Following the adoption of the 2015 Paris Agreement and 2018 European Commission Sustainable Finance Action Plan, there is a clear call upon financial services industry to play a role in financing and investing of a more sustainable economy. We see that many firms in the industry have committed themselves to contribute and we see increasingly in a broader sense Environment, Social and Governance (ESG) factors play out in a bank's strategy, underwriting, disclosures and risk management.

There is now broad consensus that climate- and environmental risks can be material and have financial implications. As such it is seen as a driver for the traditional financial risks such as credit and market risk banks need to control.

The European Central Bank (ECB) and other supervisors (DNB, MAS, PRA) expect banks incorporate climate and environmental risks more explicitly in their risk management and requested banks to formulate ambitions and implementation plans for this. From this year onwards, banks will be expected to engage with supervisors on a regular basis on their progress. A major impact on risk management is expected, affecting not only the methodologies, policies, tools and processes within the risk management function, but also in terms of impact on clients and bank strategy. Given these complexities, banks should respond thoroughly and with urgency. 

Gertjan Thomassen

Head of Financial Risk Management Banking

KPMG Nederland

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What is incorporation of climate- and environmental risks about?

The following topics require close attention:

Business model and strategy: which is understanding how climate-related and environmental risks affect the business environment in which banks operate, and to consider these risks in strategy / business decision making;

Governance and risk appetite: all banks should explicitly include climate- and environmental risk in their risk inventory, which in turn feeds into the risk appetite statements. Bank need as such develop risk indicators and set appropriate limits. This should be safeguarded through an appropriate governance and oversight to ensure climate- and environmental risk are managed within set limit. Also DNB included as of this year climate and environmental risks as an area in their fit and proper testing of banks' board members.  

Risk management: banks should include incorporate climate-related and environmental risks into their risk management framework, with a view to identifying, assessing, managing and monitoring and these risks over a sufficiently long-term horizon. In for instance their credit risk management, banks are expected to consider climate-related and environmental risks at all relevant stages of the credit-granting process.  

Incorporation of scenario analysis and stress testing as a means to monitor the risks in banks' portfolios, understand portfolio and capital sensitivities to these risks on the short and long term.

Monitoring and risk disclosures which is about developing appropriate management information to support the above and is aligned with rapidly evolving risk disclosure standards and practices.

What should be the focus?

A well-considered incorporation in risk management requires understanding the impact of climate and environmental related developments on its business strategy, its own ambition as well as a thorough understanding of the expectations of its stakeholders (which might be rapidly changing). Even more important may be to fully understand the substantial uncertainty that comes along with it. For instance in the area of technologies for climate adaptation and mitigation as well as political uncertainty on timing and nature of measures to mitigate climate risk. As the incorporation of climate and environmental factors in risk management impacts almost every part of a bank's organization, it is vital to ensure that different parts of the bank work together from the start. Developing the bank's capabilities with respect to climate risk management should go hand-in-hand with developing organizational agility and a culture that fosters change.

Timelines

Banks are requested to share gap-assessment and implementation plans with their supervisors between May and June 2021.  Banks must already demonstrate some form of integration of ESG in their credit risk management before 30 June 2021 through compliance with the EBA Guidelines on Loan Origination and Monitoring.

Both ECB as well as national supervisors have indicated they will incorporate the treatment of climate- and environmental risks in the SREP and supervisory dialogue from 2021 onwards. In addition EBA aims to share a final report on risk management integration by June 2021 and release updated and new regulations through guidelines in the period 2022-2024.

How can we help?

With the effective application timeline of 30 June 2021 getting close, banks should have a clear roadmap to achieve compliancy. KPMG can help with the whole implementation process, from analysis to planning and execution, across the organizational structure and functions. Our highly experienced interdisciplinary team with deep knowledge of related regulations gives us the unique capability to help you navigate through the complex regulatory requirements and achieve both compliancy and desired business benefits.

On top of these, KPMG has developed a comprehensive tool inventory to support the incorporation of climate risk and environmental risk factors in credit, market and operational risk management frameworks, development of risk taxonomies, as well as scenario-analysis and stress testing.