplementing their business strategy and governance and risk management
frameworks. It further explains how the ECB expects institutions to become moretransparent by enhancing their climate-related and environmental disclosures.
This guide is not binding for the institutions, but rather it serves as a basis forsupervisory dialogue. As part of this supervisory dialogue, the ECB will discuss withinstitutions the ECB’s expectations set out in this guide in terms of any possible
divergences in institutions’ practices. The ECB will continue to develop its supervisory

1

Similarly, and following the Global Assessment by the Intergovernmental Science Policy Platform on
Biodiversity and Ecosystem Services (IPBES), additional international agreements are expected under
the UN Convention on Biological Diversity to promote the sustainable use of ecosystems and reduce thecauses of biodiversity loss.

2

See, for example, ECB Financial Stability Review May 2019.

Guide on climate-related and environmental risks

3

approach to managing and disclosing climate-related and environmental risks overtime, taking into account regulatory developments, as well as evolving practices in theindustry and in the supervisory community.

Box 1
Overview of ECB supervisory expectations
1.

Institutions are expected to understand the impact of climate-related and environmental risks on
the business environment in which they operate, in the short, medium and long term, in order tobe able to make informed strategic and business decisions.

2.

When determining and implementing their business strategy, institutions are expected tointegrate climate-related and environmental risks that impact their business environment in the
short, medium or long term.

3.

The management body is expected to consider climate-related and environmental risks whendeveloping the institution’s overall business strategy, business objectives and risk management
framework, and to exercise effective oversight of climate-related and environmental risks.

4.

Institutions are expected to explicitly include climate-related and environmental risks in their risk
appetite framework.

5.

Institutions are expected to assign responsibility for the management of climate-related andenvironmental risks within the organisational structure in accordance with the three lines ofdefence model.

6.

For the purposes of internal reporting, institutions are expected to report aggregated risk datathat reflect their exposures to climate-related and environmental risks with a view to enabling themanagement body and relevant sub-committees to make informed decisions.

7.

Institutions are expected to incorporate climate-related and environmental risks as drivers ofexisting risk categories into their existing risk management framework, with a view to managing,monitoring and mitigating these over a sufficiently long-term horizon, and to review theirarrangements on a regular basis. Institutions are expected to identify and quantify these risks
within their overall process of ensuring capital adequacy.

8.

In their credit risk management, institutions are expected to consider climate-related andenvironmental risks at all relevant stages of the credit-granting process and to monitor the risks
in their portfolios.

9.

Institutions are expected to consider how climate-related and environmental events could havean adverse impact on business continuity and the extent to which the nature of their activities
could increase reputational and/or liability risks.

10. Institutions are expected to monitor, on an ongoing basis, the effect of climate-related andenvironmental factors on their current market risk positions and future investments, and todevelop stress tests that incorporate climate-related and environmental risks.

Guide on climate-related and environmental risks411. Institutions with material climate-related and environmental risks are expected to evaluate theappropriateness of their stress testing with a view to incorporating them into their baseline andadverse scenarios.
12. Institutions are expected to assess whether material climate-related and environmental risks
could cause net cash outflows or depletion of liquidity buffers and, if so, incorporate these factors
into their liquidity risk management and liquidity buffer calibration.
13. For the purposes of their regulatory disclosures, institutions are expected, to publish meaningful
information and key metrics on climate-related and environmental risks that they deem to bematerial, with due regard to the European Commission’s Guidelines on non-financial reporting:
Supplement on reporting climate-related information.

Guide on climate-related and environmental risks

5

2

Scope and application

2.1

Application to significant institutions
The expectations set out in this guide are to be used in the ECB’s supervisory dialogue
with significant institutions directly supervised by the ECB. This guide was developed
jointly by the ECB and the national competent authorities (NCAs) with the aim ofproviding greater transparency regarding the ECB’s understanding of sound, effective
and comprehensive management, as well as disclosure of climate-related andenvironmental risks under the current prudential framework. 3 Moreover, it aims toenhance the industry’s awareness of and preparedness for managing climate-related
and environmental risks.
The guide does not substitute or supersede any applicable law. It should be read in
conjunction with other ECB guides and, in particular, the ECB Guide to the internal
capital adequacy assessment process (ECB Guide to the ICAAP). 4 The supervisory
expectations relate to specific provisions under the Capital Requirements Directive(CRD) 5 and the Capital Requirements Regulation (CRR). 6 Therefore, the level andscope of consolidation to which each of the supervisory expectations applies follows
the same level and scope of application as that of the relevant provision.
Significant institutions are expected to use the guide, taking into account themateriality of their exposure to climate-related and environmental risks. For the
purposes of this guide, materiality should be considered in the light of the applicable
CRD and CRR provisions. 7 It is worth noting that the assessment of materiality is an
institution-specific assessment, taking into account the specificities of the respective
business model, operating environment and risk profile. Depending on the businessmodel, operating environment and risk profile, an institution, irrespective of its size,
could be concentrated in a market, sector or geographic area that is exposed tomaterial physical and transition risks, which means that it could be extremely
vulnerable to the impacts of climate-related change and environmental degradation. 8
Furthermore, in addition to this guide and to relevant Union law and national law,
institutions are encouraged to duly consider other relevant publications, such as thoseby the European Commission (EU COM), the EBA, the Network for Greening the3This effectively means that this guide does not intend to impose additional auditing requirements.

4

See the Guide to the internal capital adequacy assessment process (ICAAP), ECB, 2018. The current
guide further specifies how the particularities of climate-related and environmental risks are expected tobe taken into account for the management of risks to capital.

5

Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to theactivity of credit institutions and the prudential supervision of credit institutions and investment firms,
amending Directive 2002/87/EC and repealing Directive 2006/48/EC and 2006/49/EC (OJ L 176,
27.6.2013, p. 338).

6

Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on
prudential requirements for credit institutions and investment firms and amending Regulation (EU)No 648/2012 (OJ L 176, 27.6.2013, p.1).

7

See also Chapters 6 and 7 of this guide.

8

See the “Guide for Supervisors: Integrating climate-related and environmental risks in prudential
supervision”, Technical document, NGFS, May 2020.

Guide on climate-related and environmental risks

6

Financial System (NGFS), the Basel Committee on Banking Supervision (BCBS), theFinancial Stability Board, the Task Force on Climate-related Financial Disclosures(TCFD), the Organisation for Economic Co-operation and Development (OECD) andthe NCAs. 9
It should be noted that the examples of observed practices shown in the boxes in thisguide merely serve as a means of illustration and are not necessarily replicable, nor dothey necessarily meet all supervisory expectations.

2.2

Date of application
This guide is applicable as of its date of publication. Significant institutions are
expected to consider the extent to which their current management and disclosure
practices for climate-related and environmental risks are sound, effective andcomprehensive in the light of the expectations set out in the guide. Where this isneeded, significant institutions are expected to promptly start enhancing theirpractices.
As part of the supervisory dialogue, from early 2021, significant institutions will be
asked by Joint Supervisory Teams to inform the ECB of any existing divergences intheir practices from the supervisory expectations described in this guide and to informthe ECB of arrangements aimed at progressively addressing these expectations. The
ECB acknowledges that the management and disclosure of climate-related andenvironmental risks, and also the methodologies and tools used to address them, arecurrently evolving and are expected to mature over time.

2.3

Application to less significant institutions
This guide was developed jointly by the ECB and the NCAs and is aimed at ensuring
the consistent application of high supervisory standards across the euro area. NCAs
are therefore recommended to apply the expectations set out in this guide in theirsupervision of less significant institutions in a manner that is proportionate to thenature, scale and complexity of the activities of the institution concerned. The ECB
acknowledges that a number of NCAs have issued, or are in the process of issuing,
guidance on climate-related and environmental risks. Less significant institutions areinvited to consider these as well as other relevant publications by their NCAs.

2.4

General prudential framework
This guide describes the ECB’s understanding of sound, effective and comprehensive
management and disclosure of climate-related and environmental risks under the9See, for instance, “Guidance Notice on Dealing with Sustainability Risks”, BaFin, 2019, “Integration ofclimate-related risk considerations into banks’ risk management”, Good Practice document, DNB, 2020,and “Guide for Handling Sustainability Risks”, Consultation document, FMA, 2020.

Guide on climate-related and environmental risks

7current prudential framework. In that respect, the following articles under the CRD and
the CRR are of particular relevance:•

Article 73 CRD requires institutions to have in place sound, effective andcomprehensive strategies and processes to assess and maintain on an ongoingbasis the amounts, types and distribution of internal capital that they consider
adequate to cover the nature and level of the risks to which they are or might be
exposed.

•

Article 74(1) CRD requires institutions to have robust governance arrangements,
which include a clear organisational structure with well-defined, transparent andconsistent lines of responsibility, effective processes to identify, manage, monitor
and report the risks they are or might be exposed to, adequate internal control
mechanisms, including sound administration and accounting procedures, andremuneration policies and practices that are consistent with and promote soundand effective risk management.

•

Article 74(2) CRD provides that the arrangements, processes and mechanisms
referred to in paragraph 1 shall be comprehensive and proportionate to thenature, scale and complexity of the risks inherent in the business model and theinstitution’s activities. The technical criteria established in Articles 76 to 95 shallbe taken into account.

•

Article 76(1) CRD requires institutions to ensure that the management body
approves and periodically reviews the strategies and policies for taking up,
managing, monitoring and mitigating the risks the institution is or might be
exposed to, including those posed by the macroeconomic environment in which it
operates in relation to the status of the business cycle.

•

Article 79 CRD sets out specific legislative requirements for credit andcounterparty risks that the competent authorities must ensure are in placevis-à-vis credit institutions.

•

Article 83(1) CRD provides that competent authorities shall ensure that policies
and processes for the identification, measurement and management of allmaterial sources and effects of market risks are implemented.

•

Article 85 CRD provides that competent authorities shall ensure that institutions
implement policies and processes to evaluate and manage the exposure tooperational risk, […] including that contingency and business continuity plans arein place to ensure an institution’s ability to operate on an ongoing basis and limit
losses in the event of severe business disruption.

•

Article 91 CRD provides that […] members of the management body shallpossess sufficient knowledge, skills and experience to perform their duties […].

•

Article 431(3) CRR requires institutions to adopt a formal policy to comply withthe disclosure requirements laid down in Part Eight [of the CRR] and havepolicies for assessing the appropriateness of their disclosures, including theirverification and frequency. Institutions shall also have policies for assessing

Guide on climate-related and environmental risks

8whether their disclosures convey their risk profile comprehensively to market
participants.
•

Article 432(1) CRR provides that institutions may omit one or more of thedisclosures listed in Title II if the information provided by such disclosures is notregarded as material, except for the disclosures laid down in Article 435(2)(c),
Article 437 and Article 450. Information in disclosures shall be regarded asmaterial if its omission or misstatement could change or influence theassessment or decision of a user relying on that information for the purpose of
making economic decisions.

The EBA has adopted several guidelines specifying the abovementioned articles.
Where this guide makes reference to those guidelines, the reference should be read in
conjunction with the relevant articles of the CRD/CRR to which they refer. The
following EBA Guidelines are of particular relevance:•

Committee of European Banking Supervisors (CEBS) Guidelines on liquidity costbenefit allocation of 27 October 2010;•

EBA Guidelines on internal governance (EBA/GL/2017/11);•

Joint ESMA and EBA Guidelines on the assessment of the suitability of membersof the management body and key function holders under Directive 2013/36/EU
and Directive 2014/65/EU (EBA/GL/2017/12);•

EBA Guidelines on the revised common procedures and methodologies for thesupervisory review and evaluation process (SREP) and supervisory stresstesting (EBA/GL/2018/03);•

EBA Guidelines on institutions’ stress testing (EBA/GL/2018/04);•

EBA Guidelines on sound remuneration policies under Articles 74(3) and 75(2) ofDirective 2013/36/EU and disclosures under Article 450 of Regulation (EU)No 575/2013 (EBA/GL/2015/22);•

EBA Guidelines on materiality, proprietary and confidentiality and on disclosure
frequency under Articles 432(1), 432(2) and 433 of Regulation (EU)No 575/2013(EBA/GL/2014/14);•

EBA Guidelines on outsourcing arrangements (EBA/GL/2019/02);•

EBA Guidelines on loan origination and monitoring (EBA/GL/2020/06).

Guide on climate-related and environmental risks

93

Climate-related and environmental risks

3.1

Definitions
Climate change and environmental degradation are sources of structural change that
affect economic activity and, in turn, the financial system. Climate-related andenvironmental risks are commonly understood to comprise two main risk drivers:

3.2•

Physical risk refers to the financial impact of a changing climate, including more
frequent extreme weather events and gradual changes in climate, as well as ofenvironmental degradation, such as air, water and land pollution, water stress,
biodiversity loss and deforestation. 10 Physical risk is therefore categorised as“acute” when it arises from extreme events, such as droughts, floods and storms,
and “chronic” when it arises from progressive shifts, such as increasing
temperatures, sea-level rises, water stress, biodiversity loss, land use change,
habitat destruction and resource scarcity. 11 This can directly result in, forexample, damage to property or reduced productivity, or indirectly lead tosubsequent events, such as the disruption of supply chains.

•

Transition risk refers to an institution’s financial loss that can result, directly or
indirectly, from the process of adjustment towards a lower-carbon and moreenvironmentally sustainable economy. This could be triggered, for example, by arelatively abrupt adoption of climate and environmental policies, technologicalprogress or changes in market sentiment and preferences.

Characteristics of climate-related and environmental risks
Physical and transition risk drivers impact economic activities, which in turn impact thefinancial system. This impact can occur directly, through for example lower corporate
profitability or the devaluation of assets, or indirectly, through macro-financial
changes. 12
These risks also affect the resilience of an institution’s business model over the
medium to longer term, and predominantly those institutions with business models
that are reliant on sectors and markets which are particularly vulnerable toclimate-related and environmental risks. In addition, physical and transition risks cantrigger further losses, stemming directly or indirectly from legal claims (commonly
10

See the “Guide for Supervisors: Integrating climate-related and environmental risks in prudential
supervision”, Technical document, NGFS, May 2020.

11

See “Values at risk? Sustainability risks and goals in the Dutch financial sector”, Report, DNB, 2019;“Indebted to nature: Exploring biodiversity risks for the Dutch financial sector’’, Report, DNB, June 2020;
and the “Guide for Supervisors: Integrating climate-related and environmental risks in prudential
supervision”, Technical document, NGFS, May 2020.

12

While climate-related change and environmental degradation can give rise to microprudential andmacroprudential risk, it should be noted that this guide is prepared by the ECB in the context of the task
conferred to it under the relevant SSM regulation and is therefore limited to microprudential risk.

Guide on climate-related and environmental risks10referred to as “liability risk” 13) and reputational loss as a result of the public, theinstitution’s counterparties and/or investors associating the institution with adverse
environmental impacts (“reputational risk”).
Consequently, physical and transition risks are drivers of existing risk, in particularcredit risk, operational risk, market risk and liquidity risk, as well as non-Pillar 1 risks
such as migration risk, credit spread risk in the banking book, real estate risk andstrategic risk (see Table 1). Climate-related and environmental risks may, in fact, be
drivers of several different risk categories and sub-categories of existing risk
categories simultaneously.
The magnitude and distribution of physical and transition risks depend on the level andtiming of mitigation measures and whether the transition occurs in an orderly or
disorderly fashion. Potential losses stemming from climate-related and environmental
risks depend especially on the future adoption of climate-related and environmental
policies, technological developments and changes in consumer preferences andmarket sentiment. Irrespective of this, some combination of physical and transition
risks will, in all probability, materialise on the balance sheets of euro area institutions
and the economic value of their exposures. 14 Existing estimates of adverse long-term
macroeconomic effects resulting from climate change point to significant and lasting
losses in wealth. These may be due to slowing investment and lower factor
productivity in many sectors of the economy, as well as reduced potential GDP
growth. 15

13

In addition to legal claims on institutions (liability risk – see Expectation 9 on operational risk
management), the counterparties of institutions may also be impacted by legal risks arising fromenvironmental or climate-related factors which, in turn, can increase the credit risk for the institution (seeExpectation 8 on credit risk management).

14

See “A call for action: Climate change as a source of financial risk”, Report, NGFS, 2019, and “Too late,
too sudden: Transition to a low-carbon economy and systemic risk”, Report, ESRB, 2016.

15

See the “Technical supplement to the First NGFS comprehensive report”, NGFS, 2019, and “Long-Term
Macroeconomic Effects of Climate Change: A Cross-Country Analysis”, IMF working paper, 2019.

Guide on climate-related and environmental risks

11

Table 1
Examples of climate-related and environmental risk drivers
PhysicalRisks affected

Climate-related

Transition
Environmental• Extreme weather
events• Water stress• Chronic weather
patterns

Climate-related

Environmental• Policy andregulation• Policy andregulation• Biodiversity loss

• Technology• Technology• Pollution• Market sentiment• Market sentiment• Resource scarcity• Other
Credit

The probabilities of default (PD) and loss given default(LGD) of exposures within sectors or geographies
vulnerable to physical risk may be impacted, forexample, through lower collateral valuations in realestate portfolios as a result of increased flood risk.

Energy efficiency standards may trigger substantial
adaptation costs and lower corporate profitability,
which may lead to a higher PD as well as lower
collateral values.

MarketSevere physical events may lead to shifts in market
expectations and could result in sudden repricing,higher volatility and losses in asset values on somemarkets.

Transition risk drivers may generate an abrupt
repricing of securities and derivatives, for example for
products associated with industries affected by asset
stranding.

Operational

The bank’s operations may be disrupted due tophysical damage to its property, branches and data
centres as a result of extreme weather events.

Changing consumer sentiment regarding climate
issues can lead to reputation and liability risks for thebank as a result of scandals caused by the financing
of environmentally controversial activities.

Other risk types(liquidity, businessmodel)

Liquidity risk may be affected in the event of clients
withdrawing money from their accounts in order tofinance damage repairs.

Transition risk drivers may affect the viability of somebusiness lines and lead to strategic risk for specificbusiness models if the necessary adaptation or
diversification is not implemented. An abrupt repricingof securities, for instance due to asset stranding, may
reduce the value of banks’ high quality liquid assets,
thereby affecting liquidity buffers.

Source: ECB.

Methodologies to estimate the magnitude of climate-related risks for the financial
system in general, and institutions specifically are being developed rapidly. Available
estimates suggest that both physical 16 and transition 17 risks are likely to besignificant. Although the majority of studies have focused on climate-related risks,such as the decline in asset values across carbon-intensive sectors, otherenvironmental factors related to the loss of ecosystem services, such as water stress,
biodiversity loss and resource scarcity, have also been shown to drive financial
risk. 18 19 There is also evidence of an interconnection between climate-related

16

Roughly one-fifth of assessed equity and loan exposures at Dutch financial institutions are to extreme
water stress regions. See “Values at risk? Sustainability risks and goals in the Dutch financial sector”,
Report, DNB, 2019. Some 8.8% of mortgage exposures are located in flood risk zones in anotherjurisdiction. See “Transition in thinking: The impact of climate change on the UK banking sector”,
Prudential Regulation Authority report, Bank of England, 2018.

17

For example, the ESRB (2016) finds that European financial institutions’ (including banks, pension funds
and insurers) exposures to fossil fuel firms exceed €1 trillion and estimates potential losses of between€350 billion and €400 billion, even under an orderly transition scenario. Losses from asset stranding
could amount to USD 6 trillion for the EU-28 in a delayed policy action scenario (IRENA, 2017). Looking
at a sample of €720 billion, the ECB finds that 15% of the exposures are to the most carbon-intensive
firms (ECB, 2019). The ACPR (2019) found that exposures of major French banking groups to the mostcarbon-intensive sectors amounted to 12.7% of the total exposures. A transition risk stress test in the
Netherlands showed that the banking sectors’ CET1 ratio could drop by over 4% in a severe but plausible
transition scenario (DNB, 2018).

18

See, for example, “Summary for policymakers of the global assessment report on biodiversity andecosystem services”, Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem
Services, 2019.

19

See “Values at risk? Sustainability risks and goals in the Dutch financial sector”, Report, DNB, 2019.

Guide on climate-related and environmental risks12change and environmental risks, resulting in combined effects capable of potentiallygenerating even greater impacts. 20
Climate-related and environmental risks have distinctive characteristics that warrant
particular consideration by supervisors and institutions alike. These characteristics
include the far-reaching impact in breadth and magnitude, an uncertain andlonger-term time horizon and the dependency on short-term action. 21
Climate change has a far-reaching impact in terms of the business activities andgeographic areas affected. Sectors that are more likely to be physically impacted are,amongst others, agriculture, forestry, fisheries, human health, energy, mining,transport and infrastructure, and tourism. Sectors that are likely to be impacted by thetransition to a low-carbon economy include energy, transport, manufacturing,
construction and agriculture. 22 In particular, assets that are directly or indirectly
associated with the extraction, processing, combustion or use of fossil fuels, or which
are not sufficiently energy efficient, may suddenly and significantly decrease in value
or even become “stranded assets”. 23 Geographically, the impact of climate change is
expected to vary substantially across the world. The European Environment Agency
concludes that, in Europe, the most costly effects in southern Europe are projected to
be increases in energy demand and heat waves, in western Europe coastal flooding
and heat waves, in northern Europe coastal and river flooding, and in eastern Europe
river flooding. 24 The impact may differ considerably across given sectors and given
geographic areas. Climate-related and environmental risks for euro area institutions
are expected to primarily materialise in the medium to long term. 25 As the planninghorizon and average loan tenor for institutions is typically shorter than the time horizon
in which the effects of climate-related change and environmental degradation would
primarily arise, 26 it is important for institutions to take a forward-looking approach andconsider a longer than usual time horizon. In addition, adopting a forward-looking
perspective enables institutions to respond in a timely manner should the pace of thetransition to a low-carbon economy accelerate and transition risks materialise more
rapidly than expected.

20

See “Guide for Supervisors: Integrating climate-related and environmental risks in prudential
supervision”, Technical document, NGFS, May 2020.

21

See “A call for action: Climate change as a source of financial risk”, Report, NGFS, 2019.

22

See, for instance, the report entitled “In-depth analysis in support of the Commission communication
COM (2018) 773”, European Commission, 2018.

23

See the “Guide for Supervisors: Integrating climate-related and environmental risks in prudential
supervision”, Technical document, NGFS, May 2020.

24

See “Climate change, impacts and vulnerability in Europe 2012: An indicator-based report”, EEA, 2012.

25

See the “SSM Risk Map for 2020”, ECB, 2019.

26

See the “EBA report on undue short-term pressure from the financial sector on corporations”, EBA, 2019,“Waterproof? An exploration of climate-related risks for the Dutch financial sector”, DNB, 2017, and“Analysis and synthesis: French banking groups facing climate change-related risks”, ACPR, 2019. The
reports also highlight that despite a limited average loan tenor, institutions also provide loans that are
typically renewed or prolonged after the original loan period, thus potentially making these loans
particularly vulnerable to long-term risks such as climate-related and environmental risks.

Guide on climate-related and environmental risks

13

3.3

Observations from stocktakes
The ECB performed a number of assessments to take stock of how euro area
institutions are addressing climate-related and environmental risks, mainly throughtargeted surveys among samples of euro area institutions 27, the assessment of euroarea institutions’ public disclosures, as well as through the analysis of a sample of
ICAAP submissions. The evidence collected has informed the content of this guide.
While the approach towards climate-related and environmental risks varies dependingon the size, business model, complexity and geographic location of the institutions, theaforementioned assessments demonstrate that institutions have predominantly
approached the topic from the perspective of corporate social responsibility and have
yet to develop a comprehensive risk management approach.
According to a survey conducted jointly by the ECB and the EBA, institutions broadly
acknowledge the materiality of physical and transition risks and the increasing need toassess and incorporate climate-related and environmental risks into their risk
management processes. Despite the fact that the majority of institutions have
implemented one or more sustainability policies 28, most of the institutions do not havethe tools to assess the impact of climate-related and environmental risks on theirbalance sheet. More specifically, only a small number of institutions have fully
incorporated climate-related and environmental risks into their risk management
framework, through for instance a risk measurement approach, by defining their risk
appetite, performing stress tests and scenario analyses and/or assessing the impact
on their capital adequacy. The ECB sees that institutions are increasingly involved injoint industry initiatives aimed at developing adequate methodologies and obtaining
the necessary data.
The assessment of a sample of significant institutions’ ICAAP packages shows that
institutions’ practices are heterogeneous. Many institutions consider climate-relatedrisks in their risk identification processes and/or have policies to exclude certain
sectors from lending/investing based on environmental criteria. However,climate-related risk taxonomies are very heterogeneous. If at all, climate-related risks
are typically integrated within existing risk categories, such as credit risk,business/strategic risk or operational/reputational risk. Approaches to assess theirmateriality, however, are limited in terms of depth and sophistication. Someinstitutions are beginning to set limits based on quantitative indicators. Only a few
institutions include climate-related risks in their stress testing and reverse
stress-testing scenarios, and the practice of assessing the capital impact and thecapital requirements, should such risks unfold, remains limited.
An assessment of significant institutions’ public disclosures of climate-related andenvironmental risks shows sparse and heterogeneous disclosure practices. The levelof disclosures is correlated with size: the larger the institution, the morecomprehensive the disclosures. Of the institutions that disclose climate-related and27

Surveyed institutions represent approximately 44% of total euro area banking assets.

28

Understood as policies incorporating the impact of environmental, social and governance factors.

Guide on climate-related and environmental risks

14environmental risks, very few institutions are transparent as to the definitions andmethodologies used. Only a minority of institutions’ disclosures are in line with therecommendations by the TCFD. Nonetheless, the ECB has observed that a number of
institutions are involved in initiatives that promote broader and more comparable
disclosures and are working on improving their disclosure procedures.

Guide on climate-related and environmental risks15

4Supervisory expectations relating tobusiness models and strategy
Articles 73 and 74(1) of the CRD, as further specified by the EBA Guidelines oninternal governance 29, require institutions to implement internal governancearrangements, processes and mechanisms to ensure effective and prudent
management of the institution. In this respect, it is important for institutions to identify,
assess and monitor the current and forward-looking impact of climate-related andenvironmental factors on their business environment and to ensure the sustainability
and resilience of their business model going forward.

4.1

Business environment
Expectation 1
Institutions are expected to understand the impact of climate-related andenvironmental risks on the business environment in which they operate, in the short,medium and long term, in order to be able to make informed strategic and businessdecisions.

As set out in the EBA Guidelines, institutions should identify, assess and monitor thebusiness environment in which they operate, as it provides essential input for theassessment of the risks and developments that may affect the institution. 30 Institutions
are required to document material factors impacting their business environment. The
business environment captures a broad range of external factors and trends thatshape the business conditions in which an institution operates or is likely to operate
based on its main or material geographic and business exposures. 31 These include
macroeconomic variables, the competitive landscape, policy and regulation,technology, societal/demographic developments, and geopolitical trends. 32
Climate-related and environmental risks may affect all of these areas.
Expectation 1.1

When scanning their business environment, institutions are expected to
identify risks arising from climate change and environmental degradation at thelevel of key sectors, geographic areas and related to products and services
they are active in or are considering becoming active in. 33 Climate-related andenvironmental risks, for instance, may influence economic growth, employment or real29

See the EBA Guidelines on internal governance (EBA/GL/2017/11).

30

See paragraph 30 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

31

See paragraph 64 of the EBA Guidelines on common procedures and methodologies for the supervisory
review and evaluation process (SREP) (EBA/GL/2014/13).

32

See paragraph 65 of the EBA Guidelines on common procedures and methodologies for the supervisory
review and evaluation process (SREP) (EBA/GL/2014/13).

33

See also paragraphs 59 and 60 under Principle 4 of the ECB Guide to the internal capital adequacy
assessment process (ICAAP).

Guide on climate-related and environmental risks

16estate prices at the national, regional or local level. Weather events may cause
droughts or floods affecting regional agricultural production or housing demand at thenational, regional, or local level. The loss of ecosystem services, such as animal
pollination, can also directly affect crop yields and agriculture production. 34 Policychanges to promote an environmentally-resilient economy may reduce the demand forreal estate in certain areas, for example where there is high flood risk.. In parallel, thecompetitive landscape is affected by structural changes across company supply
chains, the development of a green financing market and consumer preferences thatare shifting away from carbon-intensive goods and services. In the area of technology,
institutions serving clients operating in energy-intensive industries, or power stations
with a high reliance on fossil fuels, may see that their clients are facing significant
capital expenditure requirements to decarbonise their energy mixes. In general,
institutions are expected to adopt granular approaches to mapping these impacts on
their business environment. Depending on the type of climate-related andenvironmental impact, granular approaches may include “within-sector” differences,taking into account supply chain effects or using detailed geographic location data.
Institutions are expected to properly document their assessments of climate-related
and environmental risks in terms of their business environment. For instance, it could
be reflected as part of their regular monitoring of material or emerging risks, orevidenced through management board discussions. 35
Expectation 1.2

Institutions are expected to understand how climate-related and environmental
risks affect their business environment in the short, medium and long term to
inform their business strategy process. The way that institutions strategically
respond to changes in their business environment stemming from climate-related andenvironmental risks will impact the resilience of their business model over time.
Institutions are thus expected to explicitly consider climate-related and environmental
changes to their macroeconomic and regulatory environment and their competitive
landscape, in particular. This is expected to be reflected in institutions’ businessstrategy processes, and demonstrated by documented management body 36 meetingsand discussions.
The relevant time horizon is also an important dimension to consider. While somerisks may play out in the short to medium run, for example reputational effects,
extreme weather events, such as floods or public policy-driven developments 37, others
may stretch out over considerably longer horizons. Institutions are expected to take
into account up-to-date scientific insights to enhance their understanding of thepotential changes to their business environment going forward. Institutions are also
advised to monitor relevant policy initiatives in the jurisdictions in which they operate,

34

See ‘’Indebted to nature: Exploring biodiversity risks for the Dutch financial sector’’, DNB, June 2020.

35

See also Principle 4 of the ECB Guide to the internal capital adequacy assessment process (ICAAP).

36

In line with the EBA Guidelines on internal governance, the terms “management body in its management
function” and “management body in its supervisory function” are used throughout this guide without
advocating or referring to any specific governance structure, and references to the management(executive) or supervisory (non-executive) function should be understood as applying to the bodies ormembers of the management body responsible for that function in accordance with national law.

37

Public policies refer to rules, laws and regulations made by a government entity.

Guide on climate-related and environmental risks

17for example related to energy efficiency standards that might affect real estate
portfolios. 38

4.2

Business strategy
Expectation 2
When determining and implementing their business strategy, institutions are expected
to integrate climate-related and environmental risks that impact their businessenvironment in the short, medium or long term.

The business strategy is an institution’s principal tool for positioning itself within its
business environment in order to generate acceptable returns in line with its risk
appetite. As set out in the EBA Guidelines 39, institutions should take into account any
material factors related to their long-term financial interests and solvency when
determining their business strategy. Climate-related and environmental risks may
directly impact the effectiveness of institutions’ existing and future strategies. 40
Expectation 2.1

Institutions are expected to determine which climate-related and environmental
risks impact their business strategy in the short, medium and long term, forexample by using (stress) scenario analyses. 41 As set out in the EBA Guidelines,
institutions should take the limitations, vulnerabilities and shortcomings detected ininternal stress tests and scenario analyses into account when determining theirbusiness strategy. 42 The scenario analysis tool is particularly useful in the context ofclimate-related and environmental risks given the uncertainty associated with the
future course of climate change and society’s response to it. 43 By developing a set ofplausible scenarios to test the resilience of its business model, an institution canaccount for this uncertainty in its strategic decision-making. These scenarios are
expected to include assumptions regarding the impact of climate-related andenvironmental risks and the time horizons over which these effects are expected tomaterialise. These assumptions can be quantitative and/or qualitative in nature, areexpected to rely on forward-looking information where available, and also to be
relevant to an institution’s particular exposure to environmental risk (depending on thetype of business activity, sector and geographic location of such exposures). This may
also involve an expert judgement, since the given nature of climate change as a driver38

For an analysis of the potential prudential impact of the tightening of energy efficiency standards for credit
institutions, see, for example, “Transition in thinking: the impact of climate change on the UK banking
sector”, Box 3, Prudential Regulation Authority Report, Bank of England, 2018.

39

See Article 23 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

40

See also paragraphs 25, 32 and 34 under Principles 2 and 4 of the ECB Guide to the internal capital
adequacy assessment process (ICAAP).

41

A number of publications may assist institutions in performing scenario analyses or identifying relevant
scenarios, such as the “Technical supplement: The Use of Scenario Analysis in Disclosure of
Climate-related Risks and Opportunities”, TCFD, 2017, and the “Requirements for scenario analysis”,
NGFS, forthcoming. “Institutions are also expected to consider the IEA and IPCC climate scenarios forphysical risk”, see Expectation 11.

42

See Articles 30 and 72 of the EBA Guidelines on institutions’ stress testing (EBA/GL/2018/04).

43

See the “Technical supplement: The Use of Scenario Analysis in Disclosure of Climate-related Risks andOpportunities”, TCFD, 2017.

Guide on climate-related and environmental risks18

of financial risk will present new challenges that have not yet materialised. 44 In turn,
scenario analyses can be used to assess risks in the short to medium term as well as
in the longer term:

Expectation 2.2

1.

A short-to-medium term assessment is expected to include an analysis of theclimate-related and environmental risks to which the institution is exposed within
its current business planning horizon (three to five years).

2.

A longer-term assessment beyond the typical business planning horizon (morethan five years, thus in line with public policy commitments to transitioning to amore sustainable economy), 45 assessing the resilience of the current businessmodel against a range of plausible future scenarios relevant to estimate
climate-related and environmental risks, would be required to capture thespecificities of this kind of risk.

The institution’s business strategy and its implementation is expected to reflect
climate-related and environmental risks, for example by setting and monitoring
key performance indicators (KPIs) that are cascaded down to individual
business lines and portfolios. Based on the EBA Guidelines 46, the risk
management framework of an institution should enable it to make fully informed
decisions on risk-taking, including decisions concerning both internal and external
developments. In order to support their business strategy, institutions may set KPIs forany type of climate-related or environmental risk. These KPIs should be measurable
and quantifiable, wherever possible. Depending on the nature of the institution’s
activities, these KPIs should be cascaded down to relevant business lines andportfolios. Institutions are also expected to possess the capabilities to integratematerial climate-related and environmental risks into the relevant layers of its
organisation by assigning specific duties, ensuring ongoing communication throughthe various functions, monitoring progress, taking timely corrective action and tracking
all related budget costs. When setting strategic objectives, institutions are expected, inparticular, to reflect the risks to their different lending and trading portfolios stemmingfrom the transition to a more sustainable, low-carbon economy. Any strategic
decisions related to material climate-related and environmental factors are expected
to be integrated in the institution’s policies, for example in its credit policies by sector
and by product.

Box 2
Example of observed practice: Climate-related and environmental key performanceindicators
The ECB observed an institution which had integrated the following climate-related andenvironmental key performance indicators (KPIs) into its strategic framework with a view to making its
44

Materiality matrices may be considered to identify the parameters and assumptions to be used in each of
the scenarios. These kinds of materiality matrix help prioritise the parameters given the predefined
dimensions (i.e. on each axis). For instance, by placing sensitivity to climate-related and environmental
risk by sector on one axis and placing the institution’s exposure to those sectors on the other axis.

45

See, for instance, the European Commission’s 2030 emission reduction targets for the EU.

46

See paragraphs 136 and 139 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

19strategy of reducing exposure to transition risks measurable: i) the carbon emission footprint of its
assets; ii) the average energy label of its mortgage portfolios; and iii) the number of homes that saw
an energy label improvement thanks to its financing. In addition to these KPIs, the institution stresses
its portfolios using a climate-related stress scenario. The scenario outcome is defined in terms ofnegative macroeconomic effects, which in turn may be used as an indicator to steer its strategic
portfolio decisions over time. Both the KPIs and results from the scenario analysis underpin the
bank’s strategic approach to the risks arising from climate change and other environmental
developments. The metrics are cascaded down to the business line level (e.g. retail banking, privatebanking, commercial banking and corporate banking). For each metric, the respective time horizon isset and progress is measured against a base year.

Guide on climate-related and environmental risks20

5Supervisory expectations relating togovernance and risk appetite
Under Article 74 of the CRD, institutions are required to have robust governancearrangements in place that allow institutions to effectively identify, manage, monitor
and report the risks they are or might be exposed to, so as to form a holistic view of allrisks both on an individual and consolidated basis. 47 To enable institutions tounderstand and respond to climate-related and environmental risks, institutions are
expected to embed these risks in their governance and risk appetite frameworks, while
adequately involving all relevant functions. In addition, appropriate and regular
reporting on climate-related and environmental risks to the management body is
expected to ensure proper management of these risks.

5.1Management body
Expectation 3
The management body is expected to consider climate-related and environmental
risks when developing the institution’s overall business strategy, business objectives
and risk management framework and to exercise effective oversight of climate-related
and environmental risks.
As set out in the EBA Guidelines 48, the management body’s 49 responsibilities include
setting, approving and overseeing the implementation of the overall business strategy
and key policies, the overall risk strategy, an adequate internal governance andinternal control framework. Given the impact of climate-related and environmental
risks on these aspects, the management body plays a key role in terms of both its
supervisory and its management function. 50

Expectation 3.1

The management body is expected to explicitly allocate roles andresponsibilities to its members and/or its sub-committees for climate-related
and environmental risks. Based on the EBA Guidelines, the management bodyshould ensure that the reporting lines and the allocation of responsibilities within an
institution are clear, well-defined, coherent, enforceable and duly documented. 51
Notwithstanding its collective ultimate and overall responsibility for the institution, themanagement body is expected to explicitly and formally allocate roles and47

See also paragraph 30 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

48

See paragraph 23 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

49

See footnote 29 for clarification of the use of the terms “management body in its management function”
and “management body in its supervisory function” and paragraph 9 of the EBA Guidelines on internal
governance (EBA/GL/2017/11).

50

See also Article 91 of the CRD and the joint ESMA/EBA Guidelines on the assessment of the suitability ofmembers of the management body (EBA/GL/2017/12).

51

See paragraphs 20 and 67 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

21responsibility, as appropriate, within the institution’s organisational structure and inline with its risk profile. Institutions may, on the basis of the proportionality principle,
establish committees other than those specifically referred to in the CRD. 52
Institutions may consider assigning the responsibility for climate-related andenvironmental risks to a member of an existing committee or may consider setting up
a dedicated committee.

Box 3
Example of observed practice: Setting up dedicated committees
The ECB observed several institutions that have established dedicated committees as part of theirefforts to fully consider climate-related and environmental risks. For example, as part of its
medium-term strategic plan, one bank is in the process of establishing a committee which draws oninternal and external expertise, such as scientists from relevant disciplines, to advise and assist the
management body in defining its ESG strategy (including climate-related and environmental risks).
This includes reviewing its climate-related and environmental risks, as well as related sectoral
financing policies, which determine both targets and limits for exposures to certain sectors. Anotherbank has set up a dedicated committee to provide informed guidance on transactions with complex
climate-related and environmental implications. This committee is chaired by senior management.

Expectation 3.2

The management body is expected to consider the knowledge, skills andexperience of its members in the area of climate-related and environmental risk
in its assessment of the collective suitability of such members. As set out in the
CRD and further specified in the joint ESMA and EBA Guidelines 53, the management
body shall possess adequate collective knowledge, skills and experience to be able tounderstand the institution’s activities, including the main risks, and should review thison an ongoing basis. 54 The management body itself is also expected to have anadequate understanding of climate-related and environmental risks in order to be able
to consider in its assessment of collective suitability the knowledge, skills andexperience needed for sound and effective management and disclosure ofclimate-related and environmental risks to which the institution is exposed.

Expectation 3.3

The management body is expected to ensure that the institution adequately
embeds climate-related and environmental risks in the overall businessstrategy and risk management framework. 55 The management body should be
involved in setting, approving and overseeing the business strategy process 56, and52

See paragraph 41 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

53

See the joint ESMA and EBA Guidelines on the assessment of the suitability of members of the
management body and key function holders under Directive 2013/36/EU and Directive 2014/65/EU(EBA/GL/2017/12).

54

See Article 91 of the CRD.

55

See also Principle 1 (i) and Principle 2 (iii) and (v), and paragraphs 32 and 34 of the ECB Guide to theinternal capital adequacy assessment process (ICAAP).

56

See paragraph 23 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

22should take decisions on a sound and well-informed basis. 57 As explained in theprevious sections, the management body is expected to consider the short, medium
and long-term climate-related and environmental effects on the overall businessstrategy and clearly embed the relevant responsibilities in the organisational structure.
The management body is also expected to decide on the materiality of theclimate-related and environmental risks, specifying and documenting the qualitativeand quantitative information underlying its decisions. 58 With regard to the
management body’s responsibility for setting, approving and overseeing theimplementation of the key policies of the institutions, 59 60 the management body is
expected to review on an ongoing basis whether existing policies comprehensively
cover climate-related and environmental risks, including the (credit) policies for eachsector and product.
To achieve a holistic approach to risk, 61 while considering the institution’s long-term
financial interest, 62 the management body is advised to explicitly consider the
institution’s response to the objectives set out under international agreements such as
the Paris Agreement (2015), EU environmental-related policies such as the EU Green
Deal, local and national policies, as well as the outcomes of well-foundedclimate-related and environmental assessments, such as those by the IPCC and
IPBES.
Expectation 3.4

The management body is expected to exercise effective oversight over the
institutions’ exposures and response to climate-related and environmental
risks. As stated in the EBA Guidelines, 63 the oversight role includes reviewing theperformance of the management function and the achievement of its objectives. In
order to promote an effective oversight function and informed decision-making, 64 themanagement body in its management function is encouraged to set KPIs and KRIs, as
described in the previous and following section. The management body in its
supervisory function is expected to monitor and scrutinise the targets and any
developments in those KPIs and KRIs.

57

See paragraph 28 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

58

See paragraph 63 of the ECB Guide to the internal capital adequacy assessment process (ICAAP).

59

See paragraph 23 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

60

See paragraph 33 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

61

See paragraph 95 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

62

See paragraph 23 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

63

See paragraph 24 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

64

See paragraph 28 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

23

5.2

Risk appetite
Expectation 4
Institutions are expected to explicitly include climate-related and environmental risks
in their risk appetite framework.

Institutions are expected to have in place a risk appetite framework (RAF) thatconsiders all the material risks to which the institution is exposed, that is
forward-looking, in line with the strategic planning horizon set out in the businessstrategy and that is reviewed regularly. 65 Integrating climate-related andenvironmental risks into the RAF increases institutions’ resilience to such risks andimproves their ability to manage those risks, for example, by setting limits on lending tosectors and geographic areas that are highly exposed to climate-related orenvironmental risks. 66
Expectation 4.1

Institutions are expected to develop a well-defined description ofclimate-related and environmental risks in their risk inventory that feeds into
their risk appetite statement (RAS). The risk inventory is the result of the risk
identification process and is expected to be based on the institution’s internal risktaxonomy, which is a categorisation of different risk types and factors within whichclimate-related and environmental risks are expected to be clearly defined. 67 The risk
inventory is used as a basis for the formulation of the RAS.

Expectation 4.2

Institutions are expected to develop appropriate key risk indicators and set
appropriate limits for effectively managing climate-related and environmental
risks in line with their regular monitoring and escalation arrangements. Basedon the EBA Guidelines, institutions are expected to ensure that their risk strategy andrisk appetite consider all material risks to which they are exposed and specify risk
limits, tolerances and thresholds. 68 In addition, institutions should have a risk
management framework in place that ensures that, when risk limits are breached,
there is a defined process for escalating and addressing these, together with anappropriate follow-up procedure. 69 The ECB expects institutions to monitor and reporttheir exposures to climate-related and environmental risks on the basis of their current
data and forward-looking estimations. The ECB expects institutions to assign
quantitative metrics to climate-related and environmental risks, particularly forphysical and transition risks. However, it also acknowledges that common definitions
and taxonomies in these risk areas are still under development, and that qualitative
statements can be used as intermediate steps while the institution is developing
appropriate quantitative metrics. It is also expected that the relevant risk appetite
65

See also paragraph 21 of the ECB Guide to the internal capital adequacy assessment process (ICAAP).

66

See also paragraphs 25, 32 and 34 under Principle 2 (iii) of the ECB Guide to the internal capital
adequacy assessment process (ICAAP).

67

See also paragraphs 31-35 and 59-66 of the ECB Guide to the internal capital adequacy assessment
process (ICAAP).

68

See paragraph 100 of the EBA Guidelines on the revised common procedures and methodologies for thesupervisory review and evaluation process (SREP) and supervisory stress testing (EBA/GL/2018/03).

69

See paragraph 138 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks24indicators and limits are determined based on the level of risk that the institution iswilling to assume within its risk capacity, in line with its business model.
With respect to climate-related risks, institutions are expected to develop metrics thatconsider the long-term nature of climate change, particularly how different paths oftemperature and greenhouse gas (GHG) emissions may accentuate existing risks.
These metrics are expected to support the institution’s ability to respond to a suddentransition towards a low-carbon economy or a physical event impacting its operations
or lending portfolios and to implement mitigating actions on a timely basis.

Box 4
Example of observed practice: Carbon-intensity targeting and climate resilience of thebalance sheet
The ECB observed that several institutions aim to keep the carbon content of their financed energy
mix in line with the target of remaining well below 1.5-2°C, as provided for in the 2015 Paris
Agreement. This approach is one course of action that can be taken to reduce exposure to transition
risks stemming from the public policy measures announced for the subsequent decades.
Chart A
Carbon-intensity targeting
Bank targets
IEA Sustainable Development Scenario
600

CO2 per kW h

500

400

300

200

100

0
2014

2018

2030

2040

2050

Source: World Energy Outlook 2019.

Some institutions use the International Energy Agency Sustainable Development Scenario or asimilar scenario to quantify such targets, as illustrated in the graph. Other institutions take a different
approach that involves, for each sector with a large carbon footprint, measuring and benchmarking
how lending to these sectors contributes to climate resilience, and adjusting the lending portfolio
accordingly. Such approaches are not mutually exclusive and, in fact, some institutions have adopted
several methodologies.

Expectation 4.3

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 theinstitution. As set out in the EBA Guidelines, remuneration policies and practices

Guide on climate-related and environmental risks

25

should be consistent with the institution’s risk appetite, business strategy andlong-term objectives. 70 Incentive structures should stimulate behaviour in line with therisk appetite and long-term business goals 71 and discourage excessive risk-taking.
Remuneration policies and practices, including the use of deferral and thedetermination of performance criteria, are expected to help foster a long-term
approach to managing climate-related and environmental risks in line with theinstitution’s risk appetite and strategy. To encourage behaviour consistent with theirclimate-related and environmental (risk) approach, institutions that haveclimate-related and environmental objectives could consider implementing a variable
remuneration component linked to the successful achievement of those objectives.
Where the financial impacts of climate-related and environmental risks are difficult toquantify, the management body can consider incorporating appropriate qualitative
criteria into the remuneration policy.

5.3

Organisational structure
Expectation 5
Institutions are expected to assign responsibility for the management ofclimate-related and environmental risks within the organisational structure inaccordance with the three lines of defence model.

In accordance with Article 74 of the CRD, and as further specified in the EBA
Guidelines, institutions should have in place a clear, transparent and documented
decision-making process and a clear allocation of responsibilities and authority within
their internal control framework, including their business lines, internal units andinternal control functions 72 that promote informed decision-making by the
management body. 73 Consequently, responsibilities for identifying, assessing andmanaging climate-related and environmental risks are expected to be evenly
distributed across the different functions within the institution.
Expectation 5.1

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 policies, procedures andcontrols. Institutions are expected to explicitly define which internal structures have
responsibility for considering climate-related and environmental risks and to clearly
describe their respective mandates and working procedures. Institutions may allocate
such responsibilities across existing structures or, if deemed useful, may consider
70

Furthermore, credit institutions that provide portfolio management and/or financial advice shall include in
their remuneration policies information on how those policies are consistent with the integration ofsustainability risks, and shall publish that information on their websites, from March 2021 pursuant to
Article 5 of Regulation (EU) 2019/2088 of the European Parliament and of the Council of
27 November 2019 on sustainability-related disclosures in the financial services sector.

71

See the EBA Guidelines on sound remuneration policies under Articles 74(3) and 75(2) ofDirective 2013/36/EU and on disclosures under Article 450 of Regulation (EU) No 575/2013(EBA/GL/2015/22).

72

See paragraph 131 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

73

See paragraphs 28 and 94 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

26

establishing a dedicated structure responsible for coordinating the institution’s overallrisk management approach to climate-related and environmental risk. If such a
dedicated structure for climate-related and environmental risks is established, its
integration into existing processes and interfaces with other functions is expected to
be clearly defined. Regardless of the specific arrangements, institutions are expected
to describe the relationships between the relevant structures and their working
procedures to ensure an adequate flow of information between all parties involved.
Expectation 5.2

Institutions are expected to ensure that the functions involved in managing
climate-related and environmental risks have the appropriate human andfinancial resources. Based on the EBA Guidelines, institutions should ensure thatthe internal control functions have the appropriate financial and human resources, aswell as the powers to effectively perform their role. 74 In the same vein, institutions are
expected to evaluate the appropriateness of the capacity and resources to deal withclimate-related and environmental risks, particularly in the relevant functions
responsible for managing these risks. To the extent needed, institutions are expected
to strengthen the available capacity and resources, as well as to encourage
appropriate training for all relevant functions. This also includes ensuring that theinstitution’s norms, attitudes and behaviours related to risk awareness take into
account the uncertain, but potentially significant, impacts of climate-related andenvironmental risks.

Expectation 5.3

Institutions are expected to define the tasks and responsibilities of the first lineof defence in terms of risk-taking and risk management of climate-related andenvironmental risks. Institutions are expected to ensure that the first line of defence
performs its duties in accordance with any climate-related and environmental policy,
procedure or limit. More specifically, the first line of defence is expected to identify,
assess and monitor any climate-related and environmental risks relevant for thecreditworthiness and the scoring/rating of a client, as well as to conduct proper due
diligence on climate-related and environmental risks in line with Expectation 7.4.

Expectation 5.4

Institutions are expected to define the tasks and responsibilities of the risk
management function for identifying, assessing, measuring, monitoring andreporting climate-related and environmental risks. The main responsibility of therisk management function is to ensure that all risks are identified, assessed,
measured, monitored, managed and properly reported by the relevant units in theinstitution. 75 It is expected to provide relevant independent information, analyses andexpert judgement on risk exposures. Since climate-related and environmental risksmaterialise through existing risks, the tasks and responsibilities are expected to beembedded in the framework of the existing management system, as further detailed in
the risk management section.

74

See paragraphs 155 and 160 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

75

See paragraph 174 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

27Box 5
Example of observed practice: Horizontal points of contact
The ECB observed several institutions that have implemented specific measures to promote a risk
culture that takes into account climate-related and environmental risks. For example, one bankdesignated certain employees as horizontal points of contact to ensure that climate-related andenvironmental risks were appropriately integrated into its risk management function’s working
procedures. Another bank put in place correspondents for those business lines actively cooperating
and liaising with risk management functions and/or other functions involved in ESG risks, including
climate-related and environmental risks.

Expectation 5.5

Institutions are expected to define the tasks and responsibilities of thecompliance function by ensuring that compliance risks stemming fromclimate-related and environmental risks are duly considered and effectively
integrated in all relevant processes. The compliance function should advise themanagement body on measures to be taken to ensure compliance with applicablelaws, rules, regulations and standards, and should assess the possible impact of any
changes in the legal or regulatory environment on the institution’s activities andcompliance framework. 76 As rules and standards on sustainability may change overtime, institutions may increasingly face compliance-related risks, such as liability,
litigation and/or reputational risks, stemming from climate-related and environmental
issues.

Expectation 5.6

The internal audit function is expected to consider in its reviews the extent towhich the institution is equipped to manage climate-related and environmental
risks. The internal audit function should review the institution’s internal control andrisk management framework, by considering external developments, changes in therisk profile and in products and/or business lines, among other things. 77 This is
expected to include the appropriateness of the arrangements for managing
climate-related and environmental risks. Furthermore, an institution’s policies andprocedures for climate-related and environmental risks fall within the scope of theinternal audit function, as its role is to review compliance with the institution’s internal
policies and procedures and with external requirements.

76

See paragraph 192 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

77

See paragraph 139 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

28

5.4

ReportingExpectation 6
For the purposes of internal reporting, institutions are expected to report aggregatedrisk data that reflect their exposures to climate-related and environmental risks with aview to enabling the management body and relevant sub-committees to makeinformed decisions.

The EBA Guidelines 78 set out how institutions should establish regular andtransparent reporting mechanisms so that the management body, its risk committee,
where established, and all relevant units in an institution are provided with reports in atimely, accurate, concise, clear and meaningful manner and can share relevant
information on the identification, measurement or assessment, monitoring andmanagement of risks. Consequently, the ECB expects institutions to integrate
climate-related and environmental risks into their data reporting frameworks with aview to informing decision-making at management level. The ECB acknowledges thatmetrics and tools are evolving and that, currently, data available in institutions are
sometimes incomplete. Nevertheless, it expects reporting of climate-related andenvironmental risks to mature over time. Initially, when accurate and complete
reporting is deemed unfeasible or premature, the ECB expects institutions to assess
their data needs in order to inform their strategy-setting and risk management, toidentify the gaps compared with current data and to devise a plan to overcome thesegaps and tackle any insufficiencies.
Expectation 6.1

Institutions are expected to develop a holistic approach to data governance forclimate-related and environmental risks. Based on the EBA Guidelines, regularand transparent reporting mechanisms should be established in order to ensure
timely, accurate, concise, understandable and meaningful reporting that will enable
the sharing of relevant information about the identification, measurement orassessment, monitoring and management of risks. 79 Institutions are expected todefine, document and integrate climate-related and environmental risks into the datareporting framework, so they can effectively monitor, manage and mitigate their
exposures to these risks. In particular, this includes risk data reporting governance, IT
infrastructure, risk data aggregation capabilities and reporting procedures. Institutions
are expected to ensure that the data reporting framework for climate-related andenvironmental risks operates in conjunction with the climate-related andenvironmental risk metrics set out in their existing RAS and risk management
processes. The data reporting framework is also expected to support, where relevant,78

See paragraph 145 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

79

See paragraph 145 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

Guide on climate-related and environmental risks

29the KPIs used to assess the performance of the institution in terms of climate-related
and environmental risks and public disclosure. 80
Expectation 6.2

As climate-related and environmental risks have distinctive characteristics,
institutions are expected to consider adapting their IT systems tosystematically collect and aggregate the necessary data in order to assess their
exposures to these risks. While institutions are expected to incorporate the datataxonomy of these risks, it is also acknowledged that this may not be feasible owing to
the current lack of common definitions, taxonomies and data gaps. In this case,institutions are expected to consider establishing reporting processes and procedures
based on internal or external qualitative risk metrics to ensure that climate-related andenvironmental risks are adequately reported to the management body. To this end,
the management body is expected to be aware of the limitations of the reporting it
receives in terms of its coverage, as well as legal and technical constraints. The
management body is expected to use this information to discuss, challenge and takedecisions on managing impacts arising from climate-related and environmental risks.

Expectation 6.3

An institution’s risk reports are expected to convey the impact ofclimate-related and environmental risks on its business model, strategy andrisk profile. 81 Institutions should strive to cover all material climate-related andenvironmental risks across the legal entity and/or business lines in its risk reports.
These risk reports, which also cover climate-related and environmental risks, areexpected to be integrated in the institution’s existing risk reporting framework. The
depth and scope of these reports are expected to be consistent with the size andcomplexity of the institution’s operations and risk profile.

Expectation 6.4

An institution is expected to be able to generate aggregated and up-to-dateclimate-related and environmental risks data in a timely manner. This isconsistent with EBA Guidelines that expect institutions to have effective and reliable
information and communication systems that fully support risk data aggregation
capabilities during both normal operations and times of stress. 82 The issue oftimeliness is critical to these risks owing to, for example, the impacts of a suddentransition to a low-carbon economy or the impact of a physical event on an institution’s
operations. The management body, therefore, should remain aware of any
developments at national, international, political and regulatory levels that may havean impact on its reporting expectations. An institution is expected to be adaptable inorder to generate aggregated climate-related and environmental risk data to meet abroad range of on-demand and ad hoc reporting requests, including requests during
stress/crisis situations, requests related to changing internal needs and requests tomeet supervisory queries, as demand for climate-related and environmental risks
reporting increases.
80

See BCBS standard No 239, which is used by the ECB as a benchmark for best practices in its ongoingsupervisory activities to assess institutions’ risk data aggregation capabilities and risk reporting
practices.

81

See also paragraphs 29 and 30 under Principle 2 of the ECB Guide to the internal capital adequacy
assessment process (ICAAP).

82

See the EBA Guidelines on internal governance (EBA/GL/2017/11) and Section 5.8 of the EBA
Guidelines on the revised common procedures and methodologies for the supervisory review andevaluation process (SREP) and supervisory stress testing (EBA/GL/2018/03).

Guide on climate-related and environmental risks30

6Supervisory expectations relating to risk
management
Building on the previous chapter, this section provides detailed guidance on
integrating climate-related and environmental risks into credit, operational, market andliquidity risk management, as well as into the ICAAP overall, including risk
quantification by means of scenario analysis and stress testing.

6.1

Risk management framework
Expectation 7
Institutions are expected to incorporate climate-related and environmental risks as
drivers of existing risk categories into their risk management framework, with a view tomanaging, monitoring and mitigating these over a sufficiently long-term horizon, andto review their arrangements on a regular basis. Institutions are expected to identify
and quantify these risks within their overall process of ensuring capital adequacy.

As part of their overall internal control framework, institutions should have an
institution-wide risk management framework that extends across all business lines
and internal units, including internal control functions. 83 84 According to Article 73 of
the CRD, institutions shall have in place sound, effective and comprehensive
strategies and processes for assessing and maintaining on an ongoing basis theamounts, types and distribution of internal capital that they consider adequate to cover
the nature and level of the risks to which they are or might be exposed. In addition toits current material risks, the institution is expected to consider any risks, and any
concentrations within and between those risks, that may arise from pursuing its
strategies or from relevant changes in its operating environment. 85 Institutions arethus expected to comprehensively analyse the ways in which climate-related andenvironmental risks drive the different risk areas, including liquidity, credit, operational,
market and any other material risk to capital or any of its sub-categories that it is or
might become exposed to. Furthermore, they are expected to pay particular attention
to concentrations within and between risk types that climate-related andenvironmental risks may cause.
Expectation 7.1

Institutions are expected to have a holistic and well-documented view of the
impact of climate-related and environmental risks on existing risk categories.
The risk management framework should encompass on-balance-sheet risks andoff-balance-sheet risks, with appropriate consideration of both financial and83

See paragraphs 136 and 137 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

84

See also paragraphs 32 and 34 under Principle 2 (ii) of the ECB Guide to the internal capital adequacy
assessment process (ICAAP).

85

See paragraph 60 of the ECB Guide to the internal capital adequacy assessment process (ICAAP).

Guide on climate-related and environmental risks

31

non-financial risks 86, both for risks that the institutions is currently exposed to and forrisks that the institution may be exposed to going forward. Institutions are responsiblefor implementing a regular process for identifying all material risks and including thesein a comprehensive internal risk inventory. The expectation includes the normative
and the economic perspectives of the ICAAP. 87
Expectation 7.2

Institutions are expected to comprehensively include climate-related andenvironmental risks in their assessment of materiality for all of their businessareas in the short, medium and long-term under various scenarios. The
underlying analysis is expected to be tailored to the business model and risk profile,
taking due consideration of the vulnerabilities of the economic (sub-)sectors,
operations and physical locations of the institution and its counterparties. Institutions
are expected to document the climate-related and environmental risks considered, inparticular, their transmission channels and impact on the risk profile. Moreover,institutions are expected to justify an assessment of non-materiality, specifying anddocumenting the qualitative and quantitative information underlying thatassessment. 88

Box 6
Example of observed practice: Mapping of climate-related risks to financial risksSome institutions have launched an internal process to map climate-related risks and their potential
financial impacts. One bank mapped the main transmission channels to its existing risk categories
and provided an overview of the estimated impact on its risk profile and the estimated time frame.
Table A
Stylised example of the mapping of climate-related risks to financial impacts
Climate-related risk
drivers

Impact on
risk profile

Impact on
strategy

1-3 years

**

****

3-5 years****

Consumers and investors favouring more sustainable products

1-3 years*****

Damage to property and assets in high-risk locations

1-3 years***

Increased costs for customers to address damages or losses caused by climatic
incidents affecting their ability to pay

1-3 years***

Potential financial impact

Time frame

Policy and legal

Depreciation of assets of carbon-intensive companies in the investment portfolio

Technology

Corporate clients in the car industry affected by a substitution of existing products
and services

Market sentiment
Acute physical risk
Chronic physical risk

Source: ECB.

Expectation 7.3

Institutions are expected to adequately quantify the climate-related andenvironmental risks that the institution is exposed to. 89 As also stated in the ECB
Guide to the ICAAP, risks are not expected to be excluded from the assessment

86

See paragraph 136 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

87

See Principle 4 (i) of the ECB Guide to the internal capital adequacy assessment process (ICAAP).

88

See paragraph 63 of the ECB Guide to the internal capital adequacy assessment process (ICAAP).

89

See Principle 6 of the ECB Guide to the internal capital adequacy assessment process (ICAAP), whichstates that “The institution is responsible for implementing risk quantification methodologies that are
adequate for its individual circumstances under both the economic and normative perspectives.”

Guide on climate-related and environmental risks

32because they are difficult to quantify or because the relevant data are not available. 90
Where such quantification methodologies are subject to further developments, also
taking into account the current work and upcoming publications of international
networks 91 and standard setters, institutions may use plausible assumptions todevelop proxies for the assessment of climate-related and environmental risks. As
described in Section 6.5, institutions may, in particular, consider the use of scenario
analysis and stress testing for this purpose.
Expectation 7.4

Institutions are expected to adopt a strategic approach to managing and/or
mitigating climate-related and environmental risks in line with their businessstrategy and risk appetite, and to adapt policies, procedures, risk limits and risk
controls accordingly. Based on the EBA Guidelines, an institution’s risk
management framework should provide specific guidance on the implementation of its
strategies and, where appropriate, establish and maintain internal limits consistent
with its risk appetite and commensurate with its sound operation, financial strength,
capital base and strategic goals. 92 With this in mind, institutions are expected toconsider the need to adjust their risk policies, for example by setting criteria to identify
business areas, including portfolios and investments, that can be supported in
gradually reducing climate-related or environmental risks, thus fostering theirresilience to transition and/or physical risks. Institutions are encouraged to engage inconstructive dialogue with critical counterparties, including with a long-term view toimproving the sustainability rating and/or credit rating of a counterparty. An institution
may also consider setting limits on financing certain sensitive economic (sub-)sectors,
sovereigns, businesses or real estate exposures or even excluding some specific(sub-)sectors or borrowers from credit-granting that are not aligned with its
climate-related risk appetite. Specifically for institutions originating or planning tooriginate environmentally sustainable lending, the EBA Guidelines on loan originationand monitoring envisage that institutions assess the extent to which the lending
activity “is in line with or is contributing to the overall climate-related andenvironmentally sustainable objectives of the institution”. 93

Box 7
Example of observed practice: Quantifying the climate-related and environmental impactsof financing in the ICAAPThe ECB has observed a bank that, in its internal capital plan, assesses the environmental impact of
its financing and assigns an environmental rating to either the asset or project being financed, or to
the borrower for general purpose financing, whether a corporate or public sector client. This rating isderived from an assessment of the deal’s climate impact, and factors in any significant environmental
externalities, such as water use, pollution, waste and biodiversity. On the basis of this rating, the bank
90

See paragraph 74 of the ECB Guide to the internal capital adequacy assessment process (ICAAP),), “[…]the institution is expected to determine sufficiently conservative risk figures, taking into consideration all
relevant information and ensuring adequacy and consistency in its choice of risk quantification
methodologies.”

91

See the “Overview of Environmental Risk Analysis by Financial Institutions”, NGFS, 2020 and “CaseStudies of Environmental Risk Analysis Methodologies”, NGFS, 2020.

92

See paragraphs 135, 137 and 138 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

93

See paragraph 59 of the EBA Guidelines on loan origination and monitoring (EBA/GL/2020/06).

Guide on climate-related and environmental risks

33

applies penalties to the assets projected to have the highest level of environmental impact, leading toan increase in the analytical risk weight for these exposures. The bank reports that the facilities with anegative environmental and climate impact are subject to an increase in their analytical risk-weighted
assets of up to a quarter. Ultimately, this impact is reflected in the expected rate of return of theassets, providing potential incentives to invest or disinvest in particular sectors.

Expectation 7.5

Institutions are expected to conduct a proper climate-related andenvironmental due diligence, both at the inception of a client relationship andon an ongoing basis. This should be understood to include the collection of theinformation and data needed to assess the vulnerabilities of exposures andinvestments to climate-related and environmental risks, notably at their inception.
Institutions are expected to perform reasonability checks on such information and datain line with the institutions’ risk policies and procedures. Institutions are expected to beaware of their clients’ impact on and vulnerability to climate-related and environmental
aspects and of their approach to managing this impact and risk. Moreover, proper
environmental due diligence, when appropriately acted upon, is likely to reduce
reputational and liability risks. The scope and depth of due diligence is expected to be
defined in relation to the sector and geographic location in which the client is located. If
deemed necessary, institutions may consider the need for external expertise.
Institutions are advised to ensure compliance with the OECD Guidelines forMultinational Enterprises, 94 for example. Any findings from due diligenceassessments are expected to be considered in the decision on whether and how toengage, or continue to engage, with a client.

Expectation 7.6

Institutions are expected to assess the impact of climate-related andenvironmental risks on their capital adequacy from an economic and anormative perspective. In line with the ECB Guide to the ICAAP, institutions are
expected to consider in their forward-looking capital adequacy assessment any risks,
and any concentration within and between those risks, that may arise from relevantchanges in their operating environment. 95 In the same vein, the ECB expects
institutions to incorporate climate change, in particular the energy transition, into theassessment from an economic value perspective. Institutions are expected to take into
consideration the impact of climate-related and environmental risks when determining
their capital adequacy in a way that enables the institution to sustainably follow its
business model by ensuring economic and normative capital adequacy. 96 As set out
in the ECB Guide to the ICAAP, institutions are expected to implement both anormative perspective and an economic perspective that mutually inform each other.
Institutions are expected to take into account potential effects of climate-related andenvironmental risks on economic value in the economic perspective. The potential
impact on regulatory capital ratios going forward, reflected in baseline and adverse
94

See the “OECD Guidelines for Multinational Enterprises”, OECD, 2019 and “Due Diligence for
Responsible Corporate Lending and Securities Underwriting – Key considerations for banks
implementing the OECD Guidelines for Multinational Enterprises”, OECD, 2019.

95

See paragraph 60 of the ECB Guide to the internal capital adequacy assessment process (ICAAP).

96

See Principle 3 of the ECB Guide to the internal capital adequacy assessment process (ICAAP) for thedefinitions of the normative and economic perspectives.

Guide on climate-related and environmental risks

34scenario assessments, are expected to be considered in the normative perspective.
Institutions are also expected to consider the outcomes of these assessments in theirrisk appetite and business strategy, as well as in their decision-making moregenerally.
Institutions are expected to evaluate the appropriateness of their identification,measurement and mitigation instruments for climate-related and environmental
risks in their periodic reviews. Institutions should perform regular internal reviews, 97
for instance, in the context of the ICAAP. 98 The purpose of these reviews is to assess
whether internal processes and methodologies have led to sound outcomes andwhether they remain appropriate in view of current and future developments. 99 As theavailability of data and methodologies for identifying and measuring climate-related
and environmental risks is evolving rapidly, institutions are expected to regularly
consider the appropriateness and quality of the data sources and methods in place.

Expectation 7.7

6.2

Credit risk management
Expectation 8
In their credit risk management, institutions are expected to consider climate-related
and environmental risks at all relevant stages of the credit-granting process and tomonitor the risks in their portfolios.

In accordance with Article 79 of the CRD, competent authorities must ensure, among
other things, that institutions grant credit on the basis of sound and well-defined
criteria and that the process for approving, amending, renewing and refinancing credit
is clearly established. To this end, institutions are expected to adopt a holistic
approach and take into account risks associated with climate-related andenvironmental factors in their credit risk policies and procedures, in line with the EBA
Guidelines on loan origination and monitoring. 100 101
Expectation 8.1

Climate-related and environmental risks are expected to be included in all
relevant stages of the credit-granting process and credit processing.
Specifically, institutions are expected to form an opinion on how climate-related andenvironmental risks affect the borrower’s default risk. 102 The climate-related andenvironmental factors material to the default risk of the loan exposure are expected tobe identified and assessed. As part of this assessment, institutions may take into97

See paragraph 21 of the ECB Guide to the internal capital adequacy assessment process (ICAAP). The
ECB does not prescribe the frequency with which it expects reviews to take place, but wishes to ensurethat internal processes “remain appropriate with a view to the current situation and future developments.”

98

See Article 73 CRD IV.

99

See also paragraph 18 under Principle 1 (iii) of the ECB Guide to the internal capital adequacy
assessment process (ICAAP).

100

See paragraph 51 of the EBA Guidelines on loan origination and monitoring (EBA/GL/2020/06).

101

See also Principle 2 (ii) and (iii) of the ECB Guide to the internal capital adequacy assessment process(ICAAP).

102

See paragraphs 57, 126, 127, 146, 149 and 188 of the EBA Guidelines on loan origination and monitoring(EBA/GL/2020/06).

Guide on climate-related and environmental risks

35consideration the quality of the clients’ own management of climate-related andenvironmental risks. Institutions are expected to give appropriate consideration tochanges in the risk profile of sectors and geographic areas driven by climate-related
and environmental risks. For instance, overexploitation of natural resources, such as
water, in certain areas might lead to limitations on their use, which can lead in turn todisruptions to production and losses to institutions’ counterparties.

Box 8
Example of observed practice: Climate-informed shadow probabilities of defaults
The ECB observed that institutions often consider climate-related and environmental risks
qualitatively in their credit-granting process. Nonetheless, some institutions are considering or in theprocess of developing means to incorporate these risks into their models. One bank is developing
climate-informed shadow probabilities of defaults (PDs) to be reported alongside the regular PDs.
The climate-informed shadow PDs would take into consideration a detailed analysis of physical andtransition risks for higher risk counterparties identified in a screening process. A big differential
between the two would then trigger the need to consider mitigating action. A second bank isdeveloping a scorecard for sustainability risks comprising qualitative aspects. The input from thescorecard would get a fixed weighting within the model.
Another bank includes environmental variables in its internal credit-scoring models. The
environmental valuation has been introduced for sectors where such an assessment was found to be
relevant in terms of credit quality differential analysis. The potential environmental impact of theunderlying activities influences the credit quality. The credit-scoring models have been rolled out for
exposures to large corporates, corporates and for project finance exposures.

Expectation 8.2

Institutions are expected to adjust risk classification procedures in order to
identify and evaluate, at least qualitatively, climate-related and environmental
risks. Institutions are expected to define appropriate general risk indicators or ratings
for their counterparties that take into account climate-related and environmental risks.
As part of risk classification procedures, institutions are expected to identify borrowersthat may be exposed, directly or indirectly, to increased climate-related andenvironmental risks. 103 Critical exposures to such risks should be highlighted and,
where applicable, considered under various scenarios 104 with the aim of ensuring theability to assess and introduce in a timely manner any appropriate risk mitigation
measures, including pricing. Institutions are expected to consider, for example, theuse of heat maps that highlight sustainability risks based on the relevance of individual(sub-)economic sectors for a given client.

Expectation 8.3

Institutions are expected to consider climate-related and environmental risks intheir collateral valuations. Climate-related and environmental risks may affect thevalue of collateral. Institutions are expected to give particular consideration to the103

See paragraphs 57, 126, 127, 146, 149 and 188 of the EBA Guidelines on loan origination and monitoring(EBA/GL/2020/06).

104

Possible scenarios include, among others, a review of current and projected GHG emissions, the market
environment, supervisory requirements for the companies under consideration, the likely impacts on
borrowers’ profitability and solvency, etc.

Guide on climate-related and environmental risks

36physical locations and the energy efficiency of commercial and residential real estatein this regard. Institutions are expected to incorporate these considerations into boththe process for establishing the value of collateral and into the review process
prescribed by the applicable regulations. 105
Expectation 8.4

Institutions are expected to monitor and manage credit risks in their portfolios,in particular through sectoral/geographic/single-name concentration analysis,
including credit risk concentrations stemming from climate-related andenvironmental risks, and using exposure limits or deleveraging strategies. 106
Institutions are expected to monitor how geographic and sectoral concentration isprone to climate-related and environmental risks. Likewise, institutions may measureconcentrations of assets with specific characteristics plausibly targeted by transition
policies, for example the distribution of energy efficiency labels within residential andcommercial real estate portfolios in the light of potential legislation. For larger
counterparties, institutions may consider climate-related and environmental risks inthe single-name concentration analysis. Institutions are advised to develop theirmonitoring capabilities in conjunction with the metrics and limits developed for the
purposes of their risk appetite and data governance framework.

Expectation 8.5

Institutions’ loan pricing frameworks are expected to reflect their credit risk
appetite and business strategy with regard to climate-related andenvironmental risks. 107 Pursuant to Article 76(3) of CRD IV, an institution’s risk
committee shall review whether the prices of assets offered to clients take thebusiness model and risk strategy fully into account. The pricing of loans is an
important steering mechanism for institutions, determining the level and origin of their
future income. For instance, as part of their business strategy and risk appetite,
institutions may decide to reduce or limit exposures to sectors harmful for theenvironment or the climate or to steer away from loans collateralised byenergy-inefficient real estate. The pricing framework is then expected to support thechosen risk perspective and strategy, for example by differentiating the loan prices for
exposures according to their energy efficiency or by including a sector/client-specificcharge. In line with their business strategy and risk appetite, institutions may also
incentivise their clients to mitigate climate-related and environmental risks. This could,
for instance, entail setting the interest rate of an environmentally sustainable loan at alevel consistent with a higher resilience towards such risks and the associatedimproved creditworthiness under otherwise unchanged conditions. For banks
originating sustainable lending, the interest rate adjustment process could be linked tothe achievement of sustainability targets by the client over a predefined period of timeover which climate-related and environmental risks are reduced.

105

See, for instance, Article 208 of Part Three of the CRR.

106

See paragraph 245 of the EBA Guidelines on loan origination and monitoring (EBA/GL/2020/06).

107

See paragraphs 200 and 201 of the EBA Guidelines on loan origination and monitoring(EBA/GL/2020/06).

Guide on climate-related and environmental risks

37Box 9
Example of observed practice: Mortgage price differentiation
The ECB observed an institution that differentiates the client price of retail mortgage loans according
to the energy label of the underlying real estate. Mortgages with a better energy label receive a lower
client rate than mortgages with a less energy-efficient label, so long as the institution’s overallprofitability target for mortgages is projected to be met. This differentiation is based on theconsideration that a portfolio with higher energy efficiency labels is likely to be less vulnerable totransition risk and is therefore in line with the institution’s business strategy.

Institutions’ loan pricing is expected to reflect the different costs driven byclimate-related and environmental risks. As set out in the EBA Guidelines on loan
origination and monitoring, 108 institutions should implement a pricing framework
linked to the characteristics of the loan, considering all relevant costs. The impact ofclimate-related and environmental risks may play out through various cost drivers,
such as the cost of capital, funding or credit risk. Environmentally sustainable assets
may, for example, be funded by dedicated instruments, such as green (covered)bonds, and thus incur different funding costs. Areas exposed to growing physicalclimate risks, such as floods or droughts, may see an increase in credit loss.
Institutions are expected to consider these developments and reflect them in their loan
pricing, for instance by setting the credit cost charges at a higher level to reflect the
impact of climate-related and environmental risks. In addition, institutions are
expected to reflect in their pricing any higher funding costs for assets that are
particularly affected by physical and transition risk.

Expectation 8.6

6.3

Operational risk management
Expectation 9
Institutions are expected to consider how climate-related and environmental events
could have an adverse impact on business continuity and the extent to which thenature of their activities could increase reputational and/or liability risks.
As set out in Article 85 of the CRD and in the EBA Guidelines 109, institutions should
implement policies and processes to evaluate and manage their exposure tooperational risk. They should assess operational risk across all business lines andoperations, and determine how operational risk may materialise. 110 Institutions arealso expected to adopt all necessary measures to safeguard business continuity and108

See paragraphs 186, 187 and 190 of the EBA Guidelines on loan origination and monitoring(EBA/GL/2020/06).

109

See paragraph 255 of the EBA Guidelines on the revised common procedures and methodologies for thesupervisory review and evaluation process (SREP) and supervisory stress testing (EBA/GL/2018/03).

110

See also Principle 4 and paragraph 60 of the ECB Guide to the internal capital adequacy assessment
process (ICAAP).

Guide on climate-related and environmental risks

38

ensure a timely disaster recovery, both in terms of policies and the functioning ofphysical assets, including IT systems.

Expectation 9.1

Institutions are expected to assess the impact of physical risks on theiroperations in general, including the ability to quickly recover their capacity tocontinue providing services. Institutions are reminded that this assessment should
be conducted as part of their business continuity management, as set out in the EBA
Guidelines on internal governance. 111 The geographic location in which an institution
operates might make it more prone to physical risks. Institutions are reminded toassess the materiality of operational risk arising from physical risk. This applies inparticular to outsourced services and IT activities, particularly if service providers are
established in locations that are prone to extreme weather events or otherenvironmental vulnerabilities.
Institutions are reminded to consider whether these could affect their ability to processtransactions, provide services or cause legal liabilities for damage to third parties,
such as customers and other stakeholders. In particular, when assessing its critical orimportant functions, an institution is expected to consider the impacts of climatechange on the provision of these services. 112 The outcome of this assessment, if
material for any of the institution’s business lines or operations, is expected to bereflected in its business continuity plan.

Expectation 9.2

Institutions are expected to evaluate the extent to which the nature of theactivities in which they are involved increases the risk of a negative financial
impact arising from future reputational damage, liability and/or litigation. Basedon the EBA Guidelines, all relevant risks should be encompassed in the risk
management framework of an institution, with appropriate consideration of bothfinancial and non-financial risks, including reputational risk. 113 Reputational risks canarise quickly and can rapidly affect firms. Institutions associated with social orenvironmental controversies – or more generally institutions that are perceived not totake due consideration of environmental aspects in their business activities – could
face negative financial impacts stemming from reputational risks as a result ofchanging market sentiment in relation to environmental and climate-related risks.
Similarly, to avoid reputational or litigation risks arising from controversy in connection
with their products, for instance, driven by investments in products with an adverse
environmental impact, institutions are also expected to consider evaluating thecompliance of their investment products with international or EU best practices, such

111

See paragraphs 208-213 of the EBA Guidelines on internal governance (EBA/GL/2017/11).

112

See paragraph 31 under Section 4 of the EBA Guidelines on outsourcing (EBA/GL/2019/02).

113

See paragraph 136 of the EBA Guidelines on internal governance (EBA/GL/2017/11). For theassessment of reputational risk in the context of operational risk by the competent authorities, see
Sub-section 6.4.3 of the consolidated version of the EBA Guidelines on the revised common procedures
and methodologies for the supervisory review and evaluation process (SREP) and supervisory stresstesting (EBA/GL/2018/03).

Guide on climate-related and environmental risks39

as the EU Green Bond Standard. 114 Similarly, financing companies with significant
polluting activities can be a driver of reputational risk for institutions. Moreover,institutions may wish to adopt policies related to engagement with clients andresponse to controversies, as and when they arise. Institutions may consider
periodically screening counterparties for controversial activities, conducting
environmental footprinting and/or damage cost exercises to identify potential pockets
of risk, and should reflect the outcomes of such screening exercises in the relevantrisk reports.

Box 10
Example of observed practice: Reputational risks captured in the ICAAPThe ECB observed an institution that considers reputational risks arising from environmental, social
or governance impacts in its internal capital adequacy assessment process. The institution is
exposed to considerable reputational risk related to environmental and social factors, as its businessmodel is targeted at financing private companies in emerging market economies. Each of its clients istherefore categorised based on the degree of potentially negative environmental, social andgovernance impacts. There are four risk categories in the institution’s classification system, whichrange from a “significant” to having “minimum or no” adverse environmental, social or governanceimpacts. The institution allocates an amount to capital relative to the number of clients in each of therisk classification categories. Each risk category is assigned a capital charge per client, i.e. theinstitution takes a higher capital for a client that has a higher risk classification.

6.4

Market risk management
Expectation 10
Institutions are expected to monitor on an ongoing basis the effect of climate-related
and environmental factors on their current market risk positions and future
investments, and to develop stress tests that incorporate climate-related andenvironmental risks.

Article 83 of the CRD provides that competent authorities must ensure that policies
and processes for the identification, measurement and management of all material
sources and effects of market risk are implemented. With regard to market risk
management, institutions are expected to consider that environmental andclimate-related risks could lead to potential shifts in supply and demand for financial
instruments (e.g. securities, derivatives), products and services, with a consequent
impact on their values. 115 Institutions that invest in companies with business models
114

Furthermore, credit institutions that provide portfolio management and/or financial advice will have tocomply with the disclosure requirements laid down in Regulation (EU) 2019/2088 of the European
Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial
services sector, which will be further described in the forthcoming technical standards.

115

See also Principles 2 and 7 of the ECB Guide to the internal capital adequacy assessment process(ICAAP).

Guide on climate-related and environmental risks40

that are perceived as environmentally unsustainable or that are geographically locatedin areas prone to physical risks might suffer a decline in the value of their investment
owing to changes in policy measures, market sentiment or technology, or as a result of
severe weather events or gradual adverse changes in climatic conditions.
In line with the nature of the ICAAP perspectives, institutions are expected to assess inthe normative perspective, as a minimum, risks arising from debt, equity andequity-related financial instruments in the regulatory trading book, as well as foreignexchange positions and commodities risk positions assigned to both the trading andbanking book. In the economic perspective, all instruments are expected to beassessed based on economic value considerations, irrespective of their accounting
treatment.
Moreover, the assessment is also expected to consider the banking book, and inparticular, the following sub-categories of market risk: credit spread risk arising frompositions measured at fair value and at cost, and risk arising from equity exposures.
With specific reference to the credit spread risk component of banking book positions,institutions are expected to assess the relevance of the credit spread among all thedrivers of overall market risk. This is relevant when considering, among others, that
financial instruments issued by companies belonging to sectors perceived asenvironmentally unsustainable and which do not adopt a comprehensive sustainable
management approach might suffer an abrupt decline in their value. In the same vein,
the value of equity exposures should be monitored on an ongoing basis to assess
whether their value has been negatively affected by a change in the perception of theissuer’s riskiness, specifically owing to climate-related and environmental risks.
Institutions specialised in commodities trading are expected to pay particular attention
to potential hidden vulnerabilities including, but not limited to, jumps in prices or valuesof certain commodities perceived as environmentally less sustainable than others.
Additionally, it would be advisable for institutions to monitor how the governments towhich institutions are exposed via sovereign holdings may be affected by transitionand physical risks.
Given the specific characteristics of market activities, internal stress testing (e.g. asensitivity analysis) could be usefully applied to better understand and assess therelevance of climate-related risks for an institution’s trading and banking book. Suchanalyses are expected to address climate-related and environmental risks under thenormative and economic perspectives of the ICAAP alongside other risks,,
supplementing historical distributions with hypothetical assumptions. 116

116

See paragraph 69 of the EBA Guidelines on institutions’ stress testing (EBA/GL/2018/04).

Guide on climate-related and environmental risks

41

6.5

Scenario analysis and stress testing
Expectation 11
Institutions with material climate-related and environmental risks are expected toevaluate the appropriateness of their stress testing, with a view to incorporating theminto their baseline and adverse scenarios.

As part of the ICAAP, institutions are expected to conduct a tailored and in-depth
review of their vulnerabilities through stress testing. 117 The stress scenarios should
comprise all material risks that may deplete internal capital or impact regulatory capitalratios and be used as part of the institution’s stress-testing programme in both theeconomic and normative perspective. Institutions are expected to consider using
scenarios that are in line with scientific climate change pathways, such as IPCC
scenarios. Specifically for transition risk, institutions are expected to use scenarios
that, for different policy outcomes (e.g. early or late transition), embed plausible
considerations for the related physical outcome. 118 This entails, for instance,
considering how chronic climate impacts associated with the late transition scenario
can potentially further reinforce policy action. All these aspects should be properlyreflected in an institution’s ICAAP. 119 When conducting scenario analysis and stresstesting with respect to climate-related and environmental risks, at least the following
aspects are expected to be considered for both the normative and economic
perspectives:•

how the institution might be affected by physical risk and transition risk;•

how climate-related and environmental risks might evolve under various
scenarios, taking into account that these risks may not be fully reflected inhistorical data;•

how climate-related and environmental risks might materialise in the short,medium and long term depending on the scenarios considered.

Institutions are expected to define the assumptions for their own risk profile andindividual specifications, as well as consider several scenarios based on different
combinations of assumptions. As part of their capital planning, institutions are
expected to assess their capital adequacy under a plausible baseline scenario andinstitution-specific adverse scenarios.

117

See paragraph 140 et seq. of the EBA Guidelines on internal governance (EBA/GL/2017/11) and
Chapters 5.4 and 6.5 of the Guidelines on ICAAP and ILAAP information collected for SREP purposes(EBA/GL/2016/10).

118

See, for instance, the “World Energy Model”, IEA, 2019; “NGFS Climate scenarios for central banks andsupervisors”, NGFS, 2020; and “Changing course: A comprehensive investor guide to scenario-based
methods for climate risk assessment, in response to the TCFD”, UNEP FI Investor Pilot or UNEP FI,
2019.

119

See Article 73 of the CRR.

Guide on climate-related and environmental risks42For the adverse scenarios, the institution is expected to assume unusual but plausible
developments with an adequate degree of severity in terms of their impact on its
regulatory capital ratios.
According to the ECB Guide to the ICAAP, the normative perspective is expected tocover a forward-looking horizon of at least three years. Institutions are expected totake developments beyond this minimum horizon into account in their strategicplanning in a proportionate manner if they will have a material impact. 120 Institutions
are expected to consider adopting a longer time horizon for climate-related andenvironmental risks given the likelihood that they will mostly materialise in the medium
to long term. In particular, longer time horizons could be reflected in stress testing in
the economic perspective.
Likewise, institutions are also expected to take into account the relevance ofclimate-related impacts on their business lines when designing scenarios for recovery
planning processes. As stipulated in the Bank Recovery and Resolution Directive 121,
institutions should contemplate a range of scenarios of severe macroeconomic andfinancial stress for a full scope recovery plan. Institutions are expected to test recovery
options against these scenarios to determine their effectiveness in such events.

6.6

Liquidity risk management
Expectation 12
Institutions are expected to assess whether material climate-related andenvironmental risks could cause net cash outflows or depletion of liquidity buffers and,if so, incorporate these factors into their liquidity risk management and liquidity buffer
calibration.

Pursuant to Article 86(1) of the CRD, institutions are required to have robust
strategies, policies, processes and systems for the identification, measurement,
management and monitoring of liquidity risk over an appropriate set of time horizons toensure they maintain adequate liquidity buffers.
To ensure robust liquidity risk management, institutions are expected to consider the
direct or indirect impacts of climate-related and environmental risks on their liquidity
position. 122 123 Institutions are encouraged to include such considerations in their120

See paragraph 44 and footnote 22 of the ECB Guide to the internal capital adequacy assessment
process (ICAAP).

121

See Article 5(6) of Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014
establishing a framework for the recovery and resolution of credit institutions and investment firms(BRRD).

122

Directly, as a result of a severe physical event, clients could be withdrawing money from their accounts inorder to finance damage repairs, forcing the credit institution to sell a high level of assets to cover theseoutflows (see “Guidance Notice on Dealing with Sustainability Risks”, BaFin, 2020, p. 18). Indirectly,
banks with balance sheets that would be hit by credit and market risks could be unable to refinancethemselves, potentially leading to tensions on the interbank lending market (see “The Green Swan”, BIS,
2020, p. 28). In addition, banks’ liquidity risk may increase owing to macroeconomic shocks caused byphysical and transition risks, resulting for instance in a narrower universe of investable securities.

Guide on climate-related and environmental risks

43

ILAAP, considering climate-related and environmental risks under both the economic
and the normative perspective. Such assessments are expected to be conducted in a
forward-looking manner, assuming both business-as-usual and stressed conditions,and, in particular, to consider severe but plausible scenarios that may occur in
combination, with a focus on key vulnerabilities. Consequently, they are expected toassess whether climate-related and environmental risks could have a material impact
on net cash outflows or liquidity buffers. If this is deemed to be the case, institutions
should incorporate this into their liquidity risk management and liquidity buffer
calibration.
For example, institutions could consider the possibility of a combined idiosyncratic andmarket stress situation occurring simultaneously with the materialisation ofclimate-related or environmental risks. Furthermore, institutions could consider how
their liquidity position might be affected by a climate-related or environmental risk
event that has an impact on the value of their liquidity buffers. Institutions could also
consider the impact of such risks on regional liquidity positions, for example in local
currencies, as well as potential operational and other impediments to providing
liquidity to regions where climate-related or environmental risks materialise.
In addition, institutions are expected to link their business strategy with the allocationof liquidity resources. To this end, institutions are reminded to take into account in theirinternal pricing process the specific marginal cost of funding of sustainable refinancing
instruments, including, where relevant, the liquidity cost or benefit compared toordinary refinancing instruments. 124

123

See, in particular, Principle 4 (iv) of the ECB Guide to the internal liquidity adequacy assessment process(ILAAP), November 2018.

124

See paragraphs 24 and 25 of the CEBS Guidelines on liquidity cost benefit allocation of 27 October 2010.

Guide on climate-related and environmental risks

44

7Supervisory expectations relating todisclosures
Access to information is necessary for promoting transparency within financial
institutions and contributing to the orderly functioning of financial markets. 125 The
European regulatory framework therefore sets out disclosure requirements to makekey information available about an institution’s capital, risks and risk exposures inorder to adequately inform market participants. Disclosures on climate-related risk
allow market participants to make a more informed assessment of physical andtransition risks. In turn, this will improve institutions’ and investors’ understanding of
the financial implications of climate change.
It should also be pointed out that the EU institutions have reached a politicalagreement to develop an EU-wide classification system, or taxonomy, for sustainable
investments. Going forward, institutions subject to the Non-Financial Reporting
Directive (NFRD) will be asked to provide further transparency on the extent to which
their activities can be regarded as environmentally sustainable. 126 In a similar vein, it
should be noted that the European Commission plans to conduct a review of the
NFRD as part of the strategy to strengthen the foundations for sustainable
investment. 127 128

7.1

Disclosure policies and procedures
Expectation 13
For the purposes of their regulatory disclosures, institutions are expected to publish
meaningful information and key metrics on climate-related and environmental risks
that they deem to be material, with due regard to the European Commission’s
Guidelines on non-financial reporting: Supplement on reporting climate-related
information.

Expectation 13.1

Institutions are expected to specify in their disclosure policies key
considerations that inform their assessment of the materiality of climate-related
and environmental risks, as well as the frequency and means of disclosures.
Articles 431 et seq. of the CRR require institutions to publicly disclose specific125

See Title III of the EBA Guidelines on materiality, proprietary and confidentiality and on disclosure
frequency under Articles 432(1), 432(2) and 433 of Regulation (EU) No 575/2013.

126

See the Proposal for a Regulation of the European Parliament and of the Council on the establishment ofa framework to facilitate sustainable investment (14970/19).

127

See Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending
Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large
undertakings and groups.

128

Large institutions with publicly listed issuances will also be required to disclose information on ESG risks
from June 2022 pursuant to Article 449a of the CRR2.

Guide on climate-related and environmental risks

45

information that is material, but is not proprietary or confidential. Article 432 of the
CRR provides that information shall be regarded as material where its omission or
misstatement could change or influence economic decision-making. 129 To that end,
institutions shall “have policies for assessing the appropriateness of their disclosures,
including their verification and frequency.” 130 This disclosure policy is expected to
specify the way in which the materiality of climate-related and environmental risks isassessed. 131 For this purpose, the EBA Guidelines state that, in the assessment ofmateriality of certain information, institutions should pay particular attention not only totheir business model, long-term strategy and the overall risk profile, but also to the
influence of the economic and political environment, the assumed level of relevance of
information for users, and the relationship with recent developments in risks anddisclosure needs. 132
Based on the EBA Guidelines, there are no common thresholds for materiality. 133 The
assessment of the materiality of climate-related and environmental risks is therefore
expected to be performed using both qualitative and quantitative information and to
duly consider reputational and liability risks associated with the institution’s impact on
the climate and environment and arising from controversy in connection with its
products and operations. Institutions are also reminded of the European
Commission’s advice not to prematurely consider climate-related risks as immaterial
owing to their longer-term nature. 134 Institutions are reminded that disclosures ofmaterial risks must comply with Articles 433, 434 and 434a of the CRR.
Expectation 13.2

In case an institution deems climate-related risks to be immaterial, theinstitution is expected to document this judgement with the available
qualitative and quantitative information underpinning its assessment. Pursuant
to Article 432(1) of the CRR, information shall be regarded as material if its omission
or misstatement could change or influence the assessment or decision of a user
relying on that information for the purpose of making economic decisions.
Furthermore, the EBA Guidelines state that, when an institution decides not todisclose information or a set of requirements due to immateriality, it should clearlystate this fact. 135

Expectation 13.3

When institutions disclose figures, metrics and targets as material, they are
expected to disclose or reference the methodologies, definitions and criteria

129

The expectations described in this section pertain solely to institutions’ regulatory disclosure
requirements and are not in any way applicable to existing accounting standards.

130

See Article 431(3) of the CRR.

131

In accordance with Article 431(3) CRR, and as elucidated in the EBA Guidelines, the concept ofmateriality implies the need to disclose elements that are not explicitly required under specific provisions
in the CRR.

132

See the EBA Guidelines on materiality, proprietary and confidentiality and on disclosure frequency under
Articles 432(1), 432(2) and 433 of Regulation (EU) No 575/2013, p. 17.

133

See the EBA Guidelines on materiality, proprietary and confidentiality and on disclosure frequency under
Articles 432(1), 432(2) and 433 of Regulation (EU) No 575/2013, p. 4.

134

See the European Commission Guidelines on non-financial reporting: Supplement on reporting climate
information.

135

See paragraph 19 of the EBA Guidelines on materiality, proprietary and confidentiality and on disclosure
frequency under Articles 432(1), 432(2) and 433 of Regulation (EU) No 575/2013.

Guide on climate-related and environmental risks

46

associated with them. 136 These disclosures help to convey the institution’s risk
profile in a comprehensive manner to market participants, namely with a view tolimiting reputational and liability risks. In particular, this expectation applies when
institutions commit to contribute to climate-related and environmental goals, in whichcase the ECB also expects them to provide a comprehensive overview of the impact of
the entity as a whole. The ECB has assessed that information currently disclosed isheterogeneous and partial, in some cases focusing on commitments (not) to financecertain activities without providing sufficient clarity on thresholds utilised and portfolios
covered. While institutions are encouraged to contribute to climate-related andenvironmental goals, they are also expected to provide comprehensive andmeaningful information related to it. Institutions committing to stop or limit financing tocertain industries or activities through dedicated financing policies are then expected
to disclose the definition of the covered activity and associated targets, in terms ofdates and outstanding volumes by geographic area. Institutions are also expected tocommunicate on progress in achieving these targets, the internal monitoring
governance, as well as relevant methodological aspects, in particular, the criteria used
to identify counterparties covered by the financing policy and the scope of business
relationships concerned. Likewise, institutions are expected to consider all businesslines and their exposures as a whole when reporting on their contribution toenvironmental goals.

136

Pursuant to Article 432(1) of the CRR, “information shall be regarded as material if its omission or
misstatement could change or influence the assessment or decision of a user relying on that information
for the purpose of making economic decisions.”

Guide on climate-related and environmental risks

47

Figure 1
Recommendations of the Task Force on Climate-related Financial Disclosures
Governance

Strategy

Risk management

Metrics and targets

Disclose the organisation’s
governance around climaterelated risks andopportunities.

Disclose the actual andpotential impacts of climaterelated risks andopportunities on theorganisation’s businesses,
strategy and financial
planning, where suchinformation is material.

Disclose how theorganisation identifies,
assesses and manages
climate-related risks.

Disclose the metrics andtargets used to assess andmanage relevant climaterelated risks andopportunities, where suchinformation is material.

Recommended disclosuresa)Describe the board’s
oversight of climate-relatedrisks and opportunities.

a)
Describe the climate-relatedrisks and opportunities theorganisation has identified
over the short, medium andlong term.

a)Describe the organisation’s
processes for identifying andassessing climate-relatedrisks.

a)Disclose the metrics used by
the organisation to assessclimate-related risks andopportunities in line with its
strategy and risk
management process.

b)
Describe management’s rolein assessing and managing
climate-related risks andopportunities.

b)
Describe the impact ofclimate-related risks andopportunities on theorganisation’s businesses,
strategy and financial
planning.

b)
Describe the organisation’s
processes for managing
climate-related risks.

b)Disclose Scope 1, Scope 2,
and, if appropriate, Scope 3
greenhouse gas (GHG)
emissions and the relatedrisks.

c)
Describe the resilience of theorganisation’s strategy,
taking into considerationdifferent climate-related
scenarios, including a 2°C or
lower scenario.

c)Describe how processes for
identifying, assessing andmanaging climate-relatedrisks are integrated into theorganisation’s overall risk
management.

c)Describe the targets used by
the organisation to manage
climate-related risks andopportunities andperformance against targets.

Source: TCFD.

7.2
Expectation 13.4

Content of climate-related and environmental risk
disclosures
Institutions are expected to disclose climate-related risks that are material with
due regard to the European Commission’s Guidelines on non-financial
reporting: Supplement on reporting climate-related information. The Supplement
integrates the recommendations of the TCFD and provides guidance consistent with
the NFRD. The expected disclosures revolve around five key aspects: businessmodel, policies and due diligence processes, outcomes, risks and risk management
and KPIs. In this respect, institutions are reminded of the ECB expectations regarding
their business model and strategy, governance and risk management as set out in thisguide.

Guide on climate-related and environmental risks

48

Expectation 13.5

In particular, institutions are expected to disclose the institution’s financed
Scope 3 GHG emissions 137 for the whole group. Although the ECB does notprescribe the use of a specific measurement and/or attribution methodology 138,
institutions are encouraged to adopt a granular approach to measuring carbon
emissions, while remaining consistent with the GHG Protocol, as set out in theEuropean Commission’s Supplement. This could, for instance, entail aproject-by-project approach to measuring the carbon intensity of large corporate
portfolios and the property-by-property measurement of actual energy consumption orenergy efficiency classification for real estate portfolios. Institutions are expected todisclose: 139•

the amount or percentage of carbon-related assets in each portfolio in € millions
or as a percentage of the current portfolio value and, to the extent possible, aforward-looking best estimate of this amount or percentage over the course of
their planning horizon;•

the weighted average carbon intensity of each portfolio, where data are available
or can be reasonably estimated and, to the extent possible, a forward-looking
best estimate of this weighted average carbon intensity over the course of theirplanning horizon;•

the volume of exposures by sector of counterparty and, to the extent possible, aforward-looking best estimate of this volume over the course of their planninghorizon;•credit risk exposures and volumes of collateral by geography/country of locationof the activity or collateral, with an indication of those countries/geographies
highly exposed to physical risk.

Institutions are expected to disclose or reference the methodologies used andassumptions made. In particular, this would include the definitions and formulae for thecomputation of the abovementioned metrics.
Expectation 13.6

Institutions are expected to disclose the KPIs and KRIs used for the purposesof their strategy-setting and risk management, as well as their current
performance against these metrics. In line with the European Commission’s
Supplement and the EBA’s key policy messages, institutions are expected to disclosethe metrics used, including relevant targets and the current performance of theinstitution against those targets. Using the aforementioned metrics, the institution is
expected to describe the short, medium and long-term resilience of its strategy in thelight of different climate-related scenarios.

137

The ECB understands Scope 3 emissions as including the emissions of an institution's assets (financed
emissions).

138

For instance, the ECB has observed certain institutions that measure and disclose financed emissions
using the methodology developed by the Partnership for Carbon Accounting Financials.

139

See Annex 1 of the European Commission Guidelines on non-financial reporting: Supplement onreporting climate-related information.

Guide on climate-related and environmental risks

49

Institutions are expected to evaluate any further environmental risk-related
information needed to comprehensively convey their risk profile. After all, risks
to financial institutions emanate from a wide source of environmental factors, such as
water stress, biodiversity loss, resource scarcity and pollution. As disclosure
frameworks and the needs of market participants are evolving rapidly in this area,
institutions are well-advised to actively improve their disclosures.

Expectation 13.7

Box 11
Example of observed practice: Overview of disclosure alignment with TCFD
recommendations
The ECB observed a bank that provides schematic reference to its alignment with the individual
TCFD recommendations. This lays out the respective and specific chapters containing its disclosuresthat are in line with the TCFD recommendations.
Table A
Stylised overview table
Category
Governance

Strategy

Risk management

TCFD recommendation

Reference to institutions’disclosuresa) Describe the board’s oversight of climate-related risks and opportunities.

Document X, Page ABCb) Describe management’s role in assessing and managing climate-related risks andopportunities.

Document X, Page ABCa) Describe the climate-related risks and opportunities the organisation has identified over the
short, medium and long term.

Document Y, Page ABCb) Describe the impact of climate-related risks and opportunities on the organisation’s
businesses, strategy and financial planning.

Document Y, Page ABCc) Describe the resilience of the organisation’s strategy, taking into consideration different
climate-related scenarios, including a 2°C or lower scenario.

Document X, Page ABCa) Describe the organisation’s processes for identifying and assessing climate-related risks.

Document Z, Page ABCb) Describe the organisation’s processes for managing climate-related risks.

Metrics andtargetsc) Describe how processes for identifying, assessing, and managing climate-related risks areintegrated into the organisation’s overall risk management.

Document Z, Page ABC
Document Z, Page ABCa) Disclose the metrics used by the organisation to assess climate-related risks andopportunities in line with its strategy and risk management process. Describe theorganisation’s processes for managing climate-related risks.

Document X, Page ABCb) Disclose Scope 1, Scope 2, and, if appropriate, Scope 3 GHG emissions, and the relatedrisks.

Document X, Page ABCc) Describe the targets used by the organisation to manage climate-related risks andopportunities, and performance against the targets.

Document Y, Page ABC

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50

References
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2017.
DNB, “An energy transition risk stress test for the financial system of the Netherlands”,
2018.
DNB, “Values at risk? Sustainability risks and goals in the Dutch financial sector”,
2019.
DNB, “Integration of climate-related risk considerations into banks’ risk management”,
Good Practice document, 2020.
DNB, “Indebted to nature: Exploring biodiversity risks for the Dutch financial sector’’,June 2020.
EBA, “Action Plan on Sustainable Finance”, 2019.
ECB, “Financial Stability Review”, May 2019.
EEA, “Climate change, impacts and vulnerability in Europe 2012: An indicator-based
report”, 2012.
ESRB, “Too late, too sudden: Transition to a low-carbon economy and systemic risk”,
2016.
IRENA, “Stranded assets and renewables. How the energy transition affects the valueof energy reserves, buildings and capital stock”, 2017.
NGFS, “A call for action: Climate change as a source of financial risk”, 2019.
NGFS, “Technical supplement to the First NGFS comprehensive report”, 2019.
NGFS, “Guide for Supervisors: Integrating climate-related and environmental risks inprudential supervision”, Technical document, May 2020.
NGFS, “Requirements for scenario-analysis”, forthcoming.
OECD, “Guidelines for Multinational Enterprises”, 2019.
OECD, “The economic consequences of climate change”, 2015.
OECD, “Due Diligence for Responsible Corporate Lending and Securities
Underwriting – Key considerations for banks implementing the OECD Guidelines forMultinational Enterprises”, 2019.

Guide on climate-related and environmental risks

51

TCFD, “Technical supplement: The Use of Scenario Analysis in Disclosure of
Climate-related Risks and Opportunities”, 2017.

Guide on climate-related and environmental risks

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