OFFICE OF THE DEPUTY GOVERNORFINANCIAL SUPERVISION SECTOR

042
MEMORANDUM NO. M-2022-___To:

ALL BANKS

Subject:

Guidance on the Implementation of the Environmental andSocial Risk Management (ESRM) System

The Bangko Sentral ng Pilipinas (BSP) recognizes the ongoing efforts ofbanks to develop or enhance policies and strategies in line with the expectations set
out under Circular No. 1085 dated 19 April 2020 on the Sustainable Finance
Framework, Circular No. 1128 dated 26 October 2021 on the Environmental and Social
Risk Management (ESRM) Framework and Circular No. 1149 dated 23 August 2022 on
the Guidelines on the Integration of Sustainability Principles in Investment Activities
of Banks.
In this regard, the Guidance aims to inform banks on the initial steps or
approaches that may be considered in developing an ESRM System. It describes the
BSP’s minimum expectations as embodied in the issued Circulars and provides
information and reference to publications of the Network for Greening the Financial
System (NGFS) and the Basel Committee on Banking Supervision (BCBS), among
others, to support the development of an ESRM System.
Consistent with the principle of proportionality, banks should adopt an
ESRM System commensurate to their size, risk profile, and complexity of operations.
Banks may employ other approaches which are considered more feasible
considering their business model, risk appetite, and operational capacity, provided
that these are consistent with the BSP regulations and international standards.
Banks are also encouraged to keep abreast with the local and global developmentsin the sustainability front and strengthen their awareness and capacity in responseto the evolving climate and E&S risks.
For information and guidance.
Digitally signed by
Chuchi G. FonacierDate: 2022.09.29
17:32:28 +08'00'

CHUCHI G. FONACIER
Deputy Governor

29 September 2022

GUIDANCE ON THE IMPLEMENTATION OF THE
ENVIRONMENTAL AND SOCIAL RISK MANAGEMENT SYSTEMI.

INTRODUCTION
The Bangko Sentral ng Pilipinas (BSP) recognizes that climate change andenvironmental hazards could pose significant risks to the safety and soundnessof individual financial institutions and the entire financial system.
In line with the mandate of the BSP to promote financial stability, the BSP issued
the Sustainable Finance Framework (Circular No. 1085 dated 29 April 2020)1,
Environmental and Social Risk Management (ESRM) Framework (Circular No.
1128 dated 26 October 2021)2, and the Guidelines on the Integration of
Sustainability Principles in Investment Activities of Banks (Circular No. 1149 dated
23 August 2022)3 to promote effective management of risks arising from climatechange and environmental hazards as well as promote financing to green or
sustainable projects.
Circular No. 1085 sets out broad expectations on the integration of sustainability
principles in the corporate governance and risk management frameworks as wellas in the business strategies and operations of banks. One of the major
expectations under the Sustainable Finance Framework is the development andimplementation of Environmental and Social Risk Management (ESRM) System.
This guide describes the BSP’s minimum expectations as embodied in the issued
Circulars and provides information and reference to publications of the Central
Banks and Supervisors Network for Greening the Financial System (NGFS),4 andthe Basel Committee on Banking Supervision (BCBS), among others, to support
the development of ESRM System. Consistent with the principle ofproportionality, banks should adopt ESRMS that is suited to their size, risk profile,and complexity of operations.

II.

RELEVANT BSP GUIDELINESThe sustainable finance-related issuances of the BSP are anchored on thecorporate5 and risk management6 standards earlier issued by the BSP. Theseissuances emphasize the tone from the top and set out the duties andresponsibilities of the board of directors, senior management, and the control
functions in shaping the strategic thrust and embedding risk consciousness
within the organization. The BSP issuances highlight that effective managementof risks is a result of collective actions of all personnel in the organization.
Banks’ management of risks is guided by its risk appetite with the end goal ofachieving its business objectives. Thus, they should identify and assess allmaterial risks including new and emerging risks (e.g., E&S risks), on a group-wide

1
2
3
4

5

6

https://www.bsp.gov.ph/Regulations/Issuances/2020/c1085.pdf
https://www.bsp.gov.ph/Regulations/Issuances/2021/1128(Corrected%20Copy).pdf
https://www.bsp.gov.ph/Regulations/Issuances/2022/1149.pdf
The NGFS was launched at the Paris One Plant Summit on 12 December 2017. It is a group of Central
Banks and Supervisors willing, on a voluntary basis, to share best practices and contribute to thedevelopment of environment and climate risk management in the financial sector and to mobilize
mainstream finance to support the transition toward a sustainable economy. https://www.ngfs.net/en
Part D. Corporate Governance, Manual of Regulations for Banks (MORB)
https://www.bsp.gov.ph/Regulations/MORB/2020MORB.pdf
Section 142 on Risk Governance Framework, Section 143 on Credit Risk Management, Section 146 on
Operational Risk Management, and Section 614 on Investment Activities of Banks of the MORB.

Page 1 of 24

and entity specific levels. Banks should use accurate internal and external dataand consider the external operating environment in the risk assessment process
to inform strategic business decisions and risk management approaches.
III. MANAGING ENVIRONMENTAL AND SOCIAL (E&S) RISKSA.

Scope of Sustainable Finance
Circular No. 1085 defines sustainable finance as any form of financial productor service which integrates ESG criteria into business decisions that supports
economic growth and provides lasting benefit for both clients and society
while reducing pressures on the environment. This also covers green financewhich is designed to facilitate the flow of funds towards green economic
activities and climate change mitigation and adaptation projects.
Sustainable finance aims to address various overlapping issues including
environmental, social, economic and governance issues. The BSP adopted
the broad concept of sustainable development7.
Figure 1. A simplified schema for understanding broad terms, UNEP (2016)

The United Nations Environment Programme8 (UNEP) (2016) defines thefollowing four broad issues as shown in Figure 1:9
•

7

8

9

Environmental issues relate to the quality and functioning of the naturalenvironment and natural systems including biodiversity loss;
greenhouse gas emissions, renewable energy, energy efficiency, natural
resource depletion or pollution; waste management; ozone depletion;changes in land use; ocean acidification and changes to the nitrogenand phosphorus cycles.

https://sustainabledevelopment.un.org/content/documents/5987our-common-future.pdf
The concept of sustainable development provides a framework for the integration of environment
policies and development strategies - the term 'development' being used in its broadest sense, is often
taken to refer to the processes of economic and social change. Development involves a progressive
transformation of economy and society.
United Nations Environment Programme (2016) “Inquiry into the Design of a Sustainable Financial
System”, Definitions and Concepts Background Note. Inquiry Working Paper 16/3. Retrieved athttps://wedocs.unep.org/bitstream/handle/20.500.11822/10603/definitions_concept.pdf?sequence=1&isA
llowed=y
IbidPage 2 of 24

•Social issues relate to rights, well-being and interests of people andcommunities including human rights, labor standards, health andsafety, relations with local communities, activities in conflict zones,
health and access to medicine, consumer protection, and controversial
weapons.

•

Economic issues relate to investee impacts on economic conditions at
local, national, and global levels. Performance areas include direct
financial performance and risk, and indirect impacts such as throughemployment, supply chains, and provision of infrastructure.

•

Governance issues relate to the management of investee entities. Issues
include board structure, size, diversity, skills and independence,
executive pay; shareholder rights, stakeholder interaction; disclosure of
information; business ethics; bribery and corruption; internal controls
and risk management; and in general; issues dealing with therelationship between a company’s management, its board, its
shareholders and its other stakeholders.

The Sustainable Finance Framework covers the full spectrum ofsustainability issues or scope. Hence, it is not limited to addressing
environmental issues including climate change, but also encompasses
governance and socioeconomic aspects which are both integral parts of thesaid Framework. Governance is a key element in the BSP’s supervisory
framework while socioeconomics is one of the factors that underpin its
financial inclusion advocacy.
For purposes of implementing the ESRM System, the BSP focuses on theenvironmental and social aspects considering that governance aspects are
inherent in the supervisory expectations from banks. The Board may set oralign its objectives, operations, governance and risk management approachin relation to any or all of the above sustainability areas or issues cognizantof the value it creates and culture it fosters in the banking business.
B.

E&S Risk Definition
Circular No. 1085 defines E&S risk as potential financial, legal, and/or
reputational negative effect of environmental and social issues on the bank.
E&S issues may include climate risk (both physical and transition risks),
environmental pollution, hazards to human health, safety and security, andthreats to community, biodiversity, and cultural heritage, among others.10
These risks are inherent and can directly or indirectly affect banks. CircularNo. 1085 requires banks to identify, assess, and effectively manage E&S risks
and their impact on the bank’s operations and financial condition.

C.

ESRM System
Pursuant to Circular No. 1085, ESRM System refers to policies, procedures,and tools to identify, assess, monitor, and mitigate exposures to E&S risks.
The said issuance provides that climate-related risks comprise of physicaland transition risks:10

https://www.bsp.gov.ph/Regulations/Issuances/2020/c1085.pdf

Page 3 of 24

▪

Physical risk refers to the potential loss or damage to tangible assets
arising from climate change and/or other weather-related conditions
such as floods, typhoons, droughts, extreme weather variability, andrising sea levels.
These events can disrupt businesses and individuals' income cycle orcash flows affecting their capability to pay their borrowings from banks.
This will, in turn, result in deterioration of the quality of the loan portfolio.
Physical risks may directly affect the operations of banks, such as
disruption in the delivery of services, damages to bank premises, andphysical resources, among others.

▪

Transition risk refers to the potential economic adjustment cost
resulting from policy, legal, technology, and market changes to meetclimate change mitigation and adaptation requirements.
For instance, policies that aim to regulate carbon emissions orimplement carbon taxes or pricing mechanisms can affect the
profitability and growth of carbon-intensive industries. Companies thatfail to meet the carbon emission limits or those with operations thathave an adverse impact on climate, environment, and society may facelegal risks. Moreover, businesses and industries that need to replacecurrent technologies with climate-friendly and sustainable technologies
could face technology risks. The significant shifts in the demand and thereplacement of carbon-heavy technologies can give rise to “stranded
assets”. These are assets that, at some time before the end of theireconomic life, are no longer able to meet the company’s internal rate of
return due to changes in the market and regulatory environment
associated with the transition to a low-carbon economy. 11 Banks, as
financial intermediaries, ultimately bear the potential negative impactsof transition risks to businesses and individuals.
Transition risks can likewise directly affect banks. As policies and market
preferences evolve toward meeting climate goals (e.g., Paris Climate
Agreement, Nationally Determined Contributions) by limiting exposures
to sectors with high carbon emissions and adverse E&S impact, thesewill likewise shape and shift the bank’s lending and investment portfolio.

D.

Transmission of E&S risks to financial risks
Prior to developing tools and strategies to identify, assess, monitor, andmitigate E&S risks, banks must first comprehensively understand how E&S
risks translate to financial risks.
On 10 September 2020, the NGFS published a report12 entitled “Overview ofEnvironmental Risk Analysis” that provides wide-ranging examples of how
environmental risks translate into financial risks. The report also includes anin-depth review of the tools and methodologies used by financial institutions
for measuring exposures to environmental risk.
Figure 2 shows the NGFS’ schematic illustration of the transmission ofenvironmental risks to financial risks. Both transition and physical risks affect11

Definition by the Carbon Tracker Initiative. Retrieved at https://carbontracker.org/terms/strandedassets/

12

https://www.ngfs.net/sites/default/files/medias/documents/overview_of_environmental_risk_analysis_by_financial_institutions.pdf

Page 4 of 24

the individual businesses and households and the macroeconomy, which
ultimately affect the financial risk exposure of banks.
Figure 2. Transmission from environmental risks to financial risks

The credit risks that may arise from environment and climate-related risks
include the borrowers' increased chances to default and depreciation of thevalue of collaterals. For market risk, such environmental risks may lead tothe repricing of investments in securities. In the case of operational risks,
destructions of physical assets and resources may lead to closure of banking
facilities. These events may also have an impact on banks' liquidity risks due
to increased demand for funds in times of disasters or calamities.
Understanding this transmission mechanism is the key to finding theapproach towards embedding the ESRM System in bank’s existing risk
management frameworks, including stress testing exercises.

Page 5 of 24

Table 1: Sources of Physical and Transition Risks13

Table 2: Examples of Environmental Risks Transmitted to Financial Risks1413
14

Source: https://www.ngfs.net/en/overview-environmental-risk-analysis-financial-institutions
Source: https://www.ngfs.net/en/overview-environmental-risk-analysis-financial-institutions

Page 6 of 24

Source: NGFS Technical document: Overview of Environmental Risk Analysis, September 2020

Page 7 of 24

Source: NGFS Technical document: Overview of Environmental Risk Analysis, September 2020

Page 8 of 24

Box Article 115 provides a summary of a study conducted by the BSP thatshows how E&S risks, with focus on extreme rainfall events, affected thebanks’ performance.
Box Article 1
Impact of Extreme Weather Episodes on the Philippine Banking
Sector: Evidence Using Branch-Level Supervisory Data
(A BSP Working Paper Series)
In June 2020, the BSP published a relevant study on physical climate risks
which adds empirical literatures on the impact of natural disasters onbanking sector performance. Using data gathered from the BSP’s Branch
Regional Information System (BRIS), the BSP confirmed that extreme
weather conditions adversely impact the banks, as shown by the negative
effect on the growth of deposits and loans, loan quality, and profitability.
The results found that savings and time deposit liabilities dropped while
non-performing loans surged following the country's extreme rainfall
events from 2014 to 2018. These results are particularly evident in regions
most vulnerable to extreme rainfall episodes.
The study also revealed that almost all regions were granted regulatory
relief packages during the period covered, except SOCCSARGEN and
ARMM regions. The BSP provides temporary regulatory reliefs to banks
located in areas affected by calamities. This was institutionalized throughthe issuance of Circular No. 1017 dated 10 October 2018. The regulatory
relief aims to assist affected banks in their recovery and allow them toresume normal operations.
What is interesting, however, is that the National Capital Region,
CALABARZON, and Central Luzon regions have the most significant
number of regulatory reliefs availed compared to Eastern Visayas andBicol Regions, which are along the typhoon gateway. This observation
indicates the differences of branches per region in terms of vulnerabilities
to typhoons.
Source: Bayangos, V., Cachuela, R., and Del Prado, F. (June 2020) “Impact of Extreme
Weather Episodes on the Philippines Banking Sector: Evidence Using Branch-Level
Supervisory Data. BSP Working Paper Series No. 2020-03

IV. MINIMUM SUPERVISORY EXPECTATIONS ON ESRM System
Expectation 1:

The Board of Directors and Senior Management shallinstitutionalize and oversee the adoption and implementation ofsustainability principles, including those covering E&S risk areas, inthe corporate governance and risk management frameworks aswell as in the strategic objectives and operations of the bank.

15

https://www.bsp.gov.ph/Media_And_Research/WPS/WPS202003.pdf

Page 9 of 24

In line with the board's responsibility to promote the long-term financial interestof the bank and ensure that it has beneficial influence on the economy, it is
crucial for the board to be able to identify and understand the factors that may
have potential impact on the banks’ performance, viability, and businessobjectives. The various E&S risks and the movements happening in both the local
and international scenes in response to climate change highlight thesignificance of having a governance and risk management approach that goesbeyond mere compliance.
The board and senior management are expected to understand the linkage
between E&S risks and the bank’s operations. This initial step will guide the board
in shaping the tone from the top with regard to adopting and approving an
ESRM System. It will also support the development and implementation of
appropriate measures and approaches in line with the expectations under
Circular Nos. 1085, 1128 and 1149.
Under said issuances, the board is expected to institutionalize the adoption ofsustainability principles in the bank.
The BSP expects the board to set strategic E&S objectives covering short,medium and long-term time horizons as well as approve the risk appetite thatthe bank is willing and capable to manage through which the E&S risks may
materialize.
The board is also expected to set out clear criteria involving decisions to financeor invest in high E&S risk sectors during the said term horizons. The criteria shallconsider the long-term financial interest of the bank and its role in contributing
to the sustainable goals and growth of the economy. With these set criteria,banks are expected to review the composition of their loan and investment
portfolios and start aligning their exposures with the overall E&S objectives.

Expectation 2:

Define the level of E&S risk appetite of the bank on E&S risk.
The scope and complexity of the ESRMS shall becommensurate with the level of E&S risk associatedwith the bank’s portfolio.

The BSP’s Sustainable Finance and ESRM Frameworks are governed by theoverarching principle of proportionality. In establishing and implementing ESRM
System, a bank’s approach should be commensurate to its size, complexity ofoperations and risk profile. In this case, the scope and complexity of a bank’s
ESRM System should be commensurate to the level of E&S risks it is willing totake to achieve its strategic objectives.
The ESRM System should define the level of risk appetite on E&S risk considering
the bank’s capability to manage the risk. Banks are expected to conduct anassessment of its existing and potential exposures and the quality andeffectiveness of its risk management system to support the determination of therisk appetite. This step is crucial in establishing the banks’ E&S risk thresholds andlimits, which will serve as guide in its risk-taking activities and day-to-day
operations.

Page 10 of 24

Expectation 3:

Provide clear guidance in assessing E&S risks in the bank’s
operations, products and services, transaction, activities, andoperating environment. The ESRMS shall also identify which
sectors or activities have elevated or emerging E&S risks or are
considered to have harmful effects to the environment or society.

Consistent with the set strategic objectives and risk appetite, banks need toassess the E&S risks arising from their operations, products, services, transactions,activities, and operating environment and to determine whether such risks posesignificant threats to their safety and soundness. Banks must also evaluate their
exposures to sectors and activities with elevated or emerging ESG risks or thosefound to have harmful effects on the environment or society.
Banks may initially consider identifying their E&S risk exposure by looking at thegeographical location of their touchpoints and by analyzing their portfolios.
a.

The geographical location of the bank and its assets may disclose
exposures to environmental risks and related financial risks.
Identifying the location of the bank and its assets is important in theassessment of E&S risk exposures of banks. Banks’ premises and other real
properties situated in areas prone to extreme weather events, natural
disasters, or environmental hazards are more likely to experience disruptions
in business operations or activities. A similar assessment on the location of
the clients’ business or sources of income, collaterals, or projects being
financed may indicate potential increases in default probabilities anddepreciation of the value of collateral.
Understanding the climate and environmental
risks in the areas where banks operate, and intheir assets or loan portfolios can help in theassessment and management of physical risks.
For instance, a bank located in a typhoon-prone
area will likely experience business disruptions
and incur losses due to damages in its physicalstructures or touchpoints. This may then drive
an increase in its operational risk exposures.
Meanwhile, banks with significant amount ofloan exposures to sectors vulnerable toextreme weather events (e.g., agriculture,) or
have assets/collateral located in flood-prone
areas, are likely to post higher levels of nonperforming loans due to payment difficulties ofborrowers or impairment of properties used ascollaterals. In this case, the banks face elevatedcredit risk exposures.

“Banks’ exposure
to risks from thephysical impacts ofclimate change
are in part basedon the physicallocations of theassets underlying
the loans or
projects theyfinance.”
Four Twenty Seven, a
Moody’s affiliate (2020)

For physical risk assessments to work, banks should strive to find andunderstand, relevant and science-based climate-related data, projections,and studies, to the extent practicable, to support the development of aneffective risk management approach.
Page 11 of 24

There are hazard assessment tools which are available online that banks
can use to support their physical risk assessments and risk mapping
exercises:▪

The HazardHunterPH16 is a toolthat can generate hazard
assessment reports on criticalfacilities and areas in thePhilippines prone to different
hazards such as earthquakes, floods, drought, severe wind, and sea-levelrise, among others. This tool was developed by GeoRisk Philippines,
which is a multi-agency initiative by the Philippine Institute ofVolcanology and Seismology (PHIVOLCS), Department of Science andTechnology (DOST), and the Philippine Council for Industry, Energy andEmerging Technology Research and Development (PCIEERD).

▪

The LiDAR Portal for Archiving and Distribution, or
LiPAD,17 developed under the DOST initiative inpartnership with the University of the Philippines and
15 other Higher Education Institutions, can produce
detailed flood hazard maps and resource maps using
LiDAR technology.

▪

The
Coastal
Risk
Screening
Tool, 18
referred to as Coastal
DigitalElevation
Model or CoastalDEM developed by Climate Central provides elevation
data for assessing coastal flood risks and shows areas vulnerable topermanent submergence from sea level rise or flooding caused by storm
surges, tides, and tsunamis.

Banks should conduct risk assessments based on geographical data to help
inform its enterprise risk management, which includes resource allocation
and business continuity planning.
b.

The analysis of portfolios vis-à-vis the developments in the national
government’s policies and business environment provides indicators of
the level of transition risk exposures of banks.
Policies, regulations, technology, and market
sentiments can impact the quality or
performanceofvariousloans
andinvestments. For instance, energy policies thatprohibit the establishment of new coal power
plants sends a signal to the market, investors,
and financial institutions on the long-term
viability prospects of coal-based investments.
The same goes for sectors and industries thatheavily rely on coal as an input. It may also
affect the supply chain.

“Transitions are
systemic in nature,
characterized by coevolution between
different actors,
institutions, supply anddistribution chains,”
Markard, et. al. (2012)16https://hazardhunter.georisk.gov.ph/https://lipad.dream.upd.edu.ph/18
https://sealevel.climatecentral.org/maps/
17

Page 12 of 24

Banks with significant exposures to coal-powered industries may have toreassess their financial position, strategy, and long-term growth considering
their exposures to transition risk. This assessment should strike a delicate
balance between achieving the organization’s ESG objectives andcontinuously supporting the financing needs of households and businesses
for economic growth.
In this respect, banks may first classify their assets and portfolios based on
their potential impact on the environment. This step would enable banks tomake crude assessments on the total value of the portfolios that may beaffected by changes in policies, litigations, technological developments andshifts in market sentiment in line with global and national climate objectives
and SDGs. This will also inform the development of appropriate and soundrisk management and portfolio reallocation strategies in response topotential transition risks.
TaxonomyClassifying assets as green, non-green, or brown will be challenging without
an established national taxonomy. ‘Taxonomy’19 is the systematicclassification and definition of green assets and projects. It aims to create a
uniform and harmonized classification system that can be used to assesscompanies' greenness and basis for further policy actions such as
development of standards, labels, and incentives, among others.
In a survey conducted by the NGFS (2020) on the financial institutions’experience from working with green, non-green, and brown financial assets,
the most common approaches utilized by the respondent banks, given thelack of an official taxonomy, are as follows20:
1.

Adoption of an international or national classification in the form of avoluntary classification or principle such as the Green Bond Principles21,
Green Loan Principles22, Equator Principles, UNEP Financial Institutions(UNEP FI), etc., and2.

Implementation of an internally developed classification, which isinspired in whole or in part by international classification or principles.

The following issuances may be used by banks as reference for the conductof preliminary E&S risk assessment and in the evaluation of potential
financing of green or sustainable projects or priority sectors:
1.
2.
3.

Securities and Exchange Commission (SEC) Guidelines on the issuanceof sustainable bonds
Philippine Nationally Determined Contributions
Philippine Sustainable Finance Guiding Principles

Climate Bonds Initiative (March 2019). “Growing green bond markets: The development of taxonomies
to identify green assets”.
https://www.climatebonds.net/files/reports/policy_taxonomy_briefing_conference.pdf
20
NGFS (May 2020) “A Status Report on Financial Institutions’ Experiences from working with green, nongreen and brown financial assets and a potential risk differential” NGFS Technical Document. Retrieved
at https://www.ngfs.net/sites/default/files/medias/documents/ngfs_status_report.pdf
21
https://www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/Green-BondPrinciples-June-2021-140621.pdf
22
https://www.icmagroup.org/assets/documents/Regulatory/GreenBonds/LMA_Green_Loan_Principles_Booklet-220318.pdf
19Page 13 of 24

Broad Categories of Eligible Projects under SEC Guidelines
One of the existing principles or standards adopted by green/social/sustainability bond issuers in the country is the ASEAN Green/Social/
Sustainability Bond Standards as adopted by the SEC. In particular, the SEC
issued Guidelines on the Issuance of Green/Social/Sustainability Bonds
under the ASEAN Green/Social/Sustainability Bonds Standards in thePhilippines.23 The SEC guidelines enumerate the broad categories of eligible
and ineligible projects.
Philippines’ Nationally Determined Contributions (NDC)
The country’s NDCs was communicated to the United Nations Framework
Convention on Climate Change (UNFCCC) on 15 April 2021.24 This serves as a
guide for the “country’s long-term development plan towards a climateresilient and low-carbon future”. Likewise, this “promotes the country’s
economic development and industrialization goals while contributing to theglobal efforts to stabilize the earth’s climate”.25
The Philippines commits to a projected greenhouse gas (GHG) emissions
reduction and avoidance of 75 percent representing the country’s ambition
for GHG mitigation for the period 2020 to 2030 for the sectors of agriculture,
wastes, industry, transport, and energy.
In terms of climate adaptation, there are seven (7) thematic areas under the
National Climate Change Action Plan (2011-2028), namely food security,
water sufficiency, ecological and environmental stability, humansecurity, climate-smart industries and services, sustainable energy, andknowledge and capacity development.
Philippine Sustainable Finance Guiding Principles 26
The Inter-agency Technical Working Group on Sustainable Finance or theGreen Force released in October 2021 the Philippine Sustainable Finance
Guiding Principles (Guiding Principles).
The development of the Guiding Principles is consistent with the practicesof countries in the region where a principles-based approach was pursued.
This approach considers the unique needs and developmental stages of themember states and promotes the financing flows for sustainable activities
without being compelled to adopt a framework or taxonomy designed for
different economic and social structures that may be detrimental to its
members within the region.
The Guiding Principles provides broad guidance in identifying economic
activities that support sustainable development, with special focus onaddressing the impacts of climate change, as well as encourages the flow offunds to such activities.

23

https://www.sec.gov.ph/wp-content/uploads/2019/11/2018MCNo12.pdf
https://www.sec.gov.ph/wp-content/uploads/2019/10/2019MCNo09.pdf
https://www.sec.gov.ph/wp-content/uploads/2019/10/2019MCNo08.pdf
24https://unfccc.int/sites/default/files/NDC/2022-06/Philippines%20-%20NDC.pdf
25
https://niccdies.climate.gov.ph/files/documents/Philippines%20NDC%20Quick%20Facts.pdf
26
https://www.bsp.gov.ph/Regulations/Issuances/2022/CL-2022-011.pdf

Page 14 of 24

The Guiding Principles (GP) are as follows:✓ GP 1: Climate Change Mitigation and Adaptation✓ GP 2: Promoting Transition to a Low Carbon Economy✓ GP 3: Resilient Food Systems✓ GP 4: Sustainable Cities✓ GP 5: Sustainable and Resilient Infrastructure for Inclusive Growth andPoverty Reduction✓ GP 6: Environmental Management and Conservation✓ GP 7: Prohibited Activities
Sample economic activities are provided in each principle.
The BSP issued Circular Letter 27 No. CL-2022-011 on 8 February 2022 toencourage all banks to explore and consider, where applicable, thestrategies, priorities and principles outlined in the Guiding Principles and thePhilippine Sustainable Finance Roadmap in developing their approach or
actions towards adopting sustainable finance.
ASEAN Taxonomy for Sustainable Finance28
Meanwhile, at the regional level, Version 1 of the ASEAN Taxonomy was
published in November 2021 by the ASEAN Taxonomy Board29. It consists of
two main elements, namely: (i) the Foundation Framework which isapplicable to all ASEAN Member States (AMS) and allows a qualitative
assessment of activities; and (ii) the Plus Standard with metrics andthresholds to further qualify and benchmark eligible green activities andinvestments. The ASEAN Taxonomy recognizes the differences in thesustainable finance policies and systems adopted by each AMS as well as theunique circumstances or developmental stages of each state.
The ASEAN Taxonomy was developed focusing on climate change before
covering other aspects of sustainability. It will be periodically reviewed tokeep pace with the developments in global sustainability goals andtechnology to remain relevant and effective.

Expectation 4

Provide the tools for monitoring E&S risks as well as the compliance ofthe bank and its counterparties with sustainability-related standards,
laws and regulations.
Provide tools for assessing identified E&S risks and for considering thesame in the aggregate exposures of the bank.

27

https://www.bsp.gov.ph/Regulations/Issuances/2022/CL-2022-011.pdf
ASEAN Taxonomy for Sustainable Finance, Version 1 (November 2021). Retrieved at https://asean.org/wpcontent/uploads/2021/11/ASEAN-Taxonomy.pdf
29
In March 2021, the ASEAN Capital Markets Forum (ACMF), the ASEAN Insurance Regulators Meeting(AIRM), the ASEAN Senior Level Committee on Financial Integration (SLC), and the ASEAN Working
Committee on Capital Market Development (WC-CMD), with the endorsement of the ASEAN Finance
Ministers’ and Central Bank Governors’ Meeting (AFMGM), agreed to establish the ASEAN Taxonomy
Board.
28

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Banks should have the necessary and appropriate tools for identifying,measuring, and monitoring E&S risks. These tools will facilitate and help informthe banks’ decision-making based on their defined level of E&S risk appetite.
Decision-making and risk-taking are inherent in almost all phases of the banks’operations. Hence, tools should be in place, as appropriate, from the start to theend of a financial transaction or activity.
In credit-granting, for instance, banks are expected to consider E&S risks in all
relevant stages of the credit cycle (e.g., underwriting, pricing, provisioning).
Banks should assess how E&S risks may affect a borrower’s repayment capacity
considering various factors like the borrower’s source of income, location ofcollateral provided or projects financed, and degree of dependence on E&S risksensitive sectors. Banks are expected to engage in constructive dialogues with
their borrowers, particularly if such have significant exposures to E&S risks. The
dialogues provide opportunities to gather information on the risk mitigation
measures of the borrowers. Moreover, building on the tools earlier mentioned inthis document, the results of the vulnerability assessment may inform the terms
and conditions of loans of borrowers.
The ESRM System should include tools that will enable banks to monitor theircompliance with sustainability-related standards, laws, and regulations or theirpotential impact on climate, environment, and society. These should help ensurethat banks operate safely and soundly with minimal exposure to compliance orlegal risks. In addition to constructive dialogues with borrowers, banks may
conduct site visits or validation review on the actual use of loan proceeds toensure that the credit granted was used for purposes applied for.
Government policies are updated from time to time due to the rapid
developments on sustainability related areas. In this regard, the banks’ ESRM
System should likewise provide a mechanism that will keep the banks informed
and updated with the developments in the relevant E&S-related policies,
standards, and best practices. Banks should institutionalize capacity building
program for the board, all levels of management, and personnel to equip themin E&S risk management.
ESRM tools may be developed separately by banks for this purpose orincorporated into the existing tools for managing other specific risk areas.

Expectation 5

Provide the measures that should be taken in case of breaches inlimits or thresholds or non-compliance with sustainability-related
standards, laws and regulations.

An effective ESRM System should have measures in handling cases of breaches
in limits or thresholds or non-compliance with sustainability-related standards,
laws, or regulations. Reporting lines to the board and/or senior management
must be properly implemented to ensure that they are aware of the breaches aswell as emerging issues and complex or controversial cases. In this way, control
mechanisms will be immediately implemented to ensure that such concerns
remain manageable and will not significantly affect the banks’ overall risk
exposures.

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Breaches or related concerns may not entirely be avoided as E&S risks may ariseat any point of the banks’ value chain. However, banks should ensure that E&S
policies and procedures are regularly monitored and updated to consider thefindings and fill the gaps identified during such breaches and similar events.
Deleveraging strategies may be adopted for lending to activities or projects withhigh E&S risks, but this should be carefully implemented so as not to result inunintended consequences on the borrowers, the economic sectors concerned,
and on the safety and soundness of the bank.

Expectation 6

Integrate E&S risks in stress testing exercises covering both shortterm and long-term horizons following the principles andrequirements provided under Sec. 151. The results of the stresstesting shall feed into banks’ capital and liquidity planning andmanagement exercises as well as in the business continuity anddisaster recovery plans.

Models for assessing E&S risks and for conducting stress testing exercises are stillin the nascent stage of adoption. Nonetheless, there are existing methodologies
that are being used by financial institutions in other jurisdictions, on a pilot basis.
These models and methodologies have been compiled and reviewed by the
NGFS in its Occasional Paper30 published in September 2020. Banks may use
these as a reference in exploring tools and methodologies that may be used fortheir risk assessments.

30

NGFS (September 2020). “Case Studies of Environmental Risk Analysis Methodologies. An Occasional
Paper. Retrieved athttps://www.ngfs.net/sites/default/files/medias/documents/case_studies_of_environmental_risk_analysis_methodologies.pdf

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Box Article 2
Quantifying the Impact of Physical Risks on Probabilities ofBank Loan Defaults
By
Tsinghua University
In assessing physical risk, Tsinghua University developed a climate
physical risk assessment framework for banks to analyze credit risks fromtyphoons' impact on the Probability of Default of mortgage loans in
Chinese coastal cities under various climate scenarios. The framework has
two layers.

The first one is the disaster loss model, which estimates the decline or loss
in value of physical assets due to damages or the losses incurred due todisruption in business operations.
This estimation will feed into the financial models as an input to adjust theestimates in the financial statements such as assets, liabilities, revenues,
costs, and profits/losses. These adjusted variables will then be used toestimate the financial ratios such as the loan-to-value ratio (LTV), returnon equity (ROE), asset/liability ratio, and interest coverage ratio.

Source: NGFS Case Studies of Environmental Risk Analysis Methodologies (2020)

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Box Article 3
An Approach to Measuring Physical Climate Risk inBank Loan Portfolios
By
Four Twenty Seven (A Moody’s Affiliate)
Another approach to assessing climate risk was developed by Four
Twenty Seven, a California-based climate risk data firm and a Moody’s
affiliate. This methodology uses climate data to understand and mitigate
climate risks in lending portfolios.
It starts with obtaining the specific location and features of assets
underlying the lending portfolios, including the asset type, to factor in theasset's sensitivity to climate-related hazards. It then obtains a thoroughreview of the climate risk exposure in the value chain to understand theunderlying geographic locations that underpins an asset’s value chain.
Using this, Four Twenty Seven recommends using climate risk
assessment models based on best-available, peer-reviewed science todevelop projections and risk indicators. Such indicators are based on six
hazards, including heat stress, wildfires, floods, hurricanes, typhoons, sealevel rise, and water stress. Afterwards, financial institutions obtain a scorefor each climate hazard and assign a risk rating.

Source: NGFS Case Studies of Environmental Risk Analysis Methodologies (2020)

Conduct of stress testing exercise or scenario analysis
Methodologies developed for the assessment of transition risks include thosethat utilize stress-testing or scenario analyses. The existing guidelines31 on stresstesting exercises already set out the governance expectations or generalprinciples that banks can refer to when integrating stress-testing in assessing
climate-related risks.

31

Section 151 of the MORB on Guidelines on the Conduct of Stress Testing Exercises

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Cognizant of the risks posed by climate change to financial stability, banks andsupervisors expanded the coverage of stress tests to include climate-related
financial risks.
In June 2020, the NGFS published the “Guide to climate scenario analysis forcentral banks and supervisors” to help in conducting scenario analysis to assess
impacts of climate risks on the economy and financial system.32 It provides a fourstep process, as follows:
Step 1: Identify objectives and exposures
Step 2: Choose climate scenarios
Step 3; Assess economic and financial impacts
Step 4: Communicate and use the results
Using traditional stress test to climate risk raises multiple challenges related,among others, to the (i) objectives, (ii) scenarios design, and (iii) availability ofdata. Addressing these challenges would require fundamental improvements inthe stress test techniques being used by banks.
In conducting the climate risk stress test, the board is expected to ensure thatthe exercise is linked to the risk appetite and business strategies of the bank. The
results should aid in enhancing risk management systems, capital and liquidity
plans, and business continuity and recovery plans. In particular, banks should
assess the impact of climate risks on solvency or net cash outflows or depletionof liquidity buffers. As climate risks can cause severe disruption to banks’operations, adversely impacting business continuity, banks’ Business Continuity
Plans (BCPs) may be enhanced to consider the impact of such risks and ensure
operational resilience.
The Bank for International Settlements 33 (July 2021) recognizes that theoutcomes of climate stress test exercises may inform banks’ decisions regarding
their business models and their day-to-day risk management. In turn, this will
help facilitate a smooth transition to a lower carbon economy, thus contributing
to the safety and soundness of the financial system.
Banks may also perform quantitative and qualitative analysis of how both
physical and transition risks scenarios would affect their financial statements.
Considering the business model, exposure profile and business strategy, thescenarios may incorporate a range of plausible climate pathways as well as arange of time horizons, from short- to long-term. Such scenarios may cover only
one or two key financial risks (e.g., credit and/or liquidity). A hypothetical typhoon
scenario resulting in a severe flood similar to that of Typhoon Haiyan, locallyknown as super typhoon Yolanda, one of the strongest typhoons ever recorded 34,
may be designed. If the typhoon and flood stress scenarios materialize, banks
might suffer significant losses through their exposure to flood-prone areas. As
NGFS (June 2020). “Guide to climate scenario analysis for central banks and supervisors.” TechnicalDocument. Retrieved at:https://www.ngfs.net/sites/default/files/medias/documents/ngfs_guide_scenario_analysis_final.pdf
33
Baudino, P. and Svoronos, P. (July 2021). “Stress-testing banks for climate change-a comparison ofpractices.” FSI Insights on policy implementation No. 34. Retrieved at:https://www.bis.org/fsi/publ/insights34.pdf
34
According to UN estimates, it killed over 6,201 people in the Philippines, with 1,785 missing, and displaced
4.1 million people. led to USD 13 billion (about 5 percent of GDP) in damages and losses, including income
forgone. 90 percent of this was borne by the private sector, and largely uninsured. The storm hadsignificant financial consequence for rural and cooperative banks operating in affected area, the regionof Eastern Visayas, where NPL rose to 22.7 percent in September 2014, and dampened investor
sentiment across all financial markets in the Philippines. For more info see World Bank Group, Financial
Sector Assessment Program, Technical Note, Climate Change and Environmental Risk andOpportunities, June 201932

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the main transmission channel works through changes in the value of theunderlying collateral, the stress test exercise may initially focus on mortgage
exposures and those secured by real estate. Banks should then project the
expected credit losses on such portfolios under a typhoon followed by a flood
scenario.
Following the publication of the “Guide to climate scenario analysis for central
banks and supervisors”, the NGFS released a report35 describing how 31 of its
members are using climate scenarios to identify, assess and understand climate
risks in their economies and financial systems. The exercises surveyed in thereport cover the banking sector and half of the exercises also covered insurers
and other financial institutions. The exercises covered mostly focus on how
climate risks affect the banks’ credit portfolios. The approaches adopted by themembers surveyed are split evenly between the bottom-up (those that involve
financial institutions directly) and top-down approaches (those conductedentirely by the financial authority).
The NGFS materials serves as reference materials for banks to be familiar withthe design and process in conducting initial exercises. The field of climate
scenario analysis or stress testing is highly dynamic, and methodologies orpractices are expected to evolve rapidly. Banks should explore existing oravailable methodologies and determine which is best suited to their specificneeds, capacities, and exposures.

35

NGFS (October 2021). “Scenarios in action: A progress report on global supervisory and central bankclimate scenario exercises” Technical Document. Retrieved at:https://www.ngfs.net/sites/default/files/medias/documents/scenarios-in-action-a-progress-report-onglobal-supervisory-and-central-bank-climate-scenario-exercises.pdf

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Box Article 4
Assessing Credit Risk in a Changing Climate:Transition-Related Risks in Corporate Lending Portfolios
By
Oliver Wyman
This slide provides a general description of the methodology developed
by Oliver Wyman, an American management consulting firm, to assess
the impact of climate transition scenarios on the creditworthiness ofcorporate counterparties.

This methodology utilizes climate scenario analysis, which provides aplausible “hypothetical construct” under different scenarios. Climate
scenario analysis is a crucial tool to help financial institutions understandand integrate climate risks into their broader risk management
framework and explore their potential climate-related exposures.
The scenario analysis performed under this methodology is composed ofthree modules.

•

The first one involves testing two climate transition scenarios – thetemperature-based scenarios and the event-based scenarios.
-

Researchers, policymakers mostly use temperature-based
scenarios and corporations to analyze how the economy could
evolve with per change in average global temperature. These
scenarios are more in line with the recommendations of the
Financial Stability Board’s Task Force on Climate-Related
Financial Disclosures as well as in the 2 Degree Celsius
Framework.

-

Another approach is the event-based scenarios which arefocused on the potential short-term impact of one trigger event,such as the sudden implementation of a major carbon priceregulation.

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Continued...
•The second is a “bottom-up” module that aims to assess the impact
of climate scenarios on a sample companies' creditworthiness. It
begins by assessing how key business drivers such as price, volume,
unit cost, and capital expenditure and asset value evolve under atransition scenario. When the key drivers have been estimated,these will be linked to a company’s financial statements, including
the income statement, cash flow statement, and balance sheet. This
will result in scenario-adjusted financial statements that can thenbe re-run through the credit rating models to get scenario-adjusted
ratings and probability of default for each counterparty.

•

The third is the “top-down” module, which enables institutions toperform a portfolio-wide climate stress test, even when data or timeand resources are insufficient to run a bottom-up analysis for all
counterparties. In practice, institutions that use this model
extrapolate the bottom-up analysis results based on relevant
customer characteristics to cover the rest of the portfolio.

Source: NGFS Case Studies of Environmental Risk Analysis Methodologies (2020)

Expectation 7

Identify the unit or personnel responsible for overseeing themanagement of E&S risks. The bank may establish a new unit toperform such function or integrate the same in the functions ofexisting risk management units. The ESRMS shall set out theduties and responsibilities of all personnel in the organization in
managing E&S risks.

Consistent with their size and complexity of operations, banks may create an
appropriate organizational structure that will oversee the adoption ofsustainability principles and implementation of the ESRM System. Banks may
also integrate the same function in their existing risk management units. The
policies and procedures under the ESRM System may be embedded in existingrisk management manuals or documentations to present a morecomprehensive guide in managing risk exposures. Alternatively, the bank may
also articulate its ESRM System in a separate document to provide a moredetailed and focused approach in the management of E&S risks.
It is expected that said unit or senior-level officer has the necessary backgroundor experience and has sufficient authority to ensure that bank’s sustainability
principles are adopted and ESRM System is adequately implemented. Adequate
resources should be made available to facilitate the banks’ development andimplementation of the ESRM System. Banks must implement training andcapacity-building activities to increase the knowledge of the relevant units andits personnel and equip them with the skills to manage the bank’s E&S risk
exposures.

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It should likewise be noted that managing E&S risks is not limited to thoseoverseeing the implementation of the ESRM System. All personnel should beaware of their duties and responsibilities with regard to the implementation of
the ESRM System in relation to the risk management frameworks covering theareas of credit, operational, liquidity, or market risks, among others.
The senior management is expected to assess the alignment of operations andperformance of personnel with the bank’s sustainability objectives. Scorecards
may be adopted to facilitate the assessment.

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