On 15 May 2024, the Governor of the Central Bank of Ireland (“Central Bank”), Gabrial Makhlouf gave a speech at the Annual Conference of the Environmental Protection Agency (“EPA”) entitled “Climate change: adapting to avoid the prisoner’s emissions dilemma”. Governor Makhlouf stressed that climate change is affecting both the economy and the capacity of central banks to meet their objectives of maintaining price and financial stability. In addition, he noted that climate change was one of the three significant economic transitions that are happening, alongside digitalisation and demography. While Governor Makhlouf identified the significant risks of climate change, he also acknowledged the potential for economic benefits for Ireland and noted that in the last decade €65billlion has left Ireland via energy imports, and that by 2050, Ireland will have the potential to be a major renewable electricity exporter.

Key Risks to the financial system

Governor Makhlouf noted that a major event such as flooding can have significant impacts across multiple sectors, such as insurance coverage, loan repayments, and the impact on loans secured by collateral that has been impacted. The transitional risks of decarbonisation will also have a negative effect on business costs and revenue. He noted that these risks will not be evenly spread and that while highly intensive sectors will need to make dramatic changes to their business models, there will also be winners, such as those offering lower emission products.

Adaption to the real economy

Governor Makhlouf stated that “Ireland will have more frequent and severe flood events over the coming decades”. As a result of this, properties may end up becoming uninsurable, which may have a knock on effect on the risk levels of mortgages. He noted that there was already evidence that such factors were being considered by lenders, and overseas examples of lenders withdrawing from granting mortgages from properties with high flooding risks.

Governor Makhlouf also acknowledged that many of the impacts from damage are alleviated by insurers who play a vital role in providing security for people and businesses. However, the insurance market is also facing challenges and more severe, and significant climate events will lead to higher premiums and lower insurance coverage in higher risk areas. In addition, as climate risks are increasing across the world, the diversification of country level risks via the reinsurance market is becoming more expensive and restrictive.

Opportunities for insurers still exist, and learnings from international policy innovations may help to prevent pressure on underwriting where defences are not economically or technically feasible. Governor Makhlouf noted that by reducing risk through adaption, insurers can retain a risk-based pricing approach, and potentially expand risk appetite and offers of insurance. Collaboration between the public and private sectors may also help to enable insurers to retain a risk-based approach to pricing.

Adaption to the financial sector

The financial sector must also adapt by embedding climate risks into its models, systems and policies, and to consider risk over longer time periods. Governor Makhlouf stated that “we appear to be in the midst of a climate risk transparency revolution”. He noted that investment flows follow both profitability expectations and climate risks in terms of decarbonisation costs, and the likeliness of physical damage. Disclosure requirements have also increased the flow of climate data sources, which alongside stronger government policies and target commitments, will help to align investment flows with transition goals.

Governor Makhlouf also noted that the policy mechanisms contained in the existing prudential framework must be adapted to include climate risks. He stressed that it was too soon for a “wholesale recalibration of the capital framework”. However, as data availability and risk forecasting continues to improve at pace, the Central Bank may act where risks are clear, large and quantifiable. 

On the 9 May 2024, the European Commission (“Commission”) published a Letter regarding a formal request to the European Insurance and Occupational Pensions Authority (“EIOPA”) for technical advice on the review of certain items of the Solvency II Delegated Regulation. The provisional interinstitutional agreement reached in December 2023, introduced new Commission mandates on topics that EIOPA did not provide advice on. The Commission has made these requests in order to maintain cooperation between EIOPA and the Commission.

The Letter, addressed to the chairperson of EIOPA, Petra Hielkema, invited EIOPA to provide technical advice on:

• the methodology to be used when classifying undertakings as small and non-complex, and the conditions for granting or withdrawing supervisory approval for proportionality measures to be used by undertakings not classified as small and non-complex undertakings;
• the standard formula capital requirements for exposures to central counterparties (“CCPs”) when they become direct clearing members; and
• the standard formula capital requirements for investments in crypto-assets.

Next Steps

The Commission has requested that EIOPA respond to its request for technical advice on methodology and standard formula capital requirements for exposures to CCPs by 31 January 2025, and for the standard formula capital requirements for investment in crypto-assets by 30 June 2025.

The Basel Committee on Banking Supervision (“BCBS”) released a press release following a meeting of the oversight body of the BCBS, the Group of Central Bank Governors and Heads of Supervision’s (“GHOS”)  meeting on 13 May 2024. The GHOS members unanimously reaffirmed their commitment to fully implement all aspects of the Basel III framework as soon as possible. Roughly two-thirds of member jurisdictions will have implemented either the majority or all of the standards by this year, and the others intend to achieve this by next year.

In addition, the GHOS also agreed to defer implementation of the BCBS' prudential standard for banks’ crypto-asset exposures by a year to 1 January 2026. The aim of the revised date is to ensure that members fully comply with the standard, which had been endorsed by the GHOS in December 2022, in a timely manner. In December 2023, the BCBS had carried out a consultation on targeted revisions to the standard. It will consider whether to make any revisions to the standard later this year.

On 3 May 2024, the European Central Bank (“ECB”) published a guide on effective risk data aggregation and risk reporting (“RDARR”) (“Guide”). The aim of the Guide is to outline the practices which the ECB believes are necessary from an RDARR perspective to ensure effective processes are in place to identify, manage, monitor and report the risks that supervised institutions are exposed to.

Background

The ECB carried out a thematic review on RDARR in 2016 which was complemented by 2 additional analyses – a “data lineage” exercise for credit risk and a “fire drill” exercise for liquidity risk. The findings of the thematic review and analyses identified shortcomings in the effectiveness of data governance frameworks, and that none of the significant institutions had fully followed the Basel Committee on Banking Supervision 239 principles and serious weaknesses in terms of their RDARR practices were identified. Supervisory scrutiny had been increased following further on-site inspections as part of the Supervisory Review and Evaluation Process, and the ECB issued a letter to all significant institutions under direct supervision within the Single Supervisory Mechanism, urging them to make substantial improvement and implement reporting solutions.

Despite these steps the ECB determined that insufficient progress had been made by significant institutions and RDARR had not been given sufficient focus. As a result the ECB  launched a consultation on a draft Guide in July 2023.

The Guide

The information in the Guide is based on evidence collected through supervisory activities and prioritises discussion of project management and the role of the management body, as these were identified as root causes of the insufficient progress made on RDARR. The Guide also focuses on the main deficiencies across seven key areas and sets out the ECB's  minimum supervisory expectations regarding same. The seven key areas include:

• responsibilities on the management body;
• sufficient scope of application;
• effective data governance framework;
• integrated data architecture;
• group-wide data quality management and standards;
• timeliness of internal risk reporting; and
• effective implementation programmes.

Next Steps

The Guide states that the ECB intends to follow up on these expectations in its supervisory activities on a case-by-case basis, in line with the principle of proportionality. The ECB has also included the deficiencies in RDARR as a key vulnerability in its supervisory strategy for the coming years so this will continue to be an area of focus for the ECB. 

On 6 May 2024, the European Banking Authority (“EBA”) published the first part of its Annual Report for 2023, outlining its main achievements in fulfilling its mandate and its Work Programme for the last 12 months.

In 2023, the EBA delivered on over 95% of the 280 tasks outlined in its Work Programme. Alongside this, the EBA dealt with an additional unanticipated 20% of tasks which were not included in its Work Programme, and the small number of tasks which were not completed was in large part due to the need to carry out such unanticipated tasks. However, this did not compromise legal deadlines.

The tasks achieved covered a number of areas including:

• the finalisation of Basel III in the European Union ("EU");
• the carrying out of an EU-wide stress test;
• putting data at the service of stakeholders; 
• delivering on digital finance and MiCA and DORA mandates;
• enhancements to the anti-money laundering and countering the financing of terrorism regime;
• the implementation of the ESG Roadmap; and
• the carrying out of risk assessments.

The EBA Strategic Priorities for 2024 are:

• finalising the implementation of Basel III in the EU and enhancing the Single Rulebook;
• monitoring financial stability and sustainability in a context of increased interest rates and uncertainty;
• providing a data infrastructure at the service of stakeholders;
• developing an oversight and supervisory capacity for DORA and MiCA; and
• increasing focus on innovation, consumers while preparing the transition to the new anti-money laundering and countering the financing of terrorism regime.