Europe’s three primary financial regulatory agencies, the European Supervisory Authorities (ESAs) announced the publication of new draft Joint Guidelines on ESG stress testing, setting out how banking and insurance sector authorities in the EU should integrate ESG risks into their supervisory stress tests, and aimed at harmonizing methodologies and practices among banking and insurance supervisors.
The ESAs include The European Securities and Markets Authority (ESMA), The European Banking Authority (EBA), and The European Insurance and Occupational Pensions Authority (EIOPA). The ESA’s announced that they have launched a joint consultation into the new proposed guidelines, which will remain open until September 19, 2025.
The new proposals state that supervisors “should aim to fully integrate ESG factors into overall stress testing framework,” as well as to review the ESG risks covered over time, based on data availability.
While guiding authorities to integrate ESG risks into stress testing, the publication acknowledges that “ESG stress testing is a relatively nascent field compared to more traditional financial stress testing,” although it also noted that “significant progress has been made to explore available data and models, in particular for environmental risk linked to climate change.”
Accordingly, the ESAs propose that authorities first focus on climate and environmental risks, including both physical and transition risks. The publication proposes a “gradual roll-out” to expand the scope of ESG risks assessments, with the potential to add “S” and “G” components is tools and data become available for these factors.
Additional factors covered by the guidance include time horizons to be considered in the stress tests with integrated ESG risks, scenario design, levels of data granularity to be considered, and materiality assessments, with authorities guided to take a risk-based approach to identify which ESG risks are most material to financial entities, and proposing considering factors such as the exposure of assets and liabilities to transition and physical risks, as well as the potential impact of ESG risks on traditional financial risk categories such as market, credit, counterparty and underwriting risks, as well as strategic, operational and reputational risks.
The guidance also proposes that banking, insurance, and securities regulators should collaborate to ensure a consistent approach to ESG risk assessment and facilitate data sharing, and to enable ESG stress tests to account for interconnections and spillover effects between financial sectors.
The proposals also guide supervisors to “ensure that sufficient human and material resources are allocated to the ESG stress testing process,” including staff with ESG risk expertise, and data collection and management capabilities.
The ESAs said that they plan to finalize the joint guidelines by the end of 2025, with publication of the finalized guidelines in early 2026.
Click here to access the consultation paper.
