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2. Sustainability
Climate change and the environment, social issues and good corporate governance – these issues can also result in risks for companies in the financial sector and for consumers.1
As it becomes increasingly uncertain that the objectives of the Paris Agreement will be met, climate-related financial risks are growing, particularly risks associated with the physical impacts of climate change such as extreme weather events. These risks can impact the loans granted by supervised companies, as well as insured losses and whether or not certain risks can be insured at all.
Transition risks arise when markets underestimate sudden price corrections. These risks depend, for example, on technological developments or on changes in consumer behaviour. The level of political ambition and the implementation of appropriate climate policy measures are key factors here. In a disorderly scenario where effective measures are taken at a later stage but under even greater pressure, transition risks would be particularly high.
BaFin does not treat climate and environmental risks as a new type of risk, but rather as risk drivers in line with established risk categories: credit risk, market risk, liquidity risk, operational risk, including liability and reputational risks, underwriting risk and strategic risk.
Sustainability and dynamic supervisory law
The EU’s goal is to make Europe the first climate-neutral continent by 2050. By 2030, Europe’s net greenhouse gas emissions are to be reduced by 55% compared with levels in 1990. The European Commission has introduced extensive legislative packages in order to implement this “green deal”. Many standards also impact the financial industry. One example is the Sustainable Finance Disclosure Regulation (SFDR). Since its entry into force in March 2021, the SFDR has set out the sustainability-related disclosure requirements for financial market participants and financial advisors. It is intended to ensure that, with regard to financial products that reference sustainability, investors can base their investment decisions on well-founded information. Currently, the extensive disclosure requirements under the SFDR leave room for various interpretations. The Commission launched a consultation in November 2023 to evaluate experience with the SFDR so far and to adapt the regulation as appropriate.
The Capital Adequacy Regulation and Directive, the Taxonomy Directive, the Corporate Sustainability Reporting Directive (CSRD) and the Benchmarks Regulation contain additional new requirements for the financial sector. Further regulatory projects have been planned or will enter into force in the near future. The EU Green Bond Regulation, for example, has introduced a new format that will apply from December 2024: EU Green Bonds.
The complexity of regulation in the area of sustainability, which is in part fragmented and lacking consistency, increasingly carries the risk that financial market players will not comply with regulatory standards, or will not comply in full. As a result, supervised companies may breach requirements and suffer reputational damage as a consequence.
Improvement needed in banks’ and insurers’ risk management
BaFin has found that German banks still need to make improvements in their management of sustainability risks. A structured survey conducted by the Deutsche Bundesbank from February 2022 to March 2023 showed that 80% of LSIs take account of climate-related and environmental risks and monitor their physical and transition risks; 70% take sustainability into account in their business and risk strategy. Furthermore, a quarter of these institutions consider sustainability risks to be a major factor in at least one of the established risks categories. However, only a minority have methods to assess, measure and control sustainability risks. The majority did not include findings from stress tests and scenario analyses in their strategic planning or risk management systems. The use of sustainability ratings is also not yet widespread.
In BaFin’s estimation, insurance companies have made advances in the way they deal with sustainability risks. However, there is room for improvement in almost all areas, particularly risk management, stress testing and the consistent application of sustainability strategies within company groups.
Greenwashing: risks for investors
Greenwashing also entails risks. Greenwashing describes the practice of presenting information on sustainability that does not clearly and fairly reflect the sustainability profile of a company, a financial product or a financial service. Greenwashing can mislead institutional investors as well as retail clients (private customers and small and medium-sized enterprises). The risk of greenwashing is high because there is no clear definition of sustainability characteristics. Furthermore, the information published regarding the environmental impact of products and services is often not easy enough to understand. Greenwashing damages trust in a functioning market.
BaFin's line of approach
- In the 7th amendment to the MaRisk published on 29 June 2023, BaFin turned the expectations it had previously set out in the non-binding Guidance Notice on Dealing with Sustainability Risks into binding requirements. This provides the groundwork for BaFin to take sustainability considerations into account in the Supervisory Review and Evaluation Process (SREP) in future.
- BaFin will publish its expectations for insurers’ approach to sustainability risks. It is planning to amend the Minimum Requirements under Supervisory Law on the System of Governance of Insurance Undertakings (MaGO) for Solvency II companies and to publish a guidance notice on the principle of corporate prudence that will explicitly detail the issue of sustainability.
- BaFin will address the issue of ESG risks in its supervisory interviews with selected institutions. In 2024, it will also carry out special inspections with a focus on ESG/sustainability.
- BaFin is testing at random how supervised companies implement the disclosure requirements under the SFDR and whether their marketing communications contradict the disclosed information. With its administrative practice, BaFin continues to contribute towards ensuring that German retail funds are not termed sustainable if their fund rules do not fulfil certain minimum requirements.
- BaFin assesses, using a heatmap, how supervised companies with a high level of exposure in various sectors are dealing with the financial consequences of climate risks. These findings are to be integrated into BaFin’s supervisory activities.
- BaFin is establishing additional competencies and resources in order to assess whether the companies subject to financial reporting are adhering to the new rules on sustainability reporting under the Corporate Sustainability Reporting Directive (CSRD).
- BaFin participates in consultations on the SFDR review by the European Commission. It contributes its standpoint to the review process via the relevant European working groups and discussion platforms.
- BaFin is developing a supervisory concept to implement the Green Bonds Regulation in order to review whether issuers correctly publish the required information when using the voluntary EU Green Bond Standard.
- 1 The discussion of this trend is focussed on environmental issues because, in BaFin’s view, this currently poses the greatest risk to companies in the financial sector and because regulation is currently also focussed on this topic.
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Risks in BaFin's Focus 2024
Foreword by the President
Main Riks of BaFin
1. Risks arising from significant increases in interest rates
2. Risks arising from corrections on the real estate markets
3. Risks arising from significant corrections on the international financial markets
4. Risks arising from defaults on loans to German companies
5. Risks arising from cyberattacks with serious consequences
6. Risks arising from inadequate money laundering prevention
7. Risks arising from market concentration due to the outsourcing of IT services
Trends
1. Digitalisation
3. Geopolitical turmoil
