On 20 October 2021, Frank Elderson, Member of the Executive Board of the European Central Bank (ECB) gave a keynote speech at the Financial Market Authority’s Supervisory Conference, regarding the need for banks to translate their 2050 carbon-neutral targets into milestones.
Key points in the speech include:
- Banks can no longer simply declare their intention to be compliant with the Paris Agreement by 2050. They require structural changes to the way they conduct business to ensure they reach the goal and avoid a build-up of risks.
- The ECB has been taking steps to increase understanding of the impact climate crisis has from a financial risk perspective and to ensure banks have a comprehensive strategic approach to disclosing and managing all climate-related and environmental risks (C&E risks).
- The ECB’s sustainable finance strategy acknowledged the need for financial institutions to improve their disclosures of sustainability targets and transition planning. Also, the European Commission’s proposal for a Corporate Sustainability Reporting Directive (CSRD) requires financial institutions to set out and disclose their transition plans, but the content and timing of such plans are at the discretion of the bank.
- The transition plan should contain concrete intermediate milestones and yearly targets leading up to 2050 and the associated performance indicators so the bank’s management and competent authorities can understand the risks which may arise if they stray from the transition path. If these milestones are not met, competent authorities will need to take appropriate measures to ensure failure does not result in financial risks.
In terms of the next stage, the speech notes that two crucial elements are needed:
- Science-based European transition scenarios. As suggested by the European Commission’s new sustainable finance strategy, the scenarios developed by the Network for Greening the Financial System should be considered a starting point for testing the impact of Europe-specific transition plans, as well as guiding banks in setting their own targets.
- Transparency and appropriate disclosures around banks’ transition plans. The European Banking Authority Pillar III disclosures and CSRD are steps in the right direction but there needs to be more ambition.
In the final part of the speech it is noted that in the course of next year the ECB will carry out a supervisory stress test with a focus on C&E risks. The ECB will also carry out a full supervisory review of banks’ practices for incorporating C&E risks into their risk frameworks and gradually roll out a dedicated Supervisory Review and Evaluation Process methodology which will influence banks’ minimum capital requirements. Gradually the ECB will start treating climate-related risks like any other risk and include them in all relevant supervisory requirements.