The industry has been divided on the Green Supporting Factor. For that reason, we have spent many hours in discussing with experts from different areas of banks the necessary adjustments to the Green Supporting Factor that will address the criticism, mainly its lack of risk sensitiveness, distorting the link between risk and capital and resulting financial stability concerns as well as its objectivity. Indeed, not everything what is green is less risky.
As a result of that, we are proposing a Sustainable Finance Supporting Factor as an interim measure. Pending the development of the methodologies for the incorporation of the ESG factors into supervisory framework, we suggest that EBA explores the possibility of introducing a supporting factor for certain assets that are classified as sustainable under the EU taxonomy and at the same time show a lower financial risk because of their sustainability profile.
Summary of the main SFSF features
• Limited scope – application to eligible Sustainable Sectors / Activities/Projects (SSAP) with reduced financial risk identified by the EBA.
• Risk sensitivity: the eligible SSAP – with reduced financial risk assessed by forward-looking approaches – could be clustered into a number of eligible sustainable asset classes (ESAC) under the prudential regime (e.g. green mortgages, energy efficiency device production, circular economy projects, etc.).
• Objectivity – scope defined by the EBA.
• Level playing field – the SFSF would apply to both standard and IRB / IRBA approaches.
• Not replacing risk management – the application of the SFSF would not exempt the banks from the prior creditworthiness analysis. The SFSF would apply only after calculating own funds requirements as usual. The SFSF would be applied as a “discount at checkout”, similar to the SME Supporting Factor.
• Relatively easy implementation based on information provided by third parties in terms of simple codes of eligible SSAP or ESAC.
• Evaluation after 3 years.
• Bank X has 100 potential credit deals.
• Following creditworthiness analysis, 90 are approved and become exposures.
• Under existing prudential regulation, 90 RWAs are being computed.
• Out of 90, 30 exposures are considered sustainable according to the EU taxonomy defined by the Technical Expert Group (TEG).
• Out of 30, 10 will be eligible following the EBA classification (meaning these have a lower sustainability-related financial risk). The bank will only check which out of 30 exposures belong to the eligible SSAP or ESAC as disclosed by the EBA.
• Banks will apply SFSF on the 10 RWA linked to the eligible SSAP or ESAC.
• This applies both to STA and IRB/A-IRB approaches but once banks applying IRB/IRBA approach will have embedded the sustainability profile in their validated internal rating model, the SFSF can no longer be used.