Regulatory bodies in the European Union propose integrating Environmental, Social, and Governance (ESG) risks into stress tests for financial institutions

The European supervisory authorities (ESAs) - including the European Securities and Markets Authority (Esma), the European Banking Authority (EBA), and the European Insurance and Occupational Pensions Authority (EIOPA) - have announced a joint consultation on the proposed guidelines and common framework for incorporating Environmental, Social, and Governance (ESG) risks into stress tests. The consultation runs until 19 September.

The move comes as some economists have expressed concerns that current climate stress tests may not fully capture the financial loss from climate risk. Professor Yannis Dafermos of Soas University of London has voiced his worry that financial regulators are conducting stress tests and research without taking action to address the identified risks.

The ESAs propose focusing on climate and environmental risks, including physical and transition risks, with a gradual rollout of other ESG considerations such as social and governance risks. This shift aims to harmonise the practice among EU supervisors and improve the effectiveness of ESG stress tests.

Notably, national authorities such as the Bank of England, the European Central Bank (ECB), and the Federal Reserve have already conducted climate-specific stress tests. The U.S. Securities and Exchange Commission (SEC) and other European supervisory bodies have announced plans to incorporate ESG risks into their stress testing frameworks.

The ESAs acknowledge that ESG stress testing is still new compared to traditional financing stress tests but that progress has been made, especially for "environmental risk link to climate change." However, they express concern about the effectiveness of ESG stress tests and the consultation aims to address this issue.

Professor Dafermos has suggested that there is room for improvement in stress testing analysis. He questions what action is taken with the results of these analyses, particularly if no action is taken based on the findings. He also pointed to the Bank of England's climate stress test, which found customers would be hit by climate losses, but did not address the causes of climate change.

The ESAs suggest looking at short-term shocks of five years or less and longer-term horizons of at least 10 years. They also encourage authorities to consider spillover and interconnections among different financial sectors when possible.

If the consultation is successful, member state banking and insurance regulators will be required to include ESG risks in their stress tests. This could lead to a more comprehensive approach to risk management and a better understanding of the financial implications of climate change.

The page was last updated on July 24, 2025.