FINMA Introduces Disclosure Requirements for Climate Risks

FINMA increases focus on climate-related risks

On May 31, 2021, the Swiss Financial Market Supervisory Authority FINMA (FINMA) announced that it has clarified its supervisory practice with respect to the disclosure of climate-related financial risks by financial institutions. Specifically, FINMA has amended two circulars applicable to banks and insurance companies, i.e., its Circular 2016/01 on the public disclosure of banks and its Circular 2016/02 on the public disclosure of insurance companies, to include additional disclosure requirements tailored to address climate-related financial risks. These amendments are the result of a public consultation on the disclosure of climate-related financial risks initiated by FINMA in November 2020, where various interested parties, such as industry representatives and environmental protection organizations, were invited to provide input on FINMA’s proposals.

The revised circulars will enter into force on July 1, 2021. Consequently, the disclosure of climate-related financial risks will be required for the first time in the annual reports for the financial year 2021, published in 2022.

The introduction of these disclosure obligations comes on the wings of a growing recognition that threats posed by climate change have wide-ranging impacts not only on environmental, human and societal systems but also on the structure and functioning of the economy and financial system. In particular, climate change and climate-related risks are a source of financial risk, which can have an impact on financial institutions as well as on financial stability. As such, FINMA’s updated supervisory practice dovetails with the disclosure requirements of the Task Force on Climate-related Financial Disclosures (TCFD) established by the Financial Stability Board (FSB).

This effort forms part of FINMA’s larger strategic goal of contributing to the sustainable development of Switzerland as a financial center (for more information, see FINMA’s dossier on green finance, available here). In this vein, FINMA has also stressed its commitment to preventing the public from being misled about the sustainability or economically friendly nature of certain financial products or services («green washing»).

New disclosure requirements initially only apply to large banks and insurance companies

Initially the additional disclosure requirements will only apply to banks and insurance companies that fall within the supervisory categories 1 and 2, i.e., globally systemically important banks (G-SIBs), domestically systemically important banks (D-SIBs) and insurance companies with total assets of over CHF 1 billion. The disclosure requirements for climate-related financial risks will therefore directly affect only a handful of financial institutions.

Further, as FINMA itself has pointed out, the majority of the financial institutions in scope have already voluntarily committed to disclose their climate-related financial risks in compliance with the TCFD recommendations. The current impact of the new FINMA disclosure requirements is therefore limited to creating a more uniform framework for the disclosure of climate-related financial risks with the goal of fostering increased comparability of the disclosed information across different financial institutions.

However, FINMA has indicated that it may extend the scope of application to additional financial institutions in the future, as it continues to evaluate the situation based on its experiences with the disclosure of climate-related financial risks going forward.

No uniform definition of «climate risks»

FINMA does not propose a legal definition of what exactly constitutes a climate-related financial risk. In its explanatory report, FINMA instead follows the approach set out by the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors and the TCFD by setting out two principle categories of climate-related financial risks:

  • Physical risks: risks resulting from increased damage and losses from climate-related trends (e.g., sea level rise) and events (e.g., natural catastrophes).
  • Transition risks: risks arising from disruptions and shifts that indirectly affect financial institutions, for instance due to the introduction of climate policy measures with a transition to a low-carbon economy (e.g., CO2 levies, emissions or energy efficiency standards or restrictions on «unsustainable» business sectors, such as coal or oil), shifting investor and consumer sentiment or disruptive technological breakthroughs.

On top of that, insurance companies specifically are exposed to liability risks, another climate-related risk category promulgated by the International Association of Insurance Supervisors. Liability risks refer to the «risk of climate-related claims under liability policies, as well as direct actions against insurers, for failing to manage climate risks».

FINMA also clarifies that climate-related risks do not per se constitute a new category of risk, but are a risk driver that can be adequately and efficiently captured and managed within the traditional risk categories, e.g., credit, market, insurance or operational risk.

Only material climate-related financial risks are subject to disclosure

Further, the general rule that only relevant, material risks have to be disclosed in principle also applies to the disclosure of climate-related financial risks. However, in deviation from the conventional disclosure requirements, the financial institution’s criteria and valuation methods used to assess the materiality of climate-related financial risks must be disclosed in any case.

This means that even if a financial institution concludes that it is not subject to any material climate-related financial risks and therefore should decide that it is not required to disclose such risks, it still has to disclose information on the criteria and valuation methods underpinning this decision.

Principle-based and proportional approach allows for tailored solutions

The disclosure of the climate-related financial risks are made as part of the relevant institutions’ annual reporting. Separately published reports can be included by reference to fully or partially fulfil the disclosure requirements.

The additional requirements set out in FINMA circulars 2016/01 for the public disclosure of banks (in annex 5) and 20016/02 for the public disclosure of insurance companies (in section IV) define only the broader principles for the disclosure of climate-related financial risks. As such, FINMA allows the financial institutions in scope to retain sufficient flexibility to adjust their disclosure to their respective size, complexity, structure, business activities and risks. Financial institutions are largely free to determine the level of detail of their disclosure of climate-related financial risks and to decide how and where such disclosure is integrated into their annual reporting (within the confines of the applicable regulatory disclosure framework).

At a minimum, the respective disclosure has to contain the following information:

  • Governance: description of how the board of directors exercises its overall supervision with respect to the identification, assessment and monitoring of climate-related financial risks, including information on the relevant governing bodies, responsibilities and reporting lines within the financial institution and the extent to which climate-related financial risks are addressed;
  • Strategy: Description of the material short-, medium-, and long-term climate-related financial risks identified and their qualitative and quantitative impact on the business strategy, business model, financial planning and risk profile, as well as information on the categorization of climate-related financial risks in the financial institution’s existing risk categories;
  • Risk management: Description of the risk management process for identifying, assessing and addressing climate-related financial risks and how this process is integrated in the larger risk management structures and processes.
  • Metrics: Quantitative information (key figures and targets) on climate-related financial risks and the methodology applied for their identification.

In its explanatory report of May 6, 2021 FINMA provides some additional color on its expectation for the content of the disclosure. While largely identical for banks and insurance companies, some details vary.

Existing disclosure by financial institutions varies

While most large Swiss financial institutions already provide for reporting on climate-related financial risks, the level of detail and presentation varies wildly. Some financial institutions present the relevant information in the categories set out in the revised FINMA circulars (governance, strategy, risk management and metrics), while others refer to climate-related financial risks within the larger sustainability context. In particular, insurance companies in general already provide information on climate-related financial risks that far surpasses the minimum requirements set out by FINMA, many of them publishing separate reports that specifically tackle this topic.

Especially financial institutions that already adhere to the TCFD recommendations will not have to amend their disclosure of climate-related financial risks in the first instance due to the introduction of the new FINMA disclosure requirements. However, it remains to be seen if and when a more uniform industry standard on the disclosure of climate-related financial risks emerges.

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