Europe’s three main financial supervisory bodies have jointly released new guidelines aimed at embedding environmental, social and governance (ESG) risks into supervisory stress testing frameworks for banks and insurers across the European Union.

The guidelines were issued by the European Supervisory Authorities (ESAs), comprising the European Securities and Markets Authority, the European Banking Authority, and the European Insurance and Occupational Pensions Authority.

A Common Framework for ESG Stress Testing

The finalized Guidelines on ESG stress testing are designed to create a consistent supervisory approach across EU member states. They provide national regulators with a structured framework to integrate ESG-related risks into existing stress testing methodologies, as well as into new complementary assessments that evaluate the impact of ESG risks under adverse but plausible scenarios.

While the guidelines do not introduce new binding regulatory requirements, they will operate under a “comply or explain” mechanism, meaning National Competent Authorities must either apply them or publicly justify any deviations.

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Risk-Based and Gradual Integration

A central feature of the guidelines is the adoption of a risk-based approach. Supervisory authorities are encouraged to begin with a materiality assessment to identify which ESG risks are most relevant, taking into account factors such as financial institutions’ business models, portfolio composition, geographic exposure, and sectoral concentration across different time horizons.

Initially, regulators are advised to prioritise climate and environmental risks, including both physical risks, such as extreme weather events, and transition risks linked to policy, technology and market changes. Coverage can then be progressively expanded to other ESG dimensions, such as biodiversity loss, pollution, social risks and governance issues, as data availability and modelling capabilities improve.

Time Horizons, Scenarios and Granularity

The guidelines distinguish between short-term and long-term stress testing objectives. Short-term horizons are intended to assess financial resilience to immediate shocks, while longer-term horizons focus on the sustainability of business models and strategic viability in the face of structural ESG risks.

They also provide guidance on scenario design and methodological choices, including the use of top-down versus bottom-up approaches. Regulators are encouraged to apply appropriate levels of granularity, analysing ESG risks at portfolio, sectoral, geographic and counterparty levels, and to clearly differentiate between physical risks, transition risks and other ESG-related factors.

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Data, Expertise and Implementation Timeline

Recognising the complexity of ESG risk assessment, the ESAs stress the importance of adequate human and technical resources. Supervisory authorities are encouraged to involve staff with specialised ESG expertise and to strengthen data collection and management systems to ensure access to high-quality ESG data.

The joint ESG stress testing guidelines are scheduled to apply from the beginning of 2027, giving regulators time to adapt their supervisory frameworks and build the necessary capabilities.

Overall, the move signals a further step toward embedding sustainability considerations into the core of EU financial supervision, as regulators seek to better understand how ESG risks could affect the resilience and stability of the financial system.

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