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Another tool used by institutions to offer products and services that meet customers’ expectations, on one side, and to adapt their portfolio in a timely manner to reduce ESG risks, on the other, is the strategic assessment of whether to develop sustainable productsthat are considered to be more resilient to ESGrisks. These include products typically marked as ‘green’ or ‘social’. Institutions can use such products as a tool to implement their ESG risk-related objectives and adjust their business models and portfolio composition.
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Management bodies should also ensure that a sound and consistent risk culture accounting for ESG risks is implemented within the institution. This includes clear communication from the management body (‘tone from the top’), appropriate measures to promote ESG-risk awareness, including knowledge of institutions’ ESG strategic objectives and corporate values, and a proper accountability framework. Given the relative novelty of ESG risks, institutions should ensure, as part of their training policy, that staff are adequately trained to improve the understanding and practical handling of these risks
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Institutions should also include in their ICAAP and ILAAPframeworks a description of the risk appetite/tolerance levels, thresholds and limits set for the identified material risks, as well as the time horizons, and the process applied to keeping such thresholds and limits up to date. This would align institutions’ practices with supervisory expectations as this information is indicated in the EBA Guidelines on ICAAP and ILAAP. The forward-looking approach of those frameworks should take into account the materialisation horizon of ESG risks, for the short,medium and long term. Similarly, institutions should take into account the relevance of ESGrelated impacts on business lines when designing scenarios for recovery planning processes, asthese can be especially prone to climate change and environmental degradation.
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The EBA sees the need to enhance the incorporation of ESG risks into institutions’ business strategies and processes. Whilst institutions are, and should remain, responsible for setting their strategies, the impacts of ESG risks should be appropriately taken into account in order to ensure the resilience of their business models over the short-, mediumand long-term time horizons. To achieve this, the EBArecommends that institutions carry out the actions described
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The management body is responsible for the implementation of an adequate internal control framework and the approval of internal control policies, mechanisms and procedures. It is crucial that organisational structures, implemented by institutions e.g. based on the ‘three lines of defence’ model, support and promote effective and prudent decision-making. The business lines and units taking on risk have the primary responsibility for managing the risk generated by their activities throughout the lifetime of that activity. This general principle is equally applicable for the integration of ESG risks in the risk management and control framework.
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Nevertheless, it is important that institutions proactively build up their data infrastructure and increasingly collect the information necessary to conduct such assessments. Institutions may also consider the use of proxies and estimates as first intermediate steps.
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The role of the management body applies also in the context of ESG considerations, where the management body plays a key role in addressing existing gapsin the institutions’ business, e.g. profile and strategy. Gaps can also arise from the uncertainties surrounding the impact of ESG risks on the institutions’ business activities and the implications of the transition to a more sustainable economy. the management body in its management function is responsible for ensuring that there is an appropriate monitoring of such risks and developments that currently affect, or that may in the future affect, the institutions and the achievement of their objectives in this context
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Institutions set and operate risk management functionst hat are responsible for ensuring the proper risk controls. The incorporation of ESG risks and in particular the specifics of ESG transmission channels (as described in Chapter 2) into financial risk categories, in these functions that are independent from the business lines and units, would ensure that the longterm impact of ESG risks is accounted for in the decision-making process and, overall, minimise the institutions’ exposure to ESG risks. The compliance function 183 also complements the risk management framework and monitors the alignment of institutions’ activities with applicable laws, rules, regulations and standards, including ESG regulatory aspects.
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Loan origination is a crucial phase for collecting the necessary ESG-related information and data associated with the different elements of the transaction, e.g. the product itself, collateral or counterparty. The information and data collected at the initial evaluation phase would directly feed into the monitoring process. In addition, as part of loan origination, institutions evaluate the repayment capacity and creditworthiness of the borrowers, typically based on the financial and non-financial analysis of a corporate or retail counterparty. In these evaluations, institutionstypically apply a frequently used approach by assigning a certain rating or score to the potential borrower to indicate the level of risk. In some cases, although ESG factors and associated risks are relevant and present, these rating or scoring systems have not yet reflected ESG factors as relevant parameters. As part of loan origination or ongoing engagement with customers, institutions should gradually incorporate the evaluation of ESG factors into their processes, as set down in the Guidelines on loan origination and monitoring. Including ESG considerations at a very early stage of a business relationship with clients and counterparties should help institutions in their approach to gathering data and assessing ESG risks.
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The management body’s involvement in setting and overseeing the progress against the institution’s ESG risk-related objectives and/or limits , coupled with an understanding of the distinct elements of ESG risks and a sufficiently long-term view of the financial risks that can arise beyond standard business planning horizons, is necessary for the integration of these risks into the institutions’ business models and strategies. The management body needs to understand the potential impact of ESG factor. the management body should set and oversee the implementation of near- and long-term goals and strategies
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The independent internal audit function, among other tasks, reviews the internal governance arrangements, processes and mechanisms to ascertain that they are sound and effective, that they are implemented and that they are being consistently applied throughout the organisation. Assuming that all relevant aspects of ESG factors and ESG risks are incorporated into the institution’s governance and organisational arrangements, the internal audit function would capture these under the existing processes, including by effectively communicating with all parties involved in the integration of ESG risks into its activities
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In methodology building, it is essential to evaluate which of the existing methods can sufficiently incorporate the ESG factors and transmitted ESG risks into financial risk categories, and what additional methods or approaches need to be incorporated to capture exposurebased and portfolio-based risk measurement and monitoring.The assessment of ESG risks in the initial methodology building should consider the role of additional and complementary metrics in order to take into account the realisation timeframe of ESG risk, whether in the short, medium or long term, in a forward-looking manner. As the evaluation of ESG risk involves a much longer time horizon than that used in the existing risk management tools, forward-looking tools such as scenario analysis and stress testing are being explored by institutions. It is essential for institutions to evaluate which methods and metrics are the most suitable for them, considering their strategy and overall approach to ESG risks
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The management body should ensure that responsibilities with regard to ESG risks are clearly integratedinto the organisational structure, both in business lines and internal control functions.
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ESG risks are understood to be drivers of traditional financial risks and institutions should be able to capture the risks associated with ESG factors when they account for them in their risk appetite and apply their risk management frameworks with appropriate and accurate risk metrics and limits. Depending on the overall strategy and approach to transition risk, the relevant limits might need to be reviewed or extended to include new types of limits that are relevant from the ESG perspective (e.g. sectors excluded from eligibility based on the institution’s business strategy).
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To this end, the integration of ESG factors and ESG risks in the induction and training policies and programmes of institutions can help ensure that adequate expertise is being built up, including – but not limited to – at the level of the management body. In general, it would also be beneficial for the institution’s approach to managing ESG risks that all members of the management body, on an individual basis, possess a minimum level of knowledge and understanding of ESG factors and risks.

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