On 7 December 2021, the Dutch Central Bank (De Nederlandsche Bank, DNB) published a news item in which it indicates that banks, insurers and pension funds must better account for sustainability risks. This follows on DNB’s press conference during which they, among other things, presented the result of their new study ‘Towards a sustainable balance’ (Op weg naar een duurzame balans).
DNB notes that a survey among 127 Dutch financial institutions shows that the majority has not yet adequately embedded sustainability risks in their risk management. This despite the fact that investments of financial institutions are increasingly exposed to the direct physical risks resulting from climate change and the transition to a climate neutral society. Even though financial institutions are generally aware of these risks, only a minority of pension funds (30%), insurers (22%) and banks (10%) have explicitly made sustainability risks part of their risk appetite. DNB emphasises that financial institutions must have a good understanding of all material risks and managing such risks. This includes sustainability risks. Sustainability risks should be embedded in governance, strategies and risk management cycles of financial institutions. Financial institutions need to determine to what extent sustainability risks are material to them and explicitly incorporate these risks in their risk appetite. If certain sustainability risks are not deemed material, financial institutions should be able to explain why.
DNB indicates that the need to control sustainability risks should not be interpreted as a plea for the exclusion of such risks. It is important that material risks are adequately managed. Therefore, it is necessary that financial institutions have insight into their exposures to sustainability risks, the term in which these risks will lead to financial risks, and how this contributes to the overall risk profile of the financial institution.
DNB also notes that institutions have difficulties with measuring and reporting on sustainability risks due to the limited availability of consistent and reliable data. DNB believes that limited availability of data should not be an obstacle for financial institutions to measure sustainability risks and that they should not wait until better data is available. Financial institutions can work with estimates and modeled data, which will eventually also promote the creation of better data based on harmonised standards. DNB does not suggest specific methodology, but encourages financial institutions to choose a unambiguous and detailed approach for measuring, for example, the carbon footprint of their financing and investments, as well as the risk of stranded assets in their portfolio.
With regard to the risk of stranded assets in financial institutions’ portfolios, DNB notes that they believe this risk will increase in the coming years. Using the Paris Agreement Capital Transition Assessment tool, DNB determines how CO2-intensive companies in portfolios are progressing towards compliance with the UN Paris Agreement. The results show that the activities of companies in the equity portfolios of pension funds and insurers will in the coming years increasingly deviate from the transition path with an increase in transition risks as a result. In addition, the effectiveness of governments’ climate policy will determine the magnitude of these transition risks in the future. A less effective climate policy will in the short term lead to lower transition risks, but at the same time in higher physical risks. At the same time, a less effective climate policy now will most likely result in more significant government actions in the future, which will at that time result in higher transition risks.
DNB will ensure that financial institutions comply with agreements to which they committed with regard to sustainable financing. If financial institutions fail to comply, they face reputation and liability risks. For this purpose, DNB will (continue to) make sustainability risks an integral part of their day-to-day supervision.