Financial Regulation and Supervision
Transitioning to a carbon-neutral and more circular economy entails both risks and opportunities for the economy and financial institutions, while physical damage caused by climate change and environmental degradation can have a significant impact on the real economy and the financial system.
As the regulator for the financial system in Ireland, the Central Bank seeks to ensure proper and effective regulation of financial institutions and markets, while ensuring that consumers of financial services are protected. In light of efforts to mitigate the long-term implications of climate change, the Central Bank also seeks to strengthen both the resilience of the financial system to climate-related risks and its ability to support the transition to a climate-neutral economy. Broadly, this means that financial regulation seeks to embed climate risk and sustainable finance considerations across its prudential and consumer/investor protection rulebooks for banking, insurance, investment markets and the wider financial system.
In November 2021, the Governor of the Central Bank of Ireland issued a Dear CEO letter setting out the Central Bank’s expectations in respect of climate and other ESG issues.
The Central Bank continues to incorporate climate considerations into its supervisory activities and is actively supervising regulated financial market participants in respect of their climate risk and sustainable finance obligations. A summary of some of the key regulatory and supervisory actions across various sectors in the financial system is set out below:
Banking
In the EU, credit institutions are supervised under the Single Supervisory Mechanism (SSM), and fall into two distinct categories: Significant Institutions (SIs) and Less Significant Institutions (LSIs). Since the commencement of the Single Supervisory Mechanism on 4 November 2014, the European Central Bank (ECB) has become the competent authority for the supervision of significant institutions in the euro area, while less significant institutions continue to be supervised by national competent authorities (NCA). The supervision of climate-related and environmental risks is increasingly becoming part of the supervision of SIs and LSIs. Examples of some of the key supervisory work in this area is set out below:
Insurance
In the EU, (re)insurers are subject to regulation under Solvency II. In 2021, the European Commission published amendments to Solvency II to integrate sustainability risk, which came into force in August 2022. These amendments require (re)insurers to incorporate sustainability risk in their risk management and governance systems, investment and underwriting strategies. Sustainability risk needs to be monitored by the risk management as well as the actuarial functions, and it should also feature in a firm’s application of the “prudent person principle”.
In 2021, the European Insurance and Occupational Pensions Authority (EIOPA) published an opinion on climate change scenarios in the Own Risk and Solvency Assessment (ORSA). This sets out a number of areas for supervisors to consider, including materiality assessment, time horizons and climate scenarios.
As a follow-up to the opinion, in 2022 EIOPA published application guidance. This provides (re)insurers with detailed and practical guidance on how to address climate change risks in the ORSA and includes examples using life and non-life companies.
The Central Bank has developed guidance to clarify its expectations on how (re)insurers might address climate change risk in their business and to assist (re)insurers in developing their governance and risk management frameworks.
Investment Funds
Capital markets have been identified by the European Commission as a potential catalyst for effective mobilisation and allocation of capital towards sustainable investments. In looking to the investment funds sector in particular, there has been key legislative initiatives to achieve this goal. Notably these include the implementation of the Sustainable Finance Disclosures Regulation (SFDR) and the Taxonomy Regulation. This is in addition to other amendments to existing frameworks to incorporate sustainability considerations into investment and risk management processes.
At their core, these legislative requirements aim to provide increased transparency around Environmental, Social and Governance (ESG) characteristics and the integration of sustainability risks at a product and entity level via pre-contractual documentation disclosures, website disclosures, and periodic reporting.
The Central Bank has facilitated the implementation of these legislative requirements by:
- Establishing a streamlined filing process for pre-contractual documents as required under SFDR and Taxonomy Regulation
- Carrying out a “Gatekeeper Review” of the disclosures in fund documentation and engaging with fund managers on a bilateral basis where queries arise in respect of their submissions
- Conducting an industry-wide thematic review of funds’ compliance with their self-declared SFDR designations.
The purpose of the Central Bank’s Gatekeeper Review was to ascertain whether disclosures in fund documentation provided investors with clear information to assess the sustainability characteristics of a fund, as well as to ascertain what sustainability risks may exist in a particular fund. The findings from this work, along with details of the Central Bank’s Supervisory Roadmap for supervising the requirements of SFDR and the Taxonomy Regulation are set out in the Information Note. The Central Bank will continue to monitor compliance with the SFDR and other related legislative requirements by the asset management sector in Ireland.
Consumer Protection
With the growth in the sustainable finance market and increased demand from consumers and investors for sustainable products, the Central Bank of Ireland is aware of the threat of “greenwashing” i.e. the practice by which regulated entities (knowingly or unknowingly) mislead investors or consumers as to the perceived “green” or “sustainable” characteristics of products or services provided.
The SFDR is one regulatory tool that can help to protect against greenwashing. In addition to the investment funds sector, it also applies to investment firms, insurance companies, insurance and investment intermediaries (including retail banks) when providing investment and insurance products, advice or portfolio management services to clients. It also seeks to ensure the protection of consumers and investors in respect of sustainability risks and make it easier for them to benefit from a wide range of financial products, while at the same time providing rules that enable them to make informed investment decisions.
Since 2022, the Central Bank of Ireland has incorporated supervisory activities to assess compliance with the SFDR across the relevant investment, insurance and banking sectors.
From a consumer protection perspective, the Central Bank is seeking to ensure it addresses the challenges faced by consumers of financial services both today and in the future. This is reflected in its review of the Consumer Protection Code, which recognises the impact of climate change on all consumers and seeks to ensure firms are acting in customers’ best interests as financial products and services evolve to respond to climate change.
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