ESG: Commission asks the ESAs for a climate risk scenario analysis

What’s new?

By a letter dated 8 March 2023 (published by ESMA the following day), the European Commission has mandated the European Supervisory Authorities (ESAs) to conduct a climate risk scenario analysis exercise. The letter was supported by a formal request from the Commission for a one-off stress testing exercise.

What’s behind this?

In its July 2021 Strategy for Financing the Transition to a Sustainable Economy, the Commission laid out its plans to ensure, among other things, that the financial sector was resilient to climate risks and that the Commission’s aim of reducing 1990 level greenhouse gas emissions by at least 55% by 2030 could be achieved.

To assess the resilience of the EU’s financial system (as well as to anticipate shocks to the financial system that could jeopardise the viability of the financial system in part or in whole), the Commission invites the ESAs to undertake a one-off cross-sectoral climate risk scenario analysis, going beyond ‘the usual climate stress tests’ to look at contagion and second-round effects.

The ESAs are also asked to feedback any insights into the financial system’s capacity to support green investments under stress.

What are the ESAs being asked to do?

The exercise should provide an assessment of how far early climate risk related shocks might generate significant stress for the financial system in the period up to 2030.

The ESAs are to work in close cooperation with each other to develop “severe but plausible scenarios” that could affect the financial system over that period.

These would include scenarios which

• focus on climate-change related risks that could materialise in the near term and
• combine climate change related risks with other stress factors – these should be as consistent as possible with scenarios for regular stress-testing exercises.

Adverse scenarios should use as a comparison a baseline in which implementation of the EU’s Fit for 55 package is progressing as planned and within the economic environment as forecast when the exercise is launched.

The request that accompanies the Commission’s letter also notes that the exercise should

• be EU-wide
• cover all relevant sectors of the financial system and
• be based as far as possible on available data which the ESAs collect.

The ESAs are left to determine an appropriate time horizon for the exercise - this will depend on how long it takes for the initial shocks to develop their full impact on the financial system.

When do the ESAs need to do this by?

In terms of timing, the Commission notes the importance of having any policy-relevant conclusions not later than Q1 2025 – and ideally by the end of 2024, so this can contribute to the work of the new Commission.

To achieve this, the Commission asks that the exercise be launched “as soon as possible” and notes that it could be based on end-2022 balance sheet data.