EBA Guidelines on ESG Scenario Analysis

The EBA published this year its Guidelines (GL) on the management of ESG risks. Those GL address the mandate set out in Article 87a(5) of Directive 2013/36/EU relating to minimum standards and reference methodologies for the identification, measurement, management and monitoring of Environmental, Social and Governance (ESG) risks by institutions. The GL complement the GL on the management of ESG risks on the area of scenario analysis, which were published last year.  

For institutions using the IRB approach for calculating the own funds requirements for credit risk, these GL are also intended to specify the way in which ESG risks, and in particular physical and transition risks stemming from climate change, are taken into account in the scenarios used for credit risk internal stress testing. In this respect, these GL are intended to fulfil the mandate of Article 177(2a) of Regulation (EU) No 575/2013.  

Scenario analysis is a process for identifying and assessing the potential implications of a range of plausible future states of the world on the strategy of institutions and the risks they are subject to. It ranges from very basic, purely qualitative 'what if' approaches to highly sophisticated approaches requiring in-house expertise and up-to-date monitoring of available data and methodologies. In an unstable and, in all probability, increasingly challenging environment, scenario analysis is a highly valuable tool for anticipating and better preparing for risks, as well as for seizing opportunities.  

These GL focus more specifically on the role of scenario analysis in fostering institutions’ resilience against environmental risks, starting with climate. They are built around the distinction between scenario analysis used i) to test the institution’s financial resilience to severe shocks in the short to medium term and verify its capital and liquidity adequacy and ii) to challenge the business model resilience of the institution, including in the long term, and help it navigate an uncertain future.  

The GL are divided into three sections. The first section aims to specify the different uses institutions should make of scenario analysis and to propose a progressive and proportionate approach to incorporating scenario analysis into the institution management system. The second section provides guidance on what is required before undertaking a scenario analysis and more specifically on the criteria for setting scenarios and identifying the transmission channels for translating climate risks into financial risks. Finally, the third section specifies, on the one hand, the distinctive features to be taken into account when conducting a climate stress test in addition to the requirements set out in the Guidelines on institutions’ stress testing and, on the other hand, the use of scenarios to help define and adjust the institution’s strategy and test the robustness of its business model to a range of plausible futures. 

Leaseurope responded to the EBA consultation on 16 April. In our response we highlight the role of the leasing industry to act as a facilitator of the green transition for businesses and households alike. We explain that the leasing industry currently plays a major role in improving the availability of new, more efficient and greener technologies, without the cash outlay that would often deter companies and individuals from upgrading their assets (like factory equipment or vehicles for example) to a more sustainable model.  

We also stress the importance of taking into account the principle of proportionality in the disclosure of climate-related risks. Cost versus benefit should also feature as part of any consideration of requirements.  In this regard , we point out that SMEs in Europe should not be forced to report more than required under the Corporate Sustainability Reporting Directive (CSRD) (Listed SMEs European Sustainability Reporting Standard (ESRS)) or the Voluntary SME ESRS standard. In this respect, we are pleased to see the CSRD Omnibus proposals to relieve the reporting burden for some entities.  

We also take the opportunity to suggest the EBA review those interactions and consider updating the timeline of the ESG risk management guidelines to reflect the impact of the Omnibus directive and a proportionate approach to assessing compliance with those guidelines.  

In terms of the proposed timeline for implementing the guidelines, we foresee a number of challenges, also linked to broader political developments ongoing at the time of this consultation, therefore we mention that it is instrumental that credit institutions are given sufficient time to implement the EBA Guidelines. 

In our response we also include a number of technical questions to the EBA for their clarification as well as suggestions to ensure the guidelines fit the specialised model of leasing companies.