Policies and procedures for financial risk categories

For the purposes of integrating ESG risks into credit risk policies and procedures as set out in paragraph 56 of the EBA Guidelines on loan origination and monitoring, institutions should ensure that their credit sectoral policies, reflecting ESG risks, are cascaded down and trans-lated into clear origination criteria available to business lines staff and credit decision-makers, and should ensure that ESG risks are embedded into the credit risk monitoring framework.

With regard to environmental risks, institutions should include in their policies and proce-dures a combination of qualitative and quantitative aspects. Based on their materiality as-sessment and their risk appetite, institutions should set quantitative credit risk metrics cov-ering the most significant client segments, types of collateral and risk mitigation instruments.

With respect to market risk, institutions should consider how ESG risks could affect the value of the financial instruments in their portfolio, evaluate the potential risk of losses on their portfolio and increased volatility in their portfolio’s value, and establish effective processes to control or mitigate the associated impacts as part of their market risk management frame-work including where needed reviewing the trading book risk appetite and setting internal limits for positions or client exposures.

With respect to liquidity and funding risk, institutions should at least consider how ESG risks could affect net cash outflows (e.g. increased drawdowns of credit lines) or the value of assets that constitute their liquidity buffers and, where appropriate, incorporate these impacts into the calibration of their liquidity buffers or their liquidity risk management framework.

In addition, with regard to environmental risks, institutions should consider how these risks could affect the availability and/or stability of their funding sources and take them into ac-count in their management of funding risk. To this end, institutions should consider different time horizons and both normal and adverse conditions, which should reflect among others the potential impacts of environmental risks on reputational risks, a situation of hampered or more expensive access to market funding and/or accelerated deposit withdrawals.

With respect to operational risk, institutions should consider how ESG risks could affect the different regulatory operational risk event types referred to in Article 324 of Regulation (EU) No 575/2013 and their ability to continue providing critical operations and should incorporate material ESG risks in their operational risk management framework.

With regard to environmental risks, institutions should:

With respect to reputational risks, institutions should consider and manage the impact of ESG risks on their reputation, including by considering potential risks associated with lending to and investing in businesses which may be prone to ESG-related controversies, such as viola-tions of social or human rights. Institutions should also consider, where applicable, the repu-tational risks associated with the failure to deliver on their sustainability commitments or transition plans, or with the (perceived) lack of credibility of such commitments and plans.

As part of their management of conduct, litigation and reputational risks, institutions should have in place sound processes to identify, prevent and manage risks resulting from green-washing or perceived greenwashing practices taking into account the ESAs high-level princi-ples set out in Section 2.1 of the EBA Final Report on greenwashing monitoring and supervi-sion⁽¹⁶⁾. To this end, institutions should take all necessary steps to ensure that sustainability-related communication is fair, clear, and not misleading, and that sustainability claims are accurate, substantiated, up to date, provide a fair representation of the institution’s overall profile or the profile of the product, and are presented in an understandable manner. That should be done at both the institution level (e.g. in relation to sustainability commitments including forward-looking targets) and the product or activity level (e.g. in relation to products and activities marketed as sustainable), including by monitoring legal developments, market practices, and controversies around alleged greenwashing practices.

With respect to concentration risk, institutions should consider and manage the risks posed by concentrations of exposures or collateral in single counterparties, interdependent coun-terparties or in certain industries, economic sectors, or geographic regions which may present a higher degree of vulnerability to ESG risks. To identify ESG-related concentration risks, insti-tutions should consider the size and/or shares of their exposures that may be affected by ESG risks relative to total exposures and as a proportion of Tier 1 capital. Institutions should take into account several ESG factors amongst which GHG emissions, sectoral characteristics, vul-nerability of geographical areas to physical risks, and social or governance deficiencies or con-troversies identified in jurisdictions where exposures or collateral are located, as well as the availability of risk mitigating factors. Institutions should assess if and how ESG-related con-centration risk aggravates the prior financial vulnerability of exposures.