CRD VI Directive sets out further requirements regarding credit institutions’ practices for managing ESG risks by adjusting their business strategies, governance framework and risk management.
On July 9, 2024, the new Capital Requirement Directive 2024/1619 of the European Parliament and of the Council of May 31, 2024, amending Directive 2013/36 as regards supervisory powers, sanctions, third-country branches and environmental, social and governance risks (CRD VI or the Directive), pursuing the implementation of Basel III in the European Union (EU), entered in force. Member States are required to implement the Directive by January 10, 2026 with, for the most part, a date of application set as from January 11, 2026.
The overarching objective of the Directive is to further the harmonization of the banking supervisory framework and ultimately deepen the internal market for banking. Several measures are set out under the Directive to reach that objective, including rules on internal governance, members of governance bodies, third-country branches (Third country branches regime under the CRD 6 ), etc.
Furthermore, the Directive has an impact on banks’ practices in managing their environmental, social and governance risks (ESG risks). The financial system has a role to play in supporting the transition towards a sustainable, climate-neutral and circular economy and to facilitate the achievement of climate neutrality by 2050.
Thus, the Directive requires credit institutions to be able to identify, measure and manage ESG risks by establishing robust governance arrangements and internal processes (I). In addition, the Directive strengthens the powers of competent authorities with regards to the prudential assessment and control of credit institutions’ management of ESG risks (II).
I. Integration of ESG risks into internal governance arrangements
CRD VI requires credit institutions to establish effective processes to identify, measure, manage and monitor the current, short, medium and long-term impacts of ESG factors (the ESG factors). Priority must be given to climate-related risks and risks from environmental degradation and biodiversity loss which the Directive identifies as the most pressing issues. Processes shall include stress testing whereby credit institutions must test their resilience to negative impact of ESG risks, under both baseline and adverse scenarios within a specified timeframe. These scenarios include:
- ESG scenarios which reflect the potential impact of environmental and social pressures and related public policies on the long-term business environment;
- credible scenarios inspired by scenarios elaborated by international organizations.
Strategies and policies for taking up, managing, monitoring and mitigating the credit institutions’ exposures including those arising from ESG risks must be approved by the management body and reviewed at least every two years.
Credit institutions are also required to develop and monitor a specific plan including quantifiable targets and processes to monitor and address the financial risks arising from ESG factors (the specific plan). This plan must take into account the risks arising from the transition to the full application of the regulatory objectives and legal acts introduced by the European Union and Member States in relation to ESG factors, in particular the objective of achieving climate neutrality.
In order to ensure the convergence across the EU and to harmonize the understanding of ESG risks, the European Banking Authority (EBA) should be empowered to establish a minimum set of reference methodologies for assessing the impact of ESG risks on financial stability. The EBA will need to develop common criteria for the content of the plans to address those risks and the application of stress testing methods and the setting of scenarios.
II. Prudential assessment and control of ESG risk management
The Directive empowers competent authorities to monitor and control the development of credit institutions’ practices in relation to their ESG strategies and risk management as well as of the credit institutions’ exposures to ESG risks, including the robustness of the specific plan. This assessment will take into account;
- the credit institutions’ sustainability-related product offerings;
- their transition finance policies;
- their related loan origination policies; and
- their ESG-related targets and limits.
In addition, CRD VI provides that competent authorities must (i) ensure that credit institutions have robust strategies, policies, processes and systems for the identification, measurement and management of ESG risks, and (ii) verify that credit institutions properly test their resilience to long-term adverse impacts of ESG factors, in particular climatic factors, by using enough ESG scenarios and credible scenarios.
The Directive also empowers competent authorities to require banks to reduce the impact of ESG factors by adjusting their business strategies, governance framework and risk management for which a strengthening of the objective, measures and actions of the specific plan could be required.
Contacts: Aurélia Viémont is a partner in the Banking & Finance team. Mélanie Poirrier and Sarah Hantscher are senior associates and Delia Nesbitt is an associate in CMS Luxembourg Banking & Finance, Regulatory and Insurance practices. Anne Picot-Guillot is a senior knowledge officer in CMS Luxembourg Banking & Finance practice. Anna Savary, CMS Luxembourg.
