Materiality assessment
As part of the reference methodology for institutions’ identification and measurement of ESG risks to be included in their strategies and internal procedures, institutions should provide for the regular performance of a materiality assessment of ESG risks. That assessment should be performed at least every year or, for small and non-complex institutions (SNCIs), every two years. Institutions including SNCIs should, however, update their assessment more frequently in case of a material change to their business environment related to ESG factors, such as significant new public policies or shifts in the institution’s business model, portfolios or oper-ations.
The materiality assessment of ESG risks should be performed as an institution-specific assess-ment which provides the institution with a view on the financial materiality of ESG risks for its business model and risk profile, supported by a mapping of ESG factors and transmission channels to traditional financial risk categories. The materiality assessment of ESG risks should be consistent with other materiality assessments conducted by the institution, in particular those made for the purpose of disclosing material sustainability risks in accordance with Di-rective 2013/34/EU(6) and Commission Delegated Regulation (EU) 2023/2772 (opens EUR-Lex in a new tab)(7), where applica-ble, and should be integrated into the internal capital adequacy assessment process (ICAAP) materiality assessment.
The materiality assessment of ESG risks should use a risk-based approach that takes into ac-count the likelihood of occurrence and the potential magnitude of the financial effects of ESG risks in the short and medium term and over a long-term horizon of at least 10 years.
With a view to comprehensively assessing the materiality of ESG risks, institutions should ensure that the scope of their materiality assessment sufficiently reflects the nature, size and complexity of their activities, portfolios, services, and products. Institutions should consider the impact of ESG risks on all traditional financial risk categories to which they are exposed, including credit, market, liquidity, operational (including litigation), reputational, business model and concentration risks. The determination of material ESG risks should consider both their impacts on financial risk categories and the amounts and/or shares of exposures, revenues and profits exposed to the risks.
With regard to the materiality assessment of environmental risks, institutions should use both qualitative and quantitative information. Institutions should consider a sufficiently large scope of environmental factors that includes at least climate-related factors, degradation of ecosystems and biodiversity loss. Institutions should assess both transition and physical risk drivers, taking into account at least the following:
For transition risks:
the main economic sectors that the financed assets support or in which the institution’s counterparty has its principal activities;
ongoing and potential future material changes in public policies, technologies and market preferences (e.g. new environmental regulations or tax incen-tives, development of innovative low-carbon technologies, shifts in consumer or investor demand);
with respect to climate-related risks:
1. exposures towards sectors that contribute highly to climate change as specified in Recital 6 of Commission Delegated Regulation (EU) 2020/1818 (opens EUR-Lex in a new tab) i.e. the sectors listed in Sections A to H and Section L (opens EUR-Lex in a new tab) of Annex I (opens EUR-Lex in a new tab) to Regulation (EC) No 1893/2006 (opens EUR-Lex in a new tab) (8) , with particular consideration given to exposures towards fossil fuel sector entities;
2. the degree of alignment or misalignment of portfolios with the relevant regulatory objectives of the jurisdictions where they operate
for SNCIs and other non-large institutions at least on the basis of a
high-level qualitative assessment;
For physical risks:
the geographical areas in which key assets of counterparties (e.g. production sites) and, in particular for real estate exposures, physical collateral is located;
the vulnerability level to environmental hazards (e.g. temperature-related, wind-related, water-related, solid mass-related hazards) associated with dif-ferent climate scenarios and transition pathways or, for SNCIs and other non-large institutions, associated with at least one adverse scenario.
Institutions should substantiate and document as part of their ICAAP their materiality assessments of ESG risks, including methodologies and thresholds used, inputs and factors considered and main results and conclusions reached, including non-materiality conclusions.
Institutions should develop and implement measurement methods, risk management arrangements and transition planning processes, respectively in accordance with Section 4.2, Section 5, and Section 6, that are commensurate with and informed by the outcomes of the materiality assessment. To this end, institutions should have more extensive and sophisticated arrangements for ESG risks identified as material. In turn, the ESG risk measurement methodologies and ESG risk monitoring metrics used by institutions should support and inform the regular updates of the materiality assessment. Smaller institutions with less complex activities may apply less extensive and sophisticated arrangements, which however should be commensurate with the results of their materiality assessment of ESG risks.