Sustained interest and growth in ESG criteria persist despite the absence of clear and definitive definitions, contributing to increased vulnerability and potential financial risks. Photo: Shutterstock

Sustained interest and growth in ESG criteria persist despite the absence of clear and definitive definitions, contributing to increased vulnerability and potential financial risks. Photo: Shutterstock

Despite the growing popularity of ESG investments, the absence of universally agreed-upon standards and definitions hampers the market’s ability to accurately evaluate and mitigate associated risks. This underscores the need for standardised frameworks and regulations to ensure the long-term stability and integrity of ESG investments.

In 2022, the markets for environmental, social and governance (ESG) products experienced slower growth but remained resilient to broader market trends. The total value of sustainable debt securities held in the euro area reached €1.25trn in December 2022, which included green, social, sustainability and sustainability-linked debt securities, representing an impressive 35% annual increase in Q4 2022, according to European Central Bank data.

Robust growth

In terms of the EU funds industry, the share of ESG investment vehicles continued to rise despite fluctuations in the total value of assets. During the second half of 2022, investors withdrew €210bn from funds without sustainability characteristics or objectives, which is equivalent to 4.2% of the assets under management of these funds.

In comparison, only €127bn was withdrawn from article 8 funds under the Sustainable Finance Disclosure Regulation, accounting for 2.5% of article 8 fund assets, while an additional €19bn was allocated to article 9 funds, representing 4% of article 9 fund assets.

Furthermore, on 2 February 2023, the ECB its intention to prioritise issuers with ‘stronger climate performance’ for the securities held under the asset purchase programme during the partial reinvestment phase, commencing in March 2023. This decision signifies that the demand for sustainable investment products is expected to remain robust in the near to medium term.

Bank loans

Banks have made significant progress in incorporating ESG considerations into their funding and lending practices. According to the semi-annual risk assessment questionnaire of April 2022 by the European Banking Authority, banks have shown a strong interest in providing sustainable loans to non-financial corporates (NFCs), small and medium-sized enterprises (SMEs), and retail borrowers. Analysts in the banking sector a notable increase in green corporate lending, green consumer credit and other segments like green mortgages over the next 12 months.

Among the various loan offerings, banks predominantly focus on green and sustainability-linked loans for NFCs, with 80% of banks offering such products. Additionally, 75% of banks offer green loans to a wide range of counterparties. On the other hand, the market for social products remains relatively smaller in comparison.


When identifying obstacles to the further advancement of green retail loans, banks commonly highlights the lack of data and transparency as the most significant impediment.

Following closely behind are challenges related to the absence of common definitions and regulatory uncertainties.

Insurance protection gap and climate risks

The increasing losses to properties and businesses caused by climate change continue to put pressure on reinsurance capacity. This, coupled with the withdrawal of reinsurance in certain areas of business, rising prices and higher net retentions for cedents--an increase in the amount of risk that insurance or reinsurance companies retain for themselves instead of transferring it to a reinsurer--may further widen the insurance protection gap for natural catastrophes related to climate events.

To address this issue, and to assess the reinsurance capacity for natural catastrophes in order to evaluate the resilience of the insurance industry against climate-related events, the European Insurance and Occupational Pensions Authority has developed a for natural catastrophes in Europe. Importantly, the realisation of climate risks could have a negative impact on the quality of assets held by financial institutions, and it remains uncertain how and to what extent these risks are factored into asset prices.

ESG risks

Therefore, it is essential to implement disclosure requirements, along with other regulatory initiatives, to better understand the associated risks and vulnerabilities across the financial system.

In the banking sector, the European Banking Authority has introduced implementing technical standards (ITS) on the . These standards mandate banks to disclose climate-related risks related to their lending and investment activities starting from 2023. Furthermore, beginning in 2024, banks will be required to disclose their green asset ratio (GAR) and their banking book taxonomy alignment ratio (BTAR).

Financial risk

In its first climate stress test for the institutions for occupational retirement provisions (IORPs) sector in the European Economic Area, EIOPA has that, in the adverse scenario, the total value of assets could potentially drop by 12.9%, resulting in overall losses of €255bn.

The report concludes by stating, “These impacts are significant and indicate that IORPs have a non-negligible exposure to transition risks, particularly through their investments in climate-relevant sectors.”

Furthermore, the stress test revealed that among the participating IORPs, 64% reported having documented processes to identify, assess, monitor, and manage ESG and sustainability risks. However, it is noteworthy that only a small fraction, specifically 14% of IORPs, have integrated environmental stress testing into their risk management practices.

It is important to highlight that the IORPs employing stress testing had shown better performance in the overall assessment compared to the remaining 86% of IORPs that do not utilise such measures.

Considering the financial risks associated with climate risks, the insurance protection gap, the lack of data and regulatory uncertainty, the European Banking Authority (EBA) has been emphasising the importance of enhancing risk management capabilities and disclosing ESG risks.

These risks are increasingly recognised as significant sources of financial risk, necessitating proactive measures to mitigate their impact.