Development of tools and mechanisms for the integration of environmental, social and governance (ESG) factors into the EU banking prudential framework and into banks' business strategies and investment policies INTERIM STUDY December 2020 Prepared by: BlackRock Financial Markets Advisory The information and views set out in this Interim Study are those of the author(s) and do not necessarily reflect the official opinion of the European Commission. The European Commission does not guarantee the accuracy of the data included in this Interim Study Neither the European Commission nor any person acting on the European Commission’s behalf may be held responsible for the use which may be made of the information contained therein. Financial Stability, Financial Services and Capital Markets Union EUROPEAN COMMISSION Directorate-General for Financial Stability, Financial Services and Capital Markets Union No FISMA/2019/024/D RESOURCES (Finance – IT) This document has been prepared by the Financial Markets Advisory Group within BlackRock for the sole use of the European Commission (“Commission”). The information and views contained herein are provided for Commission informational purposes only and should not be relied upon for any other reason. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The views expressed are subject to change and do not necessarily reflect the views of BlackRock. Any reliance upon information in this material is at the sole risk of the recipient. Where the information contained in these materials is from third party sources, the information is from sources believed to be reliable, but BlackRock has not independently verified any of the information contained herein and does not assume any liability for it. Additionally, BlackRock is not required to provide the Commission with updates, modifications, or amendments to the information, opinions, estimates, or forecasts described herein should BlackRock determine that such currently set forth communication becomes inaccurate. BLACKROCK, BLACKROCK SOLUTIONS, and ALADDIN are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. INTERIM STUDY Table of Contents 1. Purpose and structure of the Interim Study ........................................................ 4 1.1. Background of this Interim Study ................................................................ 4 1.2. Structure of the Interim Study .................................................................... 5 2. Context and objectives of the Study .................................................................. 7 2.1. Context of the Study ................................................................................. 7 2.2. Purpose and objectives of the Study ............................................................ 8 3. Overview of Study methodology and approach .................................................. 10 3.1. Data collection tools and techniques .......................................................... 10 3.2. Definition of stakeholder perimeter groups ................................................. 10 3.3. Total coverage of the Interim Study .......................................................... 11 4. Modalities of integrating ESG risks into EU banks’ risk management processes ..... 13 4.1 Overview of focus areas for research ......................................................... 13 4.2 Stocktake of current ESG practices ............................................................ 15 4.2.1 First key takeaways .......................................................................... 15 4.2.2 ESG risk definition & identification ....................................................... 18 4.2.3 ESG risk governance & strategy .......................................................... 35 4.2.4 ESG risk management processes & tools .............................................. 41 4.2.5 ESG risk reporting & disclosure ........................................................... 71 4.3 First overview of the possible arrangements, processes, mechanisms and strategies to map, assess and manage ESG risks ................................................. 81 5 Modalities of integrating ESG risks into EU prudential supervision........................ 87 5.1 Overview of focus areas for research ......................................................... 87 5.2 Stocktake of current ESG practices ............................................................ 89 5.2.1 First key takeaways .......................................................................... 89 5.2.2 ESG risk definition & identification ....................................................... 92 5.2.3 ESG governance & strategy .............................................................. 103 5.2.4 Supervisors’ assessment of ESG risk ................................................. 106 5.2.5 ESG requirements, guidelines & engagement initiatives ....................... 120 5.3 First overview of the tools and mechanisms for the integration of ESG risks into the EU prudential supervision ........................................................................... 130 6. Modalities of integrating ESG objectives into EU banks' business strategies and investment policies ............................................................................................. 135 6.1 Overview of focus areas for research ........................................................ 135 6.2 Stocktake of current ESG practices ........................................................... 137 6.2.1 First key takeaways ........................................................................ 137 6.2.2 ESG financial products, services and markets ..................................... 140 6.2.3 ESG strategy & governance .............................................................. 153 INTERIM STUDY 6.2.4 ESG measurement, monitoring & disclosure ....................................... 159 6.2.5 ESG portfolio steering & business as usual processes .......................... 169 6.3 A first overview of the impediments to the development of a well-functioning EU market for green finance and instruments and strategies to promote the scaling-up of green finance ................................................................................................. 175 6.3.1 A first overview of the impediments to the development of a well- functioning EU market for green finance and for responsible investment ............ 175 6.3.2 A first overview of the appropriate instruments and strategies to promote the scaling-up of green finance and of the market for sustainable financial products and to enhance the ability of banks to understand how ESG objectives can translate into financial opportunities ........................................................................... 180 Annex I. List of abbreviations .............................................................................. 185 Annex II. List of stakeholders .............................................................................. 187 Annex III. Bibliography ....................................................................................... 192 INTERIM STUDY 1. Purpose and structure of the Interim Study 1.1. Background of this Interim Study This document represents the Draft Interim Study prepared by BlackRock Financial Markets Advisory (BlackRock FMA) on the development of tools and mechanisms for the integration of environmental, social and governance (ESG) factors into the EU banking prudential framework and into banks' business strategies and investment policies, as per Tender Specifications N° FISMA/2019/024/D1 (the Tender Specifications) on behalf of the European Commission (the Commission). In line with the Commission’s Tender Specifications, the Interim Study focuses primarily on the stocktake exercise of current practices by banks and supervisors and is based on a preliminary analysis of the data collected so far as highlighted below. The Interim Study should cover all elements addressed in chapter 2.2.2 of the Tender Specifications, including “the comprehensive results of the stocktake exercise on the way banks currently deal with ESG risks”, “practices for the integration of ESG risks into prudential supervision”, as well as the “comprehensive results of the stocktake exercise on the current banks’ strategies to integrate sustainability factors”.2 Moreover, the Interim Study should provide “a first overview of possible arrangements, processes, mechanisms and strategies to be implemented by EU banks to map, assess and manage ESG risks, mechanisms for the integration of ESG risks (with particular focus on environmental risks) into EU prudential supervision”, as well as “impediments to the development of a well-functioning EU market for green finance and for responsible investment as well as of the appropriate instruments and strategies to promote the scaling-up of green finance”. As such, the Interim Study provides preliminary areas, as highlighted by the Study participants, that could be focus areas for identifying key principles, and that will be further analysed and expanded upon during the remainder of the Study. Considering the timeline set forth in the Tender Specifications, the assignment was structured in four