CBC Governor calls for assertive action on ESG issues to protect the economy

Noting that Environmental, Social and Governance (ESG) risk has been prominent for a long time now, Constantinos Herodotou, Governor, Central Bank of Cyprus (CBC) has called for stakeholders to take assertive action.

“The risks associated to ESG go beyond changing the risk profile for the banking and financial sectors,” he noted, speaking on the subject at a recent event.

More specifically, Herodotou said the global ambition to meet the Paris Agreement goals should be stepped up; the rate of change towards a net-zero economy should be accelerated; and all stakeholders play a key role in driving the world towards net-zero carbon emissions. “Otherwise, the costs to society over the longer term will be severe,” the Central Bank Governor warned.

Herodotou also noted that climate change was no longer a problem of the future, but of the present. “Global warming and extreme weather events are now part of our current reality, the impacts of which are no longer hypothetical. Acute and chronic physical events, the need to transition to a low carbon economy, the need for a more resource efficient and sustainable economy, as well as the impact from other environmental challenges, are leading to, and will continue to cause, profound economic transformations that will impact the financial sector,” he said.

As noted by Herodotou, climate risk poses a significant challenge for the banking sector. “This is through both physical risks and transition risks,” he elaborated, noting, “Physical risks typically emanate from extreme weather events, such as wildfires and floods, which could damage physical assets, thereby affecting financial exposures such as collateral values. Transition risks typically refer to financial losses that can result from the process of adjustment towards a lower carbon and a more environmentally sustainable economy. The latter may increase the credit risk of both corporates and households.”

This, the Central Bank Governor suggested, meant banks should step up their efforts to embed climate risk into their risk management practices and policies, analyse and segment their portfolios, understand their customers’ transition strategies and collect climate related information on collaterals. “A lot needs to be done. It is evident from the European Central Bank (ECB) top down climate stress test that acting earlier is expected to be significantly less costly than acting later,” Herodotou said.

In addition, the banks should be mindful to retain their access to the capital markets at a reasonable cost, he suggested. “The recent tendency of investors towards investing in green bonds has made it evident that banks need to keep up with their peers and meet specific requirements. In this respect, we look forward to the implementation of the new regulation to establish an official European Union (EU) standard for European Green Bonds, based on the EU Taxonomy, that is the classification of the sustainability criteria. At the same time practices providing misleading information on their green actions, known as greenwashing, should be guarded against and avoided. The ability to provide adequate disclosures to the market, in order to fairly price bank issuances, is evident.”

In order to achieve this, Herodotou suggested advised, banks across Europe have a lot of work to do in terms of data collection. “Data availability and quality are one of the key challenges for banks in their green transition. This has been evident and specifically pointed out in all the exercises carried out by the Single Supervisory Mechanism (SSM) so far,” he noted.