Climate and environmental risk management
Financial institutions are required by law to manage material risks, including ESG risks such as climate and environmental risks. Nevertheless, previous research indicates that institutions have embedded these risks in their core processes only to a limited extent. In this Guide, we provide insurers, pension funds, premium pension institutions, investment firms and institutions, and electronic money and payment institutions with focal points and good practices for managing climate and environmental risks (note 1). We are thus responding to a need felt throughout the sector for a clear indication of what good management of climate and environmental risks could entail. The Guide outlines focal points for a financial institution’s entire control process: from the business model and strategy, to governance, risk management and disclosure.
Consultation with stakeholders
We made the Guide to managing climate and environmental risks available to the financial sector and other stakeholders such as NGOs at an earlier stage for consultation. We received nine written responses and held discussions with the Federation of Dutch Pension Funds, the Dutch Association of Insurers, the Dutch Payments Association and a selection of institutions. The consensus was that the Guide is a useful and practical resource for the sector. Following the consultation round, we amended some parts. For instance, the final version of the Guide places more emphasis on biodiversity loss and its connection with climate risks, and a good practice has been added to assist institutions that are in the early stages of embedding climate and environmental risks in their core processes.
Risks from climate change and environmental degradation
We use the focal points in this Guide in our supervision of the management of financial and non-financial risks arising from climate change and environmental degradation. These include more frequent extreme weather events which could cause destruction of capital or which could increase the unforeseen claims burden for non-life insurers. New climate and environmental policies could also potentially reduce the market value of certain investments and even result in stranded assets. The climate and environmental impact of financial institutions themselves (known as double materiality) can also give rise to risks. For example, financial institutions that invest in companies with high negative environmental impacts may face increased reputational and legal risks.
Survey of pension funds and insurers
In April 2023, we will launch a survey on the management of ESG risks among pension funds and insurers. The survey is based on the focal points in the Guide to managing climate and environmental risks, and it is designed as a self-assessment. We will use the survey results for embedding ESG risks in our supervisory methodology, including risk assessment, among other things. We will also identify new examples of good practices and incorporate them in a subsequent version of the Guide. The pension funds and insurers we have selected for the survey have already been informed.
Financial sector action plans
Financial institutions' action plans with regard to voluntarily signed sustainability commitments or covenants, such as the Climate Commitment, also play a role in our supervision of climate and environmental risk management. Once made, failing to comply with such commitments can create reputational and legal risks for financial institutions. Action plans can also affect an institution's business model and governance, as embedding responsibilities is essential in their implementation. As part of our supervision of sound and ethical operational management, we therefore monitor how institutions assess their progress on the commitments they make under the voluntary Climate Commitment. An institution’s compliance with its own policies, for example on sustainable investments, is also an integral part of our on-site inspections of ESG risks.
We will update the Guide to climate and environmental risk management in about a year's time, adding new good practices for managing ESG risks and current developments in laws and regulations.
We are also working towards further embedding ESG factors in our risk assessments of financial institutions. In 2024, for instance, we expect to include ESG risks in our annual sector-wide risk analysis surveys as part of our supervisory practice. Additionally, we are developing ESG dashboards to gain insight into institutions’ exposure to various ESG aspects. We will use the information gleaned from these dashboards for various purposes, including as a basis for supervisory meetings and as input for risk assessments.
Note 1:This Guide is not intended for banks as we use the ECB Guide in our banking supervision.