What is Sustainable Finance?
BSP Circular No. 1085 defines “sustainable finance” as any form of financial product or service which integrates environmental, social and governance (“ESG”) criteria into business decisions that supports economic growth and provides lasting benefit for both clients and society while reducing pressures on the environment. This also covers green finance which is designed to facilitate the flow of funds towards green economic activities and climate change mitigation and adaptation projects.
What is an E&S Risk?
BSP Circular No. 1085 defines “E&S risk” as potential financial, legal, and/or reputational negative effect of environmental and social issues on the bank. E&S issues may include climate risk (both physical and transition risks), environmental pollution, hazards to human health, safety and security, and threats to community, biodiversity, and cultural heritage, among others. These risks are inherent and can directly or indirectly affect banks. BSP Memorandum No. M-2022-042 (Guidance on the Implementation of the Environmental and Social Risk Management (ESRM) System; September 29, 2022) shows a number of reports and studies that describe how E&S risks translate into financial risks.
What is an ESRM system?
Under BSP Circular No. 1085, the Environmental and Social Risk Management (“ESRM”) system refers to policies, procedures, and tools to identify, assess, monitor, and mitigate exposures to E&S risks.
What minimum supervisory expectations did the BSP set for the development of an ESRM System?
As set out in its Memorandum No. M-2022-042, the BSP expects that banks’ ESRM systems should comply with the following:
a. The Board of Directors and Senior Management shall institutionalize and oversee the adoption and implementation of sustainability principles, including those covering E&S risk areas, in the corporate governance and risk management frameworks as well as in the strategic objectives and operations of the bank.
A bank’s ESRM system should define its level of E&S risk appetite. The scope and complexity of the ESRM system shall be commensurate with the level of E&S risk associated with the bank’s portfolio.
b. The system should provide clear guidance in assessing E&S risks in the bank’s operations, products and services, transaction, activities, and operating environment. The ESRM system shall also identify which sectors or activities have elevated or emerging E&S risks or are considered to have harmful effects to the environment or society.
c. The system should provide the tools for monitoring E&S risks as well as the compliance of the bank and its counterparties with sustainability-related standards, laws and regulations. Provide tools for assessing identified E&S risks and for considering the same in the aggregate exposures of the bank.
d. The system should identify the measures that are to be taken in case of breaches in limits or thresholds or non-compliance with sustainability-related standards, laws and regulations.
e. E&S risks should be integrated in stress testing exercises covering both short-term and long-term horizons. The results of the stress testing shall feed into banks’ capital and liquidity planning and management exercises as well as in the business continuity and disaster recovery plans.
f. The system should identify the unit or personnel responsible for overseeing the management of E&S risks. The bank may establish a new unit to perform such function or integrate the same in the functions of existing risk management units. The ESRMS shall set out the duties and responsibilities of all personnel in the organization in managing E&S risks.
What are the additional obligations of banks and non-bank financial institutions performing quasi-banking functions with respect to building a sustainable finance framework?
Under BSP Circular No. 1149, series of 2022 (Guidelines on the Integration of the Sustainability Principles of Investment Activities of Banks; August 23, 2022), these additional obligations are:
a. The ESRM System must be articulated in a separate document solely relating to the management of E&S risk or embedded in existing documents related to the management of specific risk areas (e.g., credit risk management system).
b. Banks are required to consider E&S risks in defining their credit risk appetite.
c. Banks must take into account their sustainability objectives and risk appetite in their investment activities and ensure that such investments do not contribute to sectors considered to have harmful effects upon the environment or society.
What are the additional obligations of banks with respect to ensuring sustainability in investment activities?
Under BSP Circular No. 1149, these additional obligations are:
a. Risk Management Framework – A bank shall have systems to manage risks arising from its investment activities.
i. Board and Senior Management Oversight
* The board of directors must (i) approve portfolio objectives, overall investment strategies, general investment policies, and limits that are consistent with the bank’s financial condition and risk tolerance, and (ii) oversee the integration of sustainability principles and objectives in the bank’s investment activities and monitor the progress in attaining such objectives through the relevant committee it designated pursuant to Section 153 of the Manual of Regulations for Banks.
* The senior management must develop portfolio objectives that set out the acceptable instruments, expected business returns, desired asset allocation and diversification parameters, and other elements of sound investment management.
ii. Policies, Procedures, and Limits – A bank shall institute policies, procedures and limits that provide a framework for managing investment activities, which shall be consistent with its sustainability objectives.
* Policies and procedures should clearly articulate guidelines for the acquisition and accounting of investments.
* Policies should promote the development of a comprehensive understanding of the risks associated with investments prior to acquisition and on an ongoing basis.
* Policies and procedures should provide the bank’s approach for implementing the sustainability objectives of investment strategies.
* The limits for investment activities shall be consistent with the bank’s institution-wide risk limits.
* The limit structure should reflect the amount of exposure that the bank is willing to accept, taking into consideration the impact of such exposure to earnings and capital in both normal and stressed conditions.
iii. Risk Measurement, Monitoring and Management Information Systems – A bank shall ensure that it possesses the capability to measure and monitor the risks associated with its investments prior to acquisition and periodically thereafter.
iv. Internal Controls and Audit – A bank shall ensure the integrity of investment valuations, risk measurement methodologies, and controls that address model risk.
b. Risks of Investment Activities – The management of risks arising from a bank’s investment activities shall be integrated into the bank’s overall risk management system. As to credit risk, (i) a bank’s investment policies and objectives shall be consistent with its overall credit risk strategy; (ii) a bank shall not acquire an investment without conducting an independent assessment of the creditworthiness of the issuer; and (iii) a bank may consider certain factors as part of its credit risk due diligence review, such as material E&S risks.
What are the additional obligations of banks with respect to issuing bonds and commercial papers?
Under BSP Circular No. 1149, in the case of issuance of green, social, or sustainability bonds, including other sustainable bonds falling within their acceptable definition, the issuing bank shall (i) comply with the pertinent guidelines of the Securities and Exchange Commission as well as the disclosure requirements in Section 153 of the Manual of Regulations for Banks, and (ii) not engage in greenwashing (i.e., the deceptive marketing used to persuade the public that an organization’s products, aims, and policies are environmentally friendly.)