5.4.1 Controlled business operations

Financial institutions, like banks, insurance companies, asset managers and investment firms, should ensure a controlled and sound conduct of their company’s businesses. These requirements are laid down in the Wft and relevant orders in council.1 It follows from these provisions that a financial institution should analyze the risks its company is exposed to, and take measures to mitigate these risks.

Climate-related risks are not, in so many words, specifically referred to in these regulations. However, climate-related risks can be regarded as part of e.g. credit risks, market risks and operational risks (see paragraph 5.2). Financial institutions can therefore be expected to develop a thorough understanding of the climate-related risks that are relevant to their balance sheets.2 This risk perception must be followed by policy principles, stating how the company intends to manage its risk exposure. The risk management policy must then be recorded in the form of procedures and measures, tuned to the nature, size, risk profile and the complexity of the company’s activities. Of course, the company should follow these procedures and measures in its day-to-day decision processes and business operations.

As is shown in the DNB-reports Waterproof and Time for Transition,3 financial institutions increasingly pay attention to climate-related risks (for example, insurers pay substantial attention to physical risks), but there is still substantial room for improvement. Both physical risks and transition risks are, generally speaking, not appropriately identified and therefor likely to be underestimated and insufficiently controlled.4

This is, for example, the case with the assessment and control of the risks of write-downs of loans and investments in companies with carbon- intensive production processes, as well as real estate exposures.5 DNB urges financial institutions to focus more on these risks and further develop forward-looking risk management methods. Financial institutions can also make better use of relevant available data in assessing risks, including by having an overview of the energy labels of their real estate exposures. Also, financial institutions can be expected to demonstrate that they have a clear view on the viability of their business model in a two degree Celsius temperature rise- scenario.6

It is noted, however, that financial institutions face many uncertainties that may hamper an adequate assessment of climate-related risks (see also paragraph 5.2).

Even the concept of “sustainability” itself is unclear. As for now, there is no shared understanding of what “sustainable” actually means, and it is not always clear which investments can be considered sustainable and which can not. Also, sustainability may encompass many different aspects, including human rights, social inequality, labour relations and governance aspects like executive remuneration. In this respect, the Commission proposal to develop a unified classification system for sustainable activities (a taxonomy) as mentioned in paragraph 5.2.2, will prove extremely helpful. The Commission will start with a taxonomy on climate change mitigation and adaptation and environmental objectives. This kind of guidance, as well as the introduction of EU suitability benchmarks and stricter rules on transparency (see paragraph 5.2.2 and 5.4.3), will enable financial institutions to take “true” sustainable investment decisions.

Also, the Commission intends to clarify how asset managers, insurance companies, and investment or insurance advisors should integrate sustainability risks in the areas of organizational requirements, operating conditions, risk management and target market assessment.7 EIOPA and ESMA have recently been requested to supply technical advices.8

In the light of the existing uncertainties, supervisory practices may well consist of informal supervision, like information sharing and providing general guidance about how to integrate climate and environmental factors into risk management processes. However, when there is specific cause for concern, supervisors may enter into a supervisory dialogue with individual institutions to ensure that the relevant steps are taken towards compliance. In severe situations, the use of enforcement measures could be considered.