EU markets regulator the European Securities and Markets Authority (ESMA) announced today that it has established climate risk as a new, separate category in its risk assessment and monitoring framework, alongside existing categories which include liquidity, market, credit, contagion and operational risk.

ESMA was founded in 2011 with the primary objectives to enhance investor protection and promote stable and orderly financial markets, with assessing risks to investors, markets and financial stability set as one of its key activities. In its semi-annual Trends, Risks and Vulnerabilities (TRV) report, released today, the regulator added the new category “Environmental Risks” to its remit, and the regulator said that it will initially focus on climate as the most prominent risk under this category.

The new climate risk category is intended to capture physical and transition risks, as well as the potential risks associated with green finance.

In an article published along with the new TRV report, ESMA said:

“There is broad agreement that climate change has become the challenge of our generation, with potentially substantial consequences for the global economy and economic agents (households, businesses and governments). As such, climate change will also have major implications for the global financial system, even as public understanding of the potential ramifications and transmission channels between climate change and financial risks is still progressing. In recent years, a broad consensus has nonetheless formed around one fundamental message: the potential costs of inaction over the many decades to come appear disproportionately high compared to those of actions taken today to address climate change or mitigate its impact.”

The article outlines the regulators views into how environmental risks may be expected to impact EU securities markets and their participants, and ESMA’s approach to integrating environmental risks in the risk assessment and monitoring framework. The primary core risks identified by the regulator include abrupt changes in market sentiment, such as those driven by a sudden change in investors’ climate risk perception, greenwashing, and weather-related hazards, which can cause losses in physical assets or financial holdings, and also lead to policy and legislative action. Among the focus areas discussed in order to address the defined risks, ESMA discussed the need for enhanced disclosure for green financial products and enhanced transparency through increases in labelled sustainable finance products, and the development of climate-specific risk monitoring indicators.

ESMA added:

“Climate-related policies and public awareness of the climate emergency have put climate risks at the core of the agendas of many authorities and private-sector firms. The growing interest in and shift to sustainable investing confirms a public urge to consider wider ESG factors in investment decision-making. Meanwhile, the increasing visibility of climate change impacts, including on financial markets, makes it imperative to account for this new risk source in our risk monitoring and analysis.”

Click here to access the TRV article.