Finance

A recent report from the Financial Stability Board identifies two areas in which regulatory action will be essential:

• Regulators need to measure climate risk on a systemic level;
• regulators should identify information gaps in order to facilitate the process of collection of climate data and ensure effective supervision over the financial system. 

Climate risk under the spotlight long-term

In the European Union, measurement of climate risk in the financial system has attracted a lot of attention from regulators recently. The EU financial supervisors – European Supervisory Authorities (ESAs), the European Systemic Risk Board (ESRB) and the European Central Bank (ECB)– have repeatedly stated that environmental risks in general have been historically underappreciated by financial institutions and that climate risk in particular may have potential macroprudential impact in the future.

Even within the existing legislative framework, they have called on financial institutions to adequately identify, measure and manage climate and environmental risks and to take into account a long-term (10 years+) view and different climate scenarios in doing so. 

The guide on climate-related and environmental risks for banks published by the ECB is a great example of the EU regulators’ activity. In the guide, published in 2020, the ECB formulates a number of concrete supervisory expectations as to how climate and environmental risks should be managed by supervised institutions. In 2022, the ECB’s supervisory tests are focusing on climate risks. 

Regulators’ views are shaping legislation

The opinions of the regulators have also directly influenced EU legislation in the field of sustainable finance. Supervisory opinions published by the European Insurance and Occupational Pensions Authority (EIOPA) and reports of the European Banking Authority (EBA) in particular seem to have influenced legislative proposals in the insurance and banking sectors respectively. In the EU, financial regulators also create regulatory technical standards which are important for the execution of new laws – as was recently the case in the field of reporting regulations for financial institutions.

The future holds a larger role for regulators

A lot of important work is yet to be done. In the near future EIOPA and EBA are supposed to comment on the (potentially) different treatment of ESG-related assets within the financial prudential framework. A positive opinion from the regulators in that area could potentially have a colossal impact on market practice and legislation which is being developed.

The role of the financial regulators will only increase as new laws are enacted in the field of sustainable finance. And it’s not only the regulators on the European level who will have their hands full – local supervisory authorities in individual member states will also gain new competences. For example, the European’s Commission legislative proposal on European green bond standard assumes that ESMA, the European securities regulator, will supervise the external verifiers opining on green bond issues while the individual bond issues themselves should be supervised at member state level. 

As the case of the EU shows, the role of financial regulators in the field of climate change will only increase. Let us hope that, as this happens, the regulators will also build adequate internal competences to meet the coming challenges. 

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