The new European Commission study conducted by BlackRock (Development of Tools and Mechanisms for the Integration of ESG Factors into the EU Banking Prudential Framework and into Banks’ Business Strategies and Investment Policies) was published late last week. It evaluates current practices in integrating environmental, social and governance (ESG) factors within the EU banking system. Information was obtained from a variety of stakeholders, including 28 banks and 15 regulatory bodies (referred to as “supervisors”). The study is over 250 pages long. 

Below are what we view as significant excerpts primarily from the Executive Summary:

Banks

Many of the findings are not surprising, but one was unexpected: even though banks recognize the importance of an integrated ESG strategy for their operations, environmental and social risks are often grouped as sustainability risks, whereas the governance aspect is more often viewed as a compliance topic and therefore tends to be structurally and conceptually separated.

A common and granular definition of ESG risks among banks does currently not exist. There is no single governance structure … few banks have an explicit and comprehensive strategy in place that ensures coordination between the ESG pillars and visibility on potential trade-offs… Most banks have been reviewing their governance arrangements and have established centralised sustainability teams or functions to drive group-wide ESG integration… [yet] limited internal resources and capabilities are an impediment to ESG integration. 

Banks have not yet developed a clear mapping of how different ESG factors feed into financial risk types. The most significant progress can be observed on climate-related risks, which are often mapped to financial risk types. Other ESG risks tend to be viewed through the lens of reputational or strategic risk. Banks conduct targeted pilot exercises but do not embed ESG risks into business as usual practices. The scope of these exercises tends to be limited to high-carbon sectors and does not usually cover the entire balance sheet.  

While most banks state that they are planning to integrate ESG factors into their lending and investment activity as part of a broader ESG strategy, adequate monitoring and targets (e.g. Paris Agreement goals) are still often lacking… Portfolio analysis of banks’ ESG lending and investment activity, if available, is often limited to certain sectors and product types. There is a lack of harmonised definitions and classification standards for a wider range of ESG products at a global level … products are not always structured according to the same criteria. 

Most banks have not yet collected comprehensive evidence on the risk/return profile of their ESG lending or investment activities… The understanding of the impact of ESG products on profitability within banks is somewhat limited.

Disclosures by banks tend to be qualitative … disclosed quantitative metrics are often linked to funding volumes in specific sectors or ESG products, rather than measuring exposure to ESG risks.

Regulators/Supervisors

Supervisors tend to assess ESG pillars and specific risks within each pillar separately, as opposed to adopting a holistic assessment of ESG risks… ESG themes falling under the S pillar – external and internal stakeholder management – received the lowest scores from supervisors in terms of relative ranking [of relevance].

There is debate amongst supervisors as to whether the double materiality perspective should be adopted when looking at ESG risks.

Data challenges and a lack of common standards continue to be seen as the most prevalent challenges facing banks and supervisors alike.

Given the length of the report in toto, it may be somewhat challenging to read. However, many excellent details and insights are provided in Sections 3.3, 4,3, 5.3 and 5.4. We will examine these in later posts.

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