Weekend Edition Nº86 by eulawlive

Nº86

JANUARY 22

2022

Weekend

Edition

stay alert keep smart

NATHAN DE ARRIBA-SELLIER

BANKING ON GREEN:

SUSTAINABILITY IN THE COMMISSION’S BANKING REFORM www.eulawlive.com

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Banking on Green: Sustainability in the Commission’s banking reform Nathan de Arriba-Sellier

Climate action will now extend to banking law. is is in essence the signal sent out by the European Commission with its proposal for a banking reform late last year (1). It represents a turning point for the greening of EU nancial regulation, which has until now focused at increasing transparency in the exposure of the nancial system to climate change and the environment. Climate action is, however, not the main objective of the banking reform put forward by the Commission. Its main goal is the transposition and implementation of the latest Basel Accords (usually referred to as Basel III or Basel IV). Broadly modelled a er the Basel Accords, EU banking law is provided in the Capital Requirements Directive (CRD IV) and the Capital Requirements Regulation (CRR) (2). It has for main focus prudential regulation, or in other terms requirements that are aimed at ensuring the safety and soundness of banks and large investment rms (by facility, I will use the term banks to refer to them, although the law refers to (credit) ‘institutions’). Minimum capital and liquidity requirements form the rst pillar of the CRD IV/CRR legislation, the second pillar corresponds to the supervisory review and evaluation of banks’ risk management, and the third pillar provides for disclosures requirements. e banking package proposed by the Commission (CRD VI/CRR III) mainly incorporates amendments related to the second pillar (or Pillar II) as far as sustainability is concerned. ese amendments would complete the introduction of a couple of limited provisions related to climate-related nancial risks in the 2019 revision of banking rules. e reform particularly covers three elements: governance, risk management, and supervision of environmental, social and governance (ESG) risks. While the Commission’s legislative proposal is remarkable by its signi cance – the integration of sustainability considerations in the banking law of a whole continent –, it is not an isolated initiative. Based on existing law, the European Central Bank (ECB) has already adopted a Guide on climate-related and environmental risks that it will apply starting this year (3). e United Kingdom’s Prudential Regulation Authority is also implementing its i. Research Director of the Yale Initiative on Sustainable Finance (Yale University). 1. European Commission, ‘Proposal for a Directive amending Directive 2013/36/EU as regards supervisory powers, sanctions, third-country branches, and environmental, social and governance risks, and amending Directive 2014/59/EU’, COM(2021)663 nal, 27 October 2021 and ‘Proposal for a Regulation amending Regulation (EU) No 575/2013 as regards requirements for credit risk, credit valuation adjustment risk, operational risk, market risk and the output oor’ COM(2021) 664 nal, 27 October 2021. 2. Directive 2013/36/EU of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment rms, OJ 2013 L 176, p. 338 and Regulation (EU) No 575/2013 of 26 June 2013 on prudential requirements for credit institutions and investment rms, OJ L 2013 L 176, p. 1. 3. ECB, ‘Guide on climate-related and environmental risks’ (November 2020).

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

supervisory expectations and announced that it will ramp up its approach in 2022 (4). Further from home, the Oﬃce of the Comptroller of the Currency (OCC), the United States’ national banking regulator, is currently consulting on a similar regulatory mandate for the integration of climate-related risks in risk management, albeit targeting only large banks (5). Finally, the Basel Commi ee on Banking Supervision (Basel Commi ee), the commi ee that authors the Basel Accords, started its own consultation to set principles for the eﬀective management and supervision of climate-related nancial risks at international level (6).

Background and rationale e reform takes place in a context of growing regulatory overhaul of EU nancial law to support the transition to a sustainable economy. Since the Paris Agreement set the objective of making nancial ows consistent with the other objectives of climate change mitigation and climate change adaptation, the European Union has been leading the charge in ‘greening’ the rules that govern the nancial system. e nal report of the High-Level Expert Group on Sustainable Finance (HLEG) was largely considered as a roadmap for reforming EU nancial regulation (7).

e European Union has been leading the charge in ‘greening’ the rules that govern the nancial system

Within a few years of its publication, the European Union adopted a urry of texts, with at its core the EU Taxonomy, which indexes and classi es economic activities according to their contribution to environmental sustainability (8). A er years spent on increasing transparency, the European Commission is now turning with this new CRD VI/CRR III package to a more daunting task: amending EU banking law to support the transition to a sustainable economy. 4. Prudential Regulation Authority, ‘Climate-related nancial risk management and the role of capital requirements. Climate Change Adaptation Report 2021’ (28 October 2021). 5. OCC, ‘Principles for Climate-Related Financial Risk Management for Large Banks’ (December 2021). 6. Basel Commi ee, ‘Principles for the eﬀective management and supervision of climate-related nancial risks‘ (16 November 2021). 7. EU HLEG on Sustainable Finance, ‘Financing a Sustainable European Economy – Final Report’ ( January 2018). 8. Regulation (EU) 2020/852 of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, OJ 2020 L 198, p. 13. See also Nathan de Arriba-Sellier, ‘A green standard for Europe’s nance’, EU Law Live, Weekend Edition N°4, 2020.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Climate-related nancial risks are real. e Covid-19 pandemic has startlingly demonstrated the extent to which the nancial system and the economy may be vulnerable to an external shock

Although the HLEG considered the role of prudential regulation, its recommendations in this respect were timid. Hence, the Commission’s action plan on sustainable nance did not include much with respect to EU prudential regulation and the CRD V/CRR II revision passed early 2019 only incorporated three relevant amendments, with the pressure of the European Parliament (9). Only one was directly addressed to banks and required the largest of them to disclose information on ESG risks. e two other provisions required the European Banking Authority (EBA) to report on the integration of ESG risks: in pillar I as suggested by the HLEG by 2025, and in pillar II by 2021. e reform presently examined is largely based on EBA’s report on the la er, incorporating its conclusions into law (10).

e present reform was rst announced in the Commission’s renewed strategy on sustainable nance in 2021 In this document, the Commission justi es it in terms of alignment with the European Green Deal, to strengthen the nancial system’s resilience to climate change and improve its contribution to the transition. us, the problem is not only the downstream risks that climate change poses for the nancial system (or climate-related nancial risks), but also the upstream risks posed by the unsustainable economy powered by current investments which aggravate climate change. (11).

is ‘double materiality’ perspective is evident in the explanatory memorandum of the Commission’s proposal: the Commission wants not only to alert banks to climate-related nancial risks, but also to ensure that ‘bankbased intermediation will play a crucial role in nancing the transition to a more sustainable economy.’ Yet, prudential regulation is not an instrument of economic policy. Its overarching objective is not credit guidance (12), but to safeguard the safety and soundness of banks – and, through them the nancial system – from nancial risks. Indeed, those overseeing prudential regulation are independent supervisory authorities that do not engage in policymaking and lack the legitimacy for that. at is why the Commission emphasizes the risks aspect of the proposal. Climate-related nancial risks are real. Whereas the nancial and economic system has long pushed environmental limits ever further, it is now at risk of being similarly impacted by the scale of climate change and loss of biodiversity. e Covid-19 pandemic has startlingly demonstrated the extent to which the nancial system and 9. Directive (EU) 2019/878 of 20 May 2019 amending Directive 2013/36/EU as regards exempted entities, nancial holding companies, mixed nancial holding companies, remuneration, supervisory measures and powers and capital conservation measures, OJ 2019 L 150, p. 253 and Regulation (EU) 2019/876 of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, OJ 2019 L 150, p. 1. 10. EBA, ‘Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms’ ( June 2021). 11. COM(2021) 390 nal. 12. Agnieszka Smolenska and Jens van ‘t Klooster, ‘A Risky Bet: Should the EU Choose a microprudential or a Credit Guidance Approach to Climate Risk?’, EBI Working Paper No. 104, 2021.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

the economy may be vulnerable to an external shock. A growing consensus among supervisory authorities has now emerged that climate risks translate into nancial risks (13). Climate risks are usually categorized as physical risks (directly arising from climate change manifestations) and transition risks (stemming from the transition, whatever that transition may be). While physical risks are increasingly manifest and will increase as long as greenhouse gas (GHG) emissions keep accumulating in the atmosphere, the acuteness of transition risks notably stems from the general unpreparedness of the economy to transitioning to a sustainable economy. erefore, these climate risks are materializing as nancial risks in the form of credit risk, market risk, underwriting risk, liquidity risk, operational risk or even liability risk and reputational risk. Existing law is sufficient to deal with material nancial risks that arise from climate change or even biodiversity loss. Indeed, EU banking regulation is worded in terms general enough to capture a broad array of risks, regardless of their sources. Supervisory authorities’ job is to ensure that such risks are not overlooked, but understood, carefully monitored, and assured by sufficient capital reserves (14). e ECB, like some national authorities, has been doing just that, by issuing late 2020 its Guide on climate-related and environmental risks specifying its supervisory expectations vis-à-vis banks under its purview for the management of such risks. However, the capacity and will of supervisory authorities to increase the pressure on banks varies. Although the Commission recognized the efforts of some banks, it noted that ‘progress remains insufficient’ (15), and that ‘the present legal requirements alone are insufficient to provide incentives for a systematic and consistent management of ESG risks by banks. (16)’ e ECB similarly stressed that banks fell too o en short of its supervisory expectations (17). Against this background, the reform provides an express legislative mandate for the banking system to integrate climate-related risks in risk management and for supervisory authorities to pay a ention to these risks in the course of their supervision.

e content of the banking reform e rst building block of this new package de nes notions of environmental, social and governance (ESG) risks. ese de nitions reveal the diﬃculty with ascertaining the nature and scope of ESG risks. ESG risk is de ned in the proposal as ‘the risk of losses arising from any negative nancial impact on the institution stemming from the current or prospective impacts of environmental, social or governance (ESG) factors on the institution’s counterparties or invested assets’. In the same way, the de nition of environmental risk, social risk and governance risk refer respectively to ‘environmental factors’, ‘social factors’ or ‘governance factors’ that are not de ned. Only the de nition of environmental risk includes more details, by ‘including factors related to the transition towards the following environmental objectives: (a) climate change mitigation ; (b) climate change adaptation; (c) the sustai13. Network for Greening the Financial System, ‘A call for action. Climate change as a source of nancial risk' (April 2019). See also Bolton, Despres, Pereira da Silva, Samama and Svartzman, e green swan. Central banking and nancial stability in the age of climate change, Bank of International Se lements, 2020. 14. Nathan de Arriba-Sellier, ‘Turning Gold into Green: Green Finance and the Mandate of European Financial Supervision’, 4 Common Market Law Review 58, 2021, pp. 1097-1140. 15. COM(2021) 390 nal, 12. 16. COM(2021) 663 nal, 4. 17. ECB, ‘ e state of climate and environmental risk management in the banking sector. Report on the supervisory review of banks’ approaches to manage climate and environmental risks,’ November 2021.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

nable use and protection of water and marine resources; (d) the transition to a circular economy; (e) pollution prevention and control; (f) the protection and restoration of biodiversity and ecosystems’, which correspond to the environmental objectives set by the Taxonomy Regulation for qualifying sustainable economic activities. e notion of environmental risk also speci es that it includes both physical and transition risks. Although these de nitions were suggested by EBA’s Report, their tautological character, lack of clarity and speci city, particularly when it comes to social and governance factors, could represent a barrier to the implementation of the new related requirements. Yet, these de nitions set the stage for the substantive requirements proposed by the Commission.

Governance and risk management of banks e Commission proposal includes two amendments related to banks’ governance. e rst one concerns Article 74(1) CRD IV, which provides general principles of governance. One such principles commands banks to have ‘eﬀective processes to identify, manage, monitor and report the risks they are or might be exposed to’, to which the proposal would add ‘in the short, medium and long term time horizon, including environmental, social and governance risks’. A new, standalone Article 87a on the supervision of ESG risks goes further by commanding competent authorities to make sure that banks have, as part of their governance arrangements, ‘strate-

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

gies, policies, processes and systems for the identi cation, measurement, management and monitoring’ of ESG risks. In this respect, Article 87a(2) adds two precisions: that those governance arrangements be proportional to the scale, nature and complexity of ESG risks of the banks’ business model and activities; and that they consider a long-term horizon of ‘at least 10 years.’ Furthermore, EBA is mandated to issue guidelines to specify ‘minimum standards and reference methodologies for the identi cation, measurement, management and monitoring of environmental, social and governance risks’. In addition, the proposal amends the conditions that management should ful ll. Under these so-called t and proper criteria provided in Article 91 CRD IV, directors must be suﬃciently t and honest to take part in the management of banks. If amended, this provision would require their management body to have ‘collective knowledge, skills and experience to be able to adequately understand the institution's activities, as well as the associated risks it is exposed to, in the short, medium and long term, taking into account the environmental, social and governance factors.’ Banks should always ensure the respect of these criteria and, failing compliance, supervisory authorities may require changes in the composition of the management body. Other amendments focus more speci cally on banks’ risk management obligations. e Commission proposes to amend Article 73 CRD IV, which requires banks to assess and maintain enough capital on an ongoing basis to cover the risks to which they are exposed (also called Internal Capital Adequacy Assessment Process or ICAAP). e proposal would specify that ICAAP also covers risks to which banks are exposed ‘in the short, medium and long term time horizon, including environmental, social and governance risks.’ erefore, banks would have to retain capital against long-term risks, including ESG risks, but they would have to do it pursuant to their own assessment of risks to which they are exposed, not following a regulatory methodology. Indeed, capital requirements set in Pillar I are not amended by the Commission’s proposal, although the Commission would like to advance a study by EBA on the desirability of such changes to 2023. Yet, banks will for the rst time be placed under an unequivocal legal obligation to retain capital against risks that (notably) stem from climate change. In addition, banks would have to report to supervisory authorities on their exposures to ESG risks following an amendment to Article 430(1) CRR.

Banks will for the rst time be placed under an unequivocal legal obligation to retain capital against risks that (notably) stem from climate change

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Transition plans Yet, the most novel amendment consists in the addition of a subparagraph to Article 76(2) CRD IV on the treatment of risks: ‘Member States shall ensure that the management body develops speci c plans and quanti able targets to monitor and address the risks arising in the short, medium and long-term from the misalignment of the business model and strategy of the institutions, with the relevant Union policy objectives or broader transition trends towards a sustainable economy in relation to environmental, social and governance factors.’

ough formulated indirectly, banks would be required to monitor the alignment of their business model and strategy with EU’s policy objectives and the transition to a sustainable economy

ough formulated indirectly, banks would be required to monitor the alignment of their business model and strategy with EU’s policy objectives and the transition to a sustainable economy. is amendment would be completed by a requirement under Article 87a(3) CRD IV for supervisory authorities to assess and monitor those plans as part of developments of banks’ practices concerning their ESG strategy and risk management. e reform speci es that, in overseeing the implementation of this new provision, supervisory authorities should take into account a potpourri of current issues in sustainable nance, ‘sustainability related product oﬀering, transition nance policies, related loan origination policies, and environmental, social and governance related targets and limits.’ Also, Article 87a(5) mandates EBA to issue guidelines regarding the content of these plans, including ‘timelines and intermediate quanti able targets and milestones.’

In essence, the Commission proposes that banks design plans for the businesses to support the transition to a sustainable economy. is is remarkable, no less because the proposal a empts to dress as an issue of risks what is a ma er of public policy, directing enterprises to follow public policy objectives. e formulation somehow makes the requirement less stringent. Instead of straightforwardly requiring that banks design and implement plans to align their business model and strategy to the transition to a sustainable economy or to net-zero, this amendment requires banks to address risks from misalignment of their strategy with the transition. Such a formulation, hiding the true purpose of the provision, may produce unintended eﬀects, and be misinterpreted and misapplied. e risks targeted in this provision are speci ed: they would arise from the ‘misalignment’ of an institution’s business model and strategy with ‘with the relevant Union policy objectives or broader transition trends’. On the one hand, this amendment could be conceived as simply requiring banks to prepare against regulatory changes. However, identifying and managing regulatory risks is a standard practice of risk management and such an interpretation could open the door to a box-ticking exercise without guaranteeing fundamental changes in banks’ business models and strategies. On the other hand, a more careful reading of the amendment shows that it is not as-

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

king banks to prepare regulatory changes or even the transition to a sustainable economy, but to correct misalignment with objectives of public policy and socio-economic trends. In other words, to anticipate policy changes and trends, which makes the exercise prone to high legal uncertainty and run counter the freedom of enterprise. Furthermore, ‘the relevant Union policy objectives’, like the ‘broader transition trends to a sustainable economy’ are not de ned. Even related to ESG factors, the scope to consider is virtually unlimited. And it would leave a signi cant margin of discretion to Member States in transposing and implementing that provision. e Commission’s proposal a empts to address these issues by requiring EBA to issue guidelines on the content of those transition plans. at means entrusting the identi cation, de nition, and speci cation of ‘relevant Union policy objectives’ to an independent, technocratic agency with no involvement in policymaking outside the narrow eld of banking regulation and no power to do so under the Treaties or secondary law. Not only is there an obvious problem of legitimacy, but at a more basic level, such a provision could be deemed to be incompatible with the Treaties, which de ne what objectives the Union should pursue, and which institutions carry them out, interpret them and enforce them.

Supervision e Commission proposal sets the general framework of supervision of ESG risks in a new paragraph 9 to Article 98 CRD IV. Accordingly, the supervisory review and evaluation process would cover the governance and risk management process related to ESG risks as well as the assessment of exposures to ESG risks. is new paragraph would also specify that supervisory authorities take account of banks’ business models in their assessment. In addition to this general framework, the novel Article 87a CRD IV details some of the elements related to the supervision of ESG risks. Some of its features have already been discussed: the amendment speci es new expectations set by the reform for banks’ governance and transition plans from the perspective of supervisory authorities’ obligations. Article 87a also introduces a stress-testing requirement. Stress-testing amounts to assessing the resilience of banks to acute nancial risks. Concretely, Article 87a(3) would require supervisory authorities to ensure that banks test their capacity to resist long-term impacts of ESG factors ‘starting with climate-related factors.’ ese stress-testing exercises should include several scenarii ‘re ecting potential impacts of environmental and social changes and associated public policies on the long-term business environment.’ In this respect, a new Article 100(4) mandates all three European Supervisory Authorities (ESAs) to develop guidelines for the ‘consistency, long-term considerations and common standards for assessment methodologies’ of stress-testing exercises, again starting with climate-related factors. Regarding social and governance risks, the amendment merely mandates the ESAs to explore how these can be integrated into stress-testing. Furthermore, EBA is mandated to issue guidelines to ensure consistency in the application of the new framework. Speci cally, EBA should adopt guidelines regarding the criteria, both qualitative and quantitative, for assessing the impact of ESG risks on the nancial stability over the diﬀerent time horizons. Also, EBA is to set the precise criteria for stress-testing scenarii and methods. EBA would be further required to regularly update all gui-

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

delines mandated under Article 87a(5) in order to ‘re ect the progress made in measuring and managing [ESG] factors as well as the developments of policy objectives of the Union on sustainability.’ ese amendments echo the 2019 revision of the ESAs Regulations, which already enabled ESAs to consider “potential environmentalrelated systemic risk” in the measurement of systemic risk and related stress-testing exercises (18). Finally, a last amendment in Article 104 CRD IV entrusts supervisory authorities with the power to require banks to reduce the risks arising from the la er’s ‘misalignment with relevant policy objectives of the Union and broader transition trends relating to [ESG] factors over the short, medium and long term, including through adjustments to their business models, governance strategies and risk management.’ Although the wording of the proposal clearly echoes the amendment on transition plans, the power it entrusts is not limited to the control of transition plans. It would give supervisory authorities a wide margin of discretion to require adjustment for banks’ treatment of ESG factors.

Amending existing provisions Finally, the package revises provisions introduced in the CRD V/CRR II package and that relate to the other two pillars of EU banking law on capital requirements and disclosures. In 2019, Article 449a CRR was the only provision related to sustainable nance that introduced a binding requirement on banks. Accordingly, only large banks are required disclose information on ESG risks, rst in June 2022, and on a biannual basis a er the rst year. Interestingly, this provision referred to EBA’s Report for the de nition of ESG risks. e proposal of the Commission will subject all banks to the obligation to disclose information on ESG risks on a biannual basis, except for those which are quali ed as small and non-complex and that will need to disclose only information on their exposure to ESG risks on an annual basis. While Article 449a CRR currently does not specify what information must be disclosed, the amended version would grant a mandate to EBA to spell it out via an Implementing Technical Standard to be endorsed by the European Commission. Besides, the Commission proposal would advance by two years to June 2023 EBA’s mandate, provided under Article 501c CRR, to report on the desirability of introducing a dedicated ponderation of capital requirements based on sustainability factors. In other words, if EBA’s assessment is conclusive, the European Commission pledged to propose legislation that will, for instance, increase a bank’s capital reserves associated with investments that are exposed to climate change or conducive of climate change (Brown Penalizing Factor) or, conversely, reduce the reserves a bank has to retain for investments that contribute to mitigating climate change (Green Supporting Factor) (19). e amendment proposed that the Commission also speci es that EBA has to take into consideration the ‘short, medium and long-term eﬀects’ of such a change in the prudential treatment of assets under EU banking law.

18. Articles 23(1) and 32(2) ESAs Regulations as amended by Regulation (EU) 2019/2175. 19. See Alexander, ‘Stability and sustainability in banking reform: Are environmental risks missing in Basel III?’, UNEP-FI and University of Cambridge Institute for Sustainability Leadership, 2014.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

e signi cance of the reform e reform brings in ESG risks within the remit of existing requirements and sets a longer-term horizon for risk management. It is wide-ranging, covering not only strict aspects of risk management, but also tackles issues of governance and ensures a corresponding revision of provisions related to supervision. Furthermore, it integrates novel provisions, such as the one on transition plans. Yet, the reform does not consist in a systematic and granular rewriting of EU banking regulation but rather adds a sustainability perspective to some general requirements in order to ensure that ESG issues are captured by risk management and supervision. A common thread is the extension or, to be more exact, the speci cation by the reform of the term horizon that should be considered in risk management. ese amendments directly address what the former Governor of the Bank of England, Mark Carney, called the Tragedy of the Horizon (20). While climate change is predictable and irresistible, its catastrophic impacts will extend, and worsen, far beyond the business cycle, let alone the horizon of nancial markets. As Mark Carney then said (over six years ago), ‘once climate change becomes a de ning issue for nancial stability, it may already be too late.’ Responding to climate risks, thus, requires looking beyond the business-as-usual playbook. e enterprise of breaking the risks-horizon mismatch may be pursued by adopting a forward-looking approach to risk management and nancial supervision, while most approaches to risks, including those currently embedded in nancial regulation, are historical. If climate risks engender, in one way or another, a nancial crisis, one can only be sure that it will be very diﬀerent from any of the last crises. erefore, integrating a longer-term horizon in risk management is made necessary by the character of climate-related nancial risks. is speci cation is also important for supervisory authorities that may focus on short-term risks and dismiss climate risks as irrelevant because their full extent will only materialize in a distant future. Remarkably, the reform does not only consider climate change, but refers to ‘environmental, social and governance’ risks, factors or impacts. is wording ensures a more comprehensive and traditional conception of sustainability. Considering together the environment and the social is particularly relevant for the transition to a sustainable economy. Not only will the impacts of climate change be felt particularly harshly on poor populations, but mitigation and adaptation eﬀorts may also be felt disproportionately by some populations. e COP26 in Glasgow shed light on the need and challenges of a ‘Just Transition’ (21). e combination of these three dimensions of sustainability may therefore appear as justi ed and was, in any event, already apparent in the rst sustainable nance package. Nonetheless, especially when it comes to prudential regulation, such a large conceptualization may be eventually misguided. Firstly, ESG lacks a solid de nition. Although the Commission’s proposal includes de nitions for ESG risks and its components, most of them are tautological, by referring to ESG factors to de ne ESG risks. Only the notion of environmental risk is de ned with more precision, but to the sole extent that it refers to some objectives of environmental protection. A lack of solid de nition jeopardizes legal certainty. Secondly, the lack of

20. Mark Carney, ‘Breaking the Tragedy of the Horizon – climate change and nancial stability’, Speech at Lloyd’s of London, 29 September 2015. 21. Robins and Muller, ‘Lessons from COP26 for nancing the just transition’, December 2021.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Climate change is a pressing issue, generating irresistible and wide-ranging and yet uncertain risks for the society, the economy and the nancial system, which are aggravated by a business-as-usual approach.

hierarchization, or in other terms the undiﬀerentiation, between the diﬀerent elements of sustainability is highly problematic. In markets, this approach has allowed for greenwashing by branding as ESG improvements in governance or social divestments from tobacco or rearms that do not result in more environmental sustainability. In prudential regulation, this may result in complacency. Also, not all dimensions are equivalent. Climate change is a pressing issue, generating irresistible and wide-ranging and yet uncertain risks for the society, the economy and the nancial system, which are aggravated by a business-as-usual approach. e climate emergency is a scienti c reality that bears li le comparison with other issues. Besides, the necessity to prioritize environmental risks is evident from the very dra of the reform. While most requirements addressed to banks cover environmental, social, and governance risks, factors or impacts, the relative importance of climate change is clear when it comes to supervision. Amendments related to stress-testing expressly indicate that assessments of the resilience of banks to long-term impacts of ESG factors should be ‘starting with climate-related factors.’ For EBA’s mandate on stress-testing speci cally, the relevant recital indicates: ‘Environment-related risks, including risks stemming from environmental degradation and biodiversity loss, and climate-related risks in particular should take priority in light of their urgency and the particular relevance of scenario analysis and stress testing for their assessment.’ More generally, recitals of the Commission’s proposal call on supervision of risk management to be ‘giving priority to environmental factors’. EBA’s report on management and supervision of ESG risks also focused on risks stemming from the environment. While the Commission preferred to retain a large ESG-oriented scope for its reform proposal, the dra s expose the Commission’s lack of understanding regarding how the social and governance dimensions would be interpreted and applied. A similar issue arises from the quali cation of ESG not only in terms of risks, but also in terms of impacts, or factors. Interestingly, the amendments refer to factors, instead of risks, in relation to governance requirements, as well as for transition plans. is may be understood as conveying the double materiality perspective in the areas such as those where it is most relevant. Also, the stress-testing requirements do not speak of risks, but of impacts, which may also require banks and supervisory authorities to take account of risks to the climate and the environment, and not just risks that would directly bear on the nancial system. is would represent an overhaul of the

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

very understanding of stress-testing, which is supposed to assess the banks’ to acute nancial risks. Furthermore, the lack of de nitions and clarity in the dra ing may hamper the objective of ensuring a double materiality perspective and further allow complacency on the part of the banking system and supervision. e new provision on transition plans concentrates some of these problems and many others. Termed in risks, it has been modelled to t a framework of prudential regulation while capturing an (excessively) wide set of issues related to the transition. Yet, it is neither an odd, nor a bad idea to require transition plans from banks for the transition to a sustainable economy and, in particular, to a net-zero economy to which the Union is commi ed with the European Climate Law (22). Similar requirements are contemplated by the UK government and, in a milder form, in the Commission’s proposal on a Corporate Sustainability Reporting Directive (CSRD) (23). Transition plans are an instrument for making nancial ows consistent with climate resilience and the transition to a sustainable economy, which is one of the main objectives of the Paris Agreement. In this context, ‘bank-based intermediation will play a crucial role in nancing the transition to a more sustainable economy’ as the Commission stated in its proposal’s explanatory memorandum. In its current formulation, however, the amendment is both too complex and vague to be in any way eﬀective.

One cannot understand climate-related risks without considering that it is our present economic system that is forcing climate to change

It is not to say that transition plans do not contribute to risk management; they do. is requirement was called for by ECB’s Vice-Chair of the Supervisory Board, Frank Elderson because they directly relate to risk management capabilities and strategies (24). It is further justi ed by the double materiality perspective. One cannot understand climate-related risks without considering that it is our present economic system that is forcing climate to change, GHG emissions to rise, biodiversity to erode. In other words, the nancial system’s focus on shortterm pro ts and disregard of the environmental impacts of investments contributes to pu ing the future of humanity in jeopardy. Prudential regulation has a role to play in this respect, as Mark Carney rightly articulated in his speech on the Tragedy of the Horizon. It is the role of prudential regulation to take preventive action against the materialization of climate-related nancial risks that could become systemic, not wait until these risks are signi cant enough and that regulators are le empty-handed to address them. Transition plans, among other instruments, play a role in mitigating climate-related nancial risks upstream. 22. Regulation (EU) 2021/1119 of 30 June 2021 establishing the framework for achieving climate neutrality, OJ 2021 L 243, p. 1. 23. COM(2021) 189 nal; HM Government, ‘Greening Finance: A Roadmap to Sustainable Investing’, October 2021, p. 16. 24. Frank Elderson, ‘Overcoming the tragedy of the horizon: requiring banks to translate 2050 targets into milestones’, Speech at the at the Financial Market Authority’s Supervisory Conference, Vienna (Austria), 20 October 2021.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Blind spots

While wide-ranging, the banking reform falls short of a sweeping and comprehensive review of banking regulation

While wide-ranging, the banking reform falls short of a sweeping and comprehensive review of banking regulation. Even within the remit of Pillar II, some general principles of risk management are le untouched. Given that existing law is formulated in terms general enough to capture a wide array of risks, the absence of revision of some provisions should be unproblematic. However, leaving some blind spots stands in contradiction with the reform’s rationale put forward by the Commission: to provide speci c incentives for a systematic and consistent management of these risks. Remuneration policies is a good example in this respect. Sound remuneration policies are de ned by reference to a list of issues in relation to which banks are required to report. None of these issues currently relate to ESG, the environment or climate change. e reform could have been the opportunity to include the la er, especially since the integration of ESG risks in remuneration policies has been recommended not only by EBA, but also by the Basel Commi ee and, in the United States, by the OCC.

e standalone addition of Article 87a in the CRD IV’s section on the organization and treatment of risks is also unse ling, as it could be seen as creating a new category of risks, ESG risks, distinct from those already captured by prudential regulation. While it would ensure a general integration of ESG risks in risk management, it could also hinder a more granular incorporation of ESG factors in the identi cation, monitoring and management of nancial risks such as credit risk, market risk, operational risk, and liquidity risk. For instance, the reform is silent on issues related to liquidity, despite the speci c challenges of the interaction between liquidity risk and ESG risks. Again, EBA, like the Basel Commi ee and the OCC in the U.S., have clearly proposed to consider climate change in the management of liquidity risk. Also absent of the reform is the review of macro-prudential instruments. By contrast with prudential regulation which focuses on the safety and soundness of individual banks, macro-prudential policy aims to safeguard nancial stability at the nancial system level. Macro-prudential supervision is particularly adequate to the systemic nature of climate-related risks (25), which has already been recognized in the 2019 ESAs Regulations review (26). Yet, its absence from the reform is not surprising, given that it is governed by a dedicated (and weak) framework under EU law, for which a revision is also expected (27). Nonetheless, the CRD IV/CRR package provides for capital buﬀers, allowing supervisory authorities to request banks to keep additional reserves to insure against a dis-

25. Seraina N. Grünewald, ‘Climate change as a systemic risk – Are macroprudential authorities up to the task?’, EBI Working Paper No. 62, 2020. 26. Regulation (EU) 2019/2175 of 18 December 2019, OJ 2019 L 334, p. 1. 27. European Commission, ‘Targeted Consultation on Improving the EU’s Macroprudential Framework for the Banking Sector’, 30 November 2021.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

ruption in nancial markets. is is notably the case of the systemic risk buffer of Article 133 CRD IV and the countercyclical capital buffer of Articles 135 et seq. CRD IV. Interestingly, the recitals of the Commission’s proposal mention Article 133 CRD IV: ‘To the extent that the relevant competent [authorities] (…) consider that risks related to climate change have the potential to have serious negative consequences for the nancial system and the real economy in Member States, they should introduce a systemic risk buffer rate for those risks where they consider the introduction of such rate effective and proportionate to mitigate those risks.’ Yet, the Commission’s proposal includes no amendment of Article 133 CRD IV. It is not clear why the provision is le untouched if the Commission feels that it is an important precision.

Concluding remarks e Commission’s proposal for a banking reform represents a major step forward for the integration of environmental considerations in risk management. While existing law could have been deemed suﬃcient for tackling climate-related risks, the reform would not only provide an express legislative mandate but also incorporates a double materiality perspective in the management and supervision of those risks. It clari es the obligations of both banks and supervisory authorities. Moreover, the Commission’s dra s remarkably propose extending the horizon of supervision to break the Tragedy of the Horizon in banking risk management. e reform would further support the Paris Agreement’s objective of alignment nancial ows with the transition to a climate-resilient economy. However, the amendments put forward by the Commission are certainly not awless. While wide-ranging, they are not comprehensive. While adopting an inclusive understanding of sustainability, they are inadequate to the climate emergency. While incorporating a double materiality perspective, their formulation is too complex to deliver. While walking a tightrope with its reform, the Commission may be hindering the objectives it pursues. Like for the rst sustainable nance package, the legislative process will hopefully correct some of these aws, bring the reform back in line with developing international standards and expand further its scope.

While walking a tightrope with its reform, the Commission may be hindering the objectives it pursues

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

News Highlights 17 to 21 January 2022

Référendaire position available at the cabinet of David Petrlík at General Court

Commission’s decisions in ethanol market cartel case challenged before the General Court

Monday 17 January

READ MORE ON EU LAW LIVE

Judge David Petrlík at the General Court (Luxembourg) is seeking a candidate for the position of legal secretary (référendaire). e deadline for applications is 31 January 2022.

An action lodged by Alcogroup and Alcodis against Commission’s decisions adopted in antitrust case AT.40054 — Ethanol Benchmarks was published in the Oﬃcial Journal (T740/21).

General Court to hear action for annulment against Combined Nomenclature classi cation for disregarding concept of disability

Position for Spanish lawyer available at Court of Justice

Monday 17 January

READ MORE ON EU LAW LIVE

e General Court will hear an action for annulment against Commission Implementing Regulation 2021/1367, concerning the classi cation of certain goods in the Combined Nomenclature (T-721/21).

Monday 17 January

READ MORE ON EU LAW LIVE

e Court of Justice is seeking to recruit a temporary agent with Spanish legal background to perform the duties of administrator in its Research and Documentation Directorate.

Authorisation to Poland to prohibit marketing of cannabis variety challenged before General Court

ECtHR clari es safeguards applicable to criminal convictions based on wri en statements of absent witnesses

Monday 17 January

READ MORE ON EU LAW LIVE

In Callaway v Commission (T-653/21), the General Court will hear an action for annulment against Commission Implementing Decision 2021/1214, which authorised Poland to prohibit the marketing on its territory of the hemp variety Finola.

READ MORE ON EU LAW LIVE

e European Court of Human Rights ruled in Faysal Pamuk v Turkey that the way in which evidence of absent witnesses was used at a terrorism trial in Turkey was in breach of the right to a fair trial and to obtain a endance and examination of witnesses.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

National courts not required to disapply incompatible legislation lacking horizontal direct eﬀect: Court of Justice judgment Tuesday 17 January

READ MORE ON EU LAW LIVE

e Court of Justice ruled in elen Technopark Berlin (C261/20) that a national court, when hearing a dispute between private individuals, is not required, solely on the basis of EU law, to disapply that German legislation incompatible with the Services Directive.

Court of Justice: principle of proportionality must be preserved when assurance of naturalisation is revoked and applicant loses EU citizenship Tuesday 17 January

READ MORE ON EU LAW LIVE

e Court of Justice ruled in Wiener Landesregierung (C118/20) that Member States must respect the principle of proportionality when revoking the assurance of granting their nationality when such revocation results in a permanent loss of the applicant’s EU citizenship.

Decision laying down rules for restricting data subjects’ published Tuesday 17 January

READ MORE ON EU LAW LIVE

e decision of the Secretary-General of the Council laying down implementing rules concerning restriction of data subjects’ rights for the purpose of administrative investigations, disciplinary and court proceedings was published in the Oﬃcial Journal.

New President and Board of Appeal Alternate Chairperson of CPVO: decisions published Wednesday 19 January

READ MORE ON EU LAW LIVE

Oﬃcial publication was made of two decisions of the Council on the appointment of the President the alternate to the Chairperson of the Board of Appeal of the Community Plant Variety Oﬃce.

Commission adopts initiatives to strengthen eﬀective higher education cooperation for greener and more resilient Europe

General Court dismisses appeal against Commission decision holding Greek casino scheme compatible with State aid rules

Wednesday 19 January

READ MORE ON EU LAW LIVE

e European Commission adopted two initiatives to strengthen the role of universities in making the EU greener and more digital, namely, a European strategy for universities and a proposal on building bridges for eﬀective European higher education cooperation.

READ MORE ON EU LAW LIVE

In Koinopraxia Touristiki Loutrakiou v Commission (T757/18), the General Court dismissed an action lodged against the Commission decision in case SA.28973, declaring a system of levies on admissions to casinos in Greece compatible with EU State aid rules.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

General Court awards compensation for Commission’s refusal to pay default interest over an annulled ne Wednesday 19 January

READ MORE ON EU LAW LIVE

Court of Justice: Greece is ordered to pay nancial penalties for its failure to recover State aid granted to Larco ursday 20 January

READ MORE ON EU LAW LIVE

e General Court partially upheld an action for annulment brought by Deutsche Telekom against the European Commission refusal to pay default interest of a ne in its judgment in Deutsche Telekom v Commission (T-610/19)/

In Commission v Grèce (C-51/20), the Court of Justice ordered Greece to pay a lump sum of 5.5 million euros and periodic penalty payments of over 4 million euros for every six months’ delay for failure to recover State aid granted to Larco and comply with the Court of Justice’s judgment of 2017.

Court of Justice upholds Commission Decision registering the citizen’s initiative ‘Minority SafePack’

Lu hansa’s appeal against Commission Decision declaring German aid to airports compatible with internal market dismissed by the Court of Justice

ursday 20 January

READ MORE ON EU LAW LIVE

e Court of Justice con rmed the decision of the Commission to register the proposed European citizens’ initiative “Minority SafePack — one million signatures for diversity in Europe” in its judgment in Romania v Commission (C-899/19 P).

AG Collins: EU law precludes national courts from not having jurisdiction to examine conformity with EU law of national provision deemed constitutional ursday 20 January

READ MORE ON EU LAW LIVE

Advocate General Collins in his Opinion in RS (Eﬀet des arrêts d’une juridiction constitutionnelle) (C-430/21), found that the principle of the independence of the judiciary precludes national courts from being prohibited to examine the conformity with EU law of national law that the constitutional court of the Member State has found to be constitutional.

ursday 20 January

READ MORE ON EU LAW LIVE

e Court of Justice ruled in Deutsche Lu hansa v Commission (C-594/19 P) that Lu hansa has no legal standing to challenge Commission Decision nding German state aid to airports compatible with the internal market (SA.32833).

Commission preliminarily concludes Hungary breached EU Merger rules by vetoing acquisition of AEGON’s subsidiaries by VIG ursday 20 January

READ MORE ON EU LAW LIVE

Following an investigation opened in October 2021, the European Commission has now issued its preliminary conclusion that Hungary’s decision to veto the acquisition of the Hungarian subsidiaries of the AEGON Group by Vienna Insurance Group AG constitutes a breach of the EU Merger Regulation.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Court of Justice quashes General Court judgment and upholds Commission’s appeal in Hubei Xinyegang Special Tube ursday 20 January

READ MORE ON EU LAW LIVE

In Commission v Hubei Xinyegang Special Tube (C-891/19 P), the Court of Justice upheld an appeal of the Commission and annulled a judgment of the General Court by which Commission Implementing Regulation 2017/804 imposing an anti-dumping duty on certain types of pipes and tubes originating in China was annulled.

AG Pitruzzella con rms validity of public access regime to information on bene cial owners of companies under AML Directive Friday 21 January

READ MORE ON EU LAW LIVE

Advocate General Pitruzzella concluded in his Opinion in WM v Luxembourg Business Registers (C-37/20) that granting public access to information about bene cial ownership of the companies is justi able but that Member States must limit the disclosure if it can result in disproportionate interference with the bene cial owner’s fundamental rights.

AG Richard de la Tour: Austrian legislation on family bene ts for crossborder families violates principle of equal treatment Friday 21 January

READ MORE ON EU LAW LIVE

Advocate General Richard de la Tour concluded in Commission v Austria (C-328/20) that Austrian legislation on the adjustment of the amount of family bene ts and social and tax advantages for persons working in Austria whose children reside in another Member State is contrary to the principle of equal treatment.

Position of Legal and Data Protection Oﬃcer available at BEREC Friday 21 January

READ MORE ON EU LAW LIVE

e Agency for Support for the Body of European Regulators for Electronic Communications is seeking applicants for the post of Legal and Data Protection Oﬃcer at its headquarters in Latvia.

Court of Justice to interpret the Citizens’ Rights Directive Friday 21 January

READ MORE ON EU LAW LIVE

Oﬃcial publication was made of the request for a preliminary ruling in K.R (C-637/21), concerning the criteria that interrupt the period of absence for the purpose of maintaining a permanent residence in the EU.

EU challenges Russian export restrictions on wood before WTO Friday 21 January

READ MORE ON EU LAW LIVE

e EU requested consultations with Russia before the World Trade Organization concerning its export restrictions on wood products, marking a rst formal step in order to challenge the restrictions according to the WTO procedure.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Insights, Analyses & Op-Eds Between Autonomy and Respect for National Prerogatives: Another Brick in the Case Law on the Ne Bis in Idem Principle in EU Law by Lorenzo Cecche i

READ MORE ON EU LAW LIVE

Op-Ed on the Court of Justice’s judgment in AB and Others (Revocation of an amnesty) (C-203/20), which found that the ne bis in idem principle does not preclude the issue of an European Arrest Warrant when the criminal proceeding is terminated by a nal decision (based on an amnesty) and then resumed (following the revocation of such amnesty).

e Concept of Flight ‘Cancellation’ Under Regulation 261/2004 by Sara Drake

READ MORE ON EU LAW LIVE

Op-Ed concerning the two recent judgments in Corendon Airlines (C-395/20) and Airhelp Ltd (C-263/20) in which the Court of Justice interpreted the concept of ight ‘cancellation’ and the rights and obligations which it may trigger under the Air Passanger Regulation.

e Green Architecture of the New Common Agricultural Policy: A Tale of Two and a Half Environmental Measures and a Lost Opportunity

No standing for Banco Popular shareholders to challenge SRB decision not to carry out ex post de nitive valuation a er sale of business

by Erriketi Tla da Silva

by Laura Wissink

READ MORE ON EU LAW LIVE

Op-Ed analyzing the new Strategic Plans Regulation for the Common Agricultural Policy, aiming to mitigate climate change, foster sustainable development and reverse biodiversity loss by introducing a new Green Architecture.

READ MORE ON EU LAW LIVE

Analysis of the Court of Justice’s dismissing the appeals brought against the General Court’s order to dismiss their action for annulment of the alleged refusal of the Single Resolution Board to carry out an ex post de nitive valuation of Banco Popular.

A New Approach to Market Freedom’s Restrictions? Tax Advantages for Closedended Investment Funds and the Free Movement of Capital by Stefano Dorigo and Chiara Cino i

READ MORE ON EU LAW LIVE

Op-Ed analysing the recent judgment of the Court of Justice in UBS Real Estate (joined cases C-478/19 and C-479/19), concerning the compatibility with EU law of Italian law that grants a reduction of certain tax to closed-ended investment funds, and the justi cation against restrictive tax measures that is admi ed.

Nº86 · JANUARY 22, 2022

Weekend

Edition stay alert keep smart

Library - Book Review

By Pascale Dufour READ ON EU LAW LIVE

Alessandra Donati Le principe de précaution en droit de l’Union européenne e book oﬀers a comprehensive study of the precautionary principle in EU law and provides a ‘map’ of the many components of the precautionary principle. For decision makers, regulators, academics, lawyers as well as scienti c experts, and even the interested public, this is a thoroughly researched yet accessible book that illustrates how law’s function can and could evolve through new principles, in embracing the growing complexity of our society.