Sustainability risks can be measured despite data constraints

Sustainability risks are material for financial institutions

The study shows that the carbon footprint attributed to Dutch financial institutions’ global financing and investment operations is at least 82 Mtonnes, and probably more. For comparison: this number corresponds to about half of the total carbon emissions of the Dutch economy in 2019. Figure 1 shows that the carbon footprint of the Dutch financial sector is mainly attributable to exposures of pension funds (47 Mtonnes) and banks (30 Mtonnes). The transition to a carbon-neutral economy thus implies a material sustainability risk for financial institutions, commonly referred to as  transition risk. For example, changes in government climate policy can give rise to increased credit and market risks due to unexpected or premature write-downs and impairment of their assets (stranded assets). The effectiveness of such policy strongly determines the magnitude of transition risks.  A less strict climate policy does lead to smaller transition risks in the near term, but also requires more incisive government action in the future, resulting in greater transition risks.

The study also shows that the transition risk, and thus the risk of stranded assets, will continue to increase in the coming years. In the years ahead, the planned activities of firms in which pension funds and insurers invest will increasingly deviate from the transition path required to achieve the climate goals of the UN Paris Agreement. This does not mean, however, that investment in these companies must necessarily be reduced. For example, by means of voting at shareholders' meetings and shareholder engagement, financial institutions can encourage firms in which they invest  to reduce their carbon-intensive activities and invest in low-carbon alternatives.

Measuring sustainability risks despite data constraints

It is important that financial institutions do not wait to measure sustainability risks until ‘perfect data’ is available. Experience shows that data is actually improved through measurement of these risks. Inevitably, estimates and modelled data must be used for the time being until better and more harmonized data becomes available. In this context, the International Financial Reporting Standards Foundation (IFRS Foundation) recently announced the establishment of a Sustainability Standards Board , which seeks to consolidate several existing sustainability reporting initiatives into a single harmonised global reporting standard.  In tandem with the ECB, we are also committed to developing harmonised standards and calculation methods to improve data quality in the field of sustainability.7

Sustainability risks as an integral part of regular supervision

We supervise adequate risk management by financial institutions. The same applies to sustainability risk management.  In 2022 we will further define how we expect  financial institutions to manage sustainability risks. We will also consult the financial sector on this. We seek to align our expectations with the ECB’s guide to supervisory expectations for banks, which addresses the integration of sustainability into strategy, governance, risk management and reporting. We will also take the specific characteristics of non-banking Dutch financial institutions into account.