The Global Risks Report 2023 recently published by the World Economic Forum shows that climate-related and environmental (CRE) risks remain a major theme of concerns as climate change mitigation, climate change adaptation, extreme weather events and biodiversity top the list of the biggest risks the world will face over the next ten years.

Likewise, the European supervisors and policy makers are taking an increasingly active interest in the matter, confirmed by their recent publications about the results of the ECB 2022 thematic review on CRE risks and the first draft of climate-related statistical indicators as well as the launch on 1st February by the European Banking Authority (EBA) of the 2023 EU-wide stress test that aims to assess banks' performance under a baseline and adverse scenario over a 3-year horizon (2023-25).

Expectations were already high, and they are growing fast, irrespective of the banks’ profile and type of business. While most large banks have started implementing dedicated plans to embed climate-related, environmental, social and governance matters in their governance and risk management framework, smaller actors are also invited to perform self-assessment of their alignment with national expectations (that are closed to the ones of the ECB) and prepare their own roadmap.

While many actors are actively strengthening internal expertise, updating their risk appetite statement, policies, processes and related risk indicators, they must also look further ahead and keep an eye on the future developments as anticipated in the EBA roadmap on Sustainable Finance released on 13 December last year. There is still a long way to go and the ABBL ESG Risks Task Force will continue exploring evolving market practices, methodologies and tools in the field to support its members in continually improving their management of CRE risks in the light of the upcoming new supervisory expectations.

ESG Risks – Benchmarking exercise on 20 European Central Bank (ECB) Supervised Banks following the ECB thematic review

In the context of the 2022 ECB thematic reviews on Climate-related and Environmental (C&E) risk management, KPMG ECB Office, which combines the expertise from KPMG's International network of banking professionals and former regulators, conducted a benchmark survey across 20 EU banking actors to compare the scores, practices, and findings they received in their feedback from ECB. 


In this benchmark analysis, KPMG covered 7 pillars of the C&E risk management principles and divided them into 4 core modules: materiality assessment, business environment & strategy, governance & risk appetite, and risk management framework; and 3 specific risk modules: credit risk, operational risk and market risk. The main conclusion was that less than 50% of the participant banks have ‘broadly adequate’ practices in place in any of the 7 pillars. Therefore, there is still a large margin of improvement to fulfill the ECB expectations.   


KPMG emphasized that the most common ECB findings identified were in the sections ‘materiality assessment’ and ‘risk management framework’. This strongly demonstrates the willingness of the ECB to push risk management methodologies even further than what banks have been implementing so far. The most frequent ECB findings addressed the excessive utilization of descriptive qualitative judgments instead of quantitative information and the lack of forward-looking quantitative assessments for all material portfolios. Additionally, numerous findings emerged in relation to two other aspects: governance & risk appetite. The ECB focuses on the limited inclusion of C&E risk considerations in the risk appetite statement and expects the banks to put a systemic collection of data in place. Following these findings, the institutions will need to develop internal initiatives which go beyond the perimeter of the Chief Risk Officers, where a coordination between the ESG coordination teams, data governance and strategy offices will be vital for the success of the remediation.  


Finally, in the specific risk modules, banks are prioritizing the integration of C&E risks into credit risk processes. In relation to this, ECB recommended to the majority of the banks to improve their systematic integration of climate-related risks in the client on-boarding process, and great attention was given by the ECB to include C&E risks in product pricing and collateral valuation.  

A local perspective on ESG Risks – Benchmarking exercise on 15 Luxembourgish Banks following the ECB Guidelines on C&E Risks and CSSF Circular 21/773 on the Management of Climate-related and Environmental risks

To evaluate the level of readiness of Luxembourgish banking industry, the ABBL alongside KPMG Luxembourg distributed a self-assessment questionnaire to ABBL’s members, in which a diverse sample of 15 banks took part.  


Overall, one third of the participants expect to reach an 80% readiness level in 2023, while the remaining respondents expect to be compliant by latest 2026. Moreover, although it is observed that the size of the bank is not correlated to their level of readiness and maturity, banks with more diversified and complex operations are still developing the topic across the whole organization and therefore, show a lower level of implementation. In contrast, the ECB thematic review found a correlation between the size of the institutions and the C&E risks readiness, concluding that smaller institutions performed poorer than larger ones, due to an overall lack of resources to be allocated to this aim. 


The survey then deep dived into the degree of implementation of C&E risks across different pillars. In general, banks scored better in the identification of risk exposures, while challenges seem to emerge for both the implementation of the business strategy, risk appetite and risk management framework. This statement is in line with what was observed in the ECB thematic review, as European banks also struggle to comprehensively implement C&E risks in the institution’s internal governance, business strategy and risk management framework.  


More specifically, some other interesting insights were discovered from this exercise, especially with regards to the risk identification process. In this process, the majority of the participants (11 institutions) consider C&E risk could impact other traditional risk types. In the risk assessment most banks are material for credit risk, in line with ECB thematic review observations and operational risk. Moreover, most of the local banks answered that they have KPIs and/or KRIs to assess C&E risks in place, contrasting with what was observed at ECB level.  To this aim, the availability of ESG data is fundamental. All the participants obtained the data from a diverse mix of data sources, including internal and external data providers. 


Finally, the banks that assessed themselves with a higher degree of readiness (above 80%), are more advanced in the implementation of C&E risks within their business strategy and risk management framework. 


Raluca Carp Hengy, Managing Director in the Sustainable Team at KPMG Luxembourg stated that “in-depth implementation of C&E Risks remains a challenge for the sector, both at a European and local level. Therefore, banks should focus on developing a solid and complete materiality assessment, including Strategic, Compliance and Reputational risk. Conversely to the relevance given to these risks in the ECB thematic Review, only two local institutions deem them as material. With this in mind, we see a trend in which more advanced European Banks are challenging the robustness of the Greenwashing Risk Management Framework with the aim to mitigate their risks.”  


Authors: Raluca Carp Hengy (Managing Director, Sustainability Team), Elena Fuzzi (Manager, Risk & Regulatory Team) and Javier Casado Carnero (Senior Adviser, Risk & Regulatory Team), at KPMG Luxembourg.  


Mehtap Numanoglu – Chief Risk Officer at BBH Luxembourg - also shared with us her personal thoughts about ESG and her role as the Chair of the ABBL ESG risks Task Force: “Being a CRO, you are always interested in the ESG matters as it is one of the most important risks globally and ESG is everywhere! But, my personal interest to the subject became deeper during Covid period and due to the floods in this part of the world that we live and wildfires that happened especially in the Mediterranean. It was at those moments, that I thought that I need to do even more on this urgent and hot topic and started doing some specific courses and certifications on the matter. Once you read more on the subject, you see that it is a subject which needs continuous attention and engagement.


We are living on this planet and we do not have another one to go to and we, as human beings, can not afford not doing anything. I am thrilled that I was given the opportunity to chair sustainability related forums internally in my organization and in the industry in Luxembourg. ABBL’s ESG Risks Task Force is a great initiative (that I am very proudly chairing)  and is forming a leading example for all the world and Europe in this area.”  

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