Europe’s Supervisors Want to Put ESG Risk to the Test

Key Takeaways

• Common EU Approach: The ESAs aim to harmonize how ESG risks are integrated into supervisory stress tests for banks and insurers across Europe.
• Climate First, Others to Follow: The draft Guidelines prioritize environmental and climate risks, with a gradual roadmap to include social and governance risks.
• Scenario-Based Testing: Supervisors are encouraged to use science-backed, forward-looking scenarios to assess both short-term shocks and long-term strategic resilience.
• Proportional and Risk-Based: Stress testing should focus on the most material ESG risks, with expectations scaled to the size and complexity of the financial institution.
• Feedback Open Until September: Stakeholders can submit comments until September 19, ahead of final Guidelines set to be published by January 2026.

Deep Dive

Europe’s financial watchdogs are drawing a sharper line on how banks and insurers prepare for climate, social, and governance shocks, and they’re inviting everyone to weigh in.

On June 27, the European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA), and European Securities and Markets Authority (ESMA), unveiled a major draft guideline that could reshape how ESG risks are stress tested across the EU’s financial system. The proposal is now out for public consultation until September 19, with a final version expected by January 2026.

A Common Rulebook for an Uncommon Type of Risk

ESG risks are complicated. They don’t show up neatly on balance sheets, and they don’t play by traditional financial rules. Climate disasters don’t wait for quarter-end, and social unrest doesn’t follow a market calendar. The ESAs’ new draft Guidelines aim to give national supervisors a structured, consistent way to integrate these unpredictable forces into the one tool regulators know best, stress testing.

The Guidelines don’t force supervisors to run ESG stress tests, but when they do, they’ll be expected to follow a shared approach. That means applying clear objectives, defining what ESG risks matter most (spoiler: it starts with climate), and tailoring the scope to portfolios, geographies, and institutions that actually carry material risk.

So what does ESG stress testing look like under this new playbook?

• First, authorities need to ask: what are we testing for? Short-term shocks to capital and liquidity? Or longer-term threats to business models from climate policy, biodiversity loss, or societal shifts? The Guidelines allow both, as long as the approach fits the goal.
• Then comes the tough part, scenarios. These stress tests aren’t just about simulating a bad quarter; they’re about mapping plausible futures. Think rising temperatures, regulatory crackdowns, or sudden shifts in consumer behavior. The ESAs want these scenarios grounded in science (like those from NGFS or IPCC) and capable of capturing both direct and ripple effects.
• Flexibility is built in. Supervisors can go top-down (calculating impacts themselves), bottom-up (letting firms do it), or use a hybrid approach. The key is transparency, comparability, and realism, no wishful thinking or rosy assumptions.
• Granularity matters too. ESG stress tests shouldn’t just look at “the bank” or “the insurer” as a blob. The Guidelines ask for breakouts by portfolio, sector, region, even individual counterparties in some cases. The aim is to actually see where the cracks might form.

A Gradual Climb, Not a Leap

The ESAs aren’t pretending this is easy. In fact, they’ve opted for a phased approach, starting with what’s better understood (climate and environmental risks) and build toward more complex territory (social and governance risks). Methodologies are still maturing, and data gaps remain a huge hurdle. That’s why the Guidelines stress proportionality and pragmatism, supervisors should go deep where it matters and keep things simple where it doesn’t.

And while this framework is about national supervisors, it has knock-on effects for financial institutions. Firms will need to be ready to supply high-quality ESG data, explain their transition strategies, and show their resilience to unfamiliar risks over long time horizons.

This is about more than ticking boxes. ESG risks, especially climate risks, are no longer hypothetical. They pose real threats to financial stability, and regulators know they can’t afford to play catch-up. With these Guidelines, the ESAs are saying that if we’re going to understand the impact of wildfires, carbon taxes, or broken supply chains on the financial system, we need to start running the numbers now.

Public feedback is open until September 19 via online survey. An online hearing is scheduled for August 26, giving stakeholders another chance to shape the final rules. The clock is ticking, but the tone is collaborative.

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