Europe

Regulatory emphasis on ESG and climate change issues is set to keep increasing this year making it an area banks will need to pay close attention to. By David Strachan and Hina Majid, Centre for Regulatory Strategy at Deloitte

Environmental, social and governance (ESG) risks and factors, in particular those arising from climate change, are set to become increasingly prominent features of financial regulation and supervision across the globe in 2020. It is therefore critical that banks accelerate their efforts in dealing with financial risks arising from this. Based on Deloitte’s Financial Markets Regulatory Outlook 2020 here are five predictions and focus areas for global banks within EMEA for the year ahead.

Risk management

A key development in 2020 will be the growing use of stress testing to assess the risks arising from climate change. The Bank of France, Denmark’s Central Bank and the Bank of England (BoE) intend to launch stress tests this year, while the European Banking Authority (EBA) has announced its intention to develop its own climate stress tests. 

The European Central Bank is also undertaking work to define better stress testing. We expect this approach to be rolled out more widely by regulators, with similar ambitions, following the work and growth of the international Network for Greening the Financial System (NGFS).

On risk management more generally we expect regulators, especially in the EU and UK, to continue to progress towards integrating ESG and in particular climate risks, into the Supervisory Review and Evaluation Process.

Some regulators who are members of the NGFS can also be expected to follow the Prudential Regulation Authority’s (PRA) lead by issuing their own supervisory expectations on climate risk management. However, we anticipate that regulators in France, the Netherlands and the UK will continue to lead the pack in this area in ways that are consistent with NGFS outputs. And in the UK, we foresee more granular expectations emerging in the areas of climate risk management and scenario analysis, both of which are also policy focus areas for the EBA.

As well as tracking these developments, banks should focus on: gathering the necessary climate data, understanding and mapping physical and transition risks, embedding climate scenarios and stress testing to inform risk identification processes and enhancing risk modelling frameworks. They should also invest in new climate (and broader ESG) risk capabilities.

In the UK, banks should additionally be working towards implementing plans they submitted to the PRA for integrating climate risks into their governance and risk management frameworks.

Capital regime

The political and policy debates around ‘brown penalising’ and ‘green supporting’ factors are likely to intensify in discussions around Capital Requirements Directive 6 and Capital Requirements Regulation 3. However, we do not think that regulators are yet at the point of using the prudential capital regime to promote green and brown objectives.

If pressed, we expect regulators generally to favour brown penalising factors over green supporting measures. Other policy-makers may, in contrast, take a more positive view of the merits of incentivising green supporting factors relative to brown penalising ones.

Disclosure

We anticipate policy-makers and regulators will move towards making climate disclosures mandatory. The BoE has already confirmed that it expects listed banks to provide disclosures that are consistent with the Task Force on Climate-Related Financial Disclosures (TCFD) Recommendations by 2022. Further clarification around disclosures is expected from the Financial Conduct Authority (FCA) and the FCA/PRA Climate Financial Risk Forum.

In the EU, the EBA intends to submit technical standards to the European Commission (EC) on CRR 2 Pillar 3 ESG disclosures later this year, while EU ESG risk disclosure obligations for banks under CRR 2 are due to apply from 2022. The EC also intends to introduce proposals to revise the Non-Financial Reporting Directive this year.

Banks will need to make progress with TCFD consistent disclosures in line with these initiatives and their scheduled timetable. They should focus on: refining metrics, developing climate resilient strategies, establishing effective governance structures and increasing the quantity and quality of disclosures.

Sustainability standards

The taxonomy regulation provides an EU green classification system. While much of the detail will be in implementing delegated acts adopted over 2020/2021, we expect to see this driving a growth in green products and service standards – the EU green bond standard and EU ecolabel for financial products are examples of this.

Banks should track these developments and participate in associated industry initiatives – the European Banking Federation and United Nations Environment Programme Initiative will, for example, be launching taxonomy recommendations for banks later this year.

One key challenge we foresee for global banks in this area is navigating multiple, and sometimes conflicting, global sustainability standards. Policy-makers and regulators are aware of this and we expect to see efforts to achieve greater global alignment.

Governance

We anticipate additional expectations to emerge in the area of ESG – and in particular climate governance. Jurisdictions with accountability regimes are likely to follow the PRA, by using these regimes to achieve climate risk objectives. In the EU, amendments to MiFID II will also require changes to product governance, suitability processes and organisational requirements. Finally, with the rapidly rising importance of climate risks to regulators, policy-makers and investors, banks will need to ensure that their boards are equipped to deal with this.

Adequate and timely training will be essential for providing boards with the capabilities they will need to navigate this rapidly shifting regulatory landscape successfully.

A Speakers’ Corner is an area where open-air public speaking, debate and discussion are allowed. The original and most noted is in the north-east of Hyde Park in London

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