How FINMA is taking actions for greater transparency in the marketplace
This post is part of the SFG law review, a monthly contribution from Oberson Abels that keeps our members up to date on the latest legal and regulatory updates.
Increasing transparency in the area of climate-related risks has become a central part of climate policy in Switzerland and internationally. In this context, the financial market supervisory authorities have a significant role to play in ensuring that supervised institutions integrate climate risks into their risk management and properly inform the regulator about the measures that are taken to mitigate the impact of climate risks. The partial revision of FINMA Circulars 2016/1 “Disclosure – banks” and 2016/2 “Disclosure – insurers” is the first step towards the implementation of a Swiss regulatory framework regarding climate-related financial risks.
- Climate-related risks and FINMA’s prudential supervision
Increased transparency regarding climate-related risks has become the backbone of sustainability policies in many jurisdictions, including Switzerland and the European Union. Various regulations and initiatives have emerged over the past two years to better integrate climate risks into companies’ risk management.[1]
As noted in both the EU Action Plan of March 8, 2018 (Action 8) and the Swiss Federal Council’s report of June 24, 2020 (Measure 9), the regulators have a role to play in the process leading to increased transparency in the marketplace, specifically towards banks and insurance companies.
The will to integrate FINMA into the Swiss climate strategy first materialized in the revised Federal Act on the Reduction of Greenhouse Gas Emissions (CO2 Act), which included an obligation for FINMA to periodically assess the micro prudential financial risks resulting from climate change and to report on its conclusions.[2] However, the revised CO2 Act was rejected by popular vote on June 13, 2021.
Over the years FINMA has also been paying more attention to the issue of climate change and its possible consequences in the long run. In its recent risk monitors, FINMA identified the impact of climate change as a factor that can pose significant financial risks for financial institutions in the longer term. In 2019, FINMA stated that it “[…] will refine its analyses of climate-related risks in the balance sheets of financial institutions and develop approaches for improved voluntary or regulated disclosure of financial climate risks.”[3]
The revision of FINMA Circular 2016/1 “Disclosure – banks” and FINMA Circular 2016/2 “Disclosure – insurers” is part of this process to better integrating financial climate risks into FINMA’s prudential supervision.
It should also be noted that the new disclosure rules on climate-related financial risks provided for in the two FINMA Circulars are the first binding rules in this area adopted by a federal authority in Switzerland.
- FINMA disclosure requirements
- Notion of climate-related financial risks
There is no legal definition of “climate-related financial risks”. FINMA relies on the approach taken by the Task Force on Climate-Related Financial Disclosures (TCFD) in its recommendations[4] and makes a distinction between physical risks and transition risks[5]:
- physical risks: arise from the increased costs that can result from climate-related natural disasters and gradual climate change. For example, climate change can lead to an unexpected increase in damage amounts for insurance companies.
- transition risks: arise from binding climate policy measures, new customer preferences or breakthroughs in disruptive technologies. These changes entail a change in the existing operational or legislative framework which may result, for example, in price adjustments in asset values and have an impact on the market risk of banks and insurance companies. In addition, regulatory changes can adversely affect the creditworthiness of companies active in non-sustainable sectors, such as the coal and oil industry. Also, the counterparty default risk may increase in the context of credit risk.
Climate-related financial risks are not a new category of risk that supervised entities are required to disclose. Instead, they refer to the impact that climate risks may have on existing risk categories (e.g., credit, liquidity, market or operational risks). In other words, climate-related financial risks are not a category of risk, but rather a new risk factor.
- Scope of application
Pursuant to a risk-based approach, the new reporting requirements apply only to systemically important banks and large insurance companies (i.e., entities belonging to supervisory categories 1 and 2).[6] To date, most banks and insurance companies in Switzerland belong to category 5.
The (limited) scope of the entities subject to these new reporting obligations was one of the criticisms made by some participants in the hearing procedure which took place between November 2020 and January 2021. In particular, it was argued that data comparability and customer protection – two of the objectives of the partial revision of the FINMA Circulars – could only be achieved if all financial institutions, regardless of category, were included.
FINMA commented that it is not opposed to the extension of the scope of application in the future. This issue will be examined by FINMA as part of an ex-post assessment of the new rules. The assessment will be based on the experiences carried out with respect to category 1 and 2 supervised entities.
- Information to be disclosed
FINMA’s approach follows the recommendations of the TCFD, which are also built around four thematic areas: governance, strategy, risk management, and metrics and targets. In addition, FINMA applies a principle-based approach, which leaves some flexibility to the relevant supervised entities in the way they wish to implement the new obligations considering their size, complexity, structure, business activity and the risks they are exposed to.
The disclosure of climate-related financial risks will be included in the annual reporting (banks) or in the financial condition report (insurance companies). It must contain at least the following information:
- description of the main features of the governance structure of the supervised entity to enable it to identify, evaluate, manage, monitor, and report on climate-related financial risks. In the Explanatory Report, FINMA specifies that it is the responsibility of the governing bodies to define the scope and quality of the company’s climate risk policy ;
- description of the short-, medium- and long-term climate-related financial risks and their impact on the entity’s business and risk strategy and any effects on existing risk categories. In its Explanatory Report, FINMA specifies that the TCFD recommends presenting several scenarios, including one based on the assumption of global warming of 2°C or less ;
- risk management structures and processes in place to identify, evaluate and manage climate-related financial risks ;
- quantitative information (targets and key data) on climate-related financial risks including the methodology used. Specifically, the supervised entity must disclose the criteria and methods used to evaluate the materiality of climate-related financial risks.
- Objectives
By extending the disclosure requirements to include climate-related risks, FINMA aims to promote market discipline and comparability and, ultimately, increase the protection of creditors, investors and insured parties.
- Timeline
The two revised Circulars entered into force on July 1, 2021. The first implementation of the reporting requirements regarding climate-related risks will take place in the financial year 2022 (for the business year 2021).
- Prospective assessment of the new publication requirements
According to FINMA, most of the banks and insurance companies subject to the new disclosure requirements were already voluntarily applying the TCFD disclosure principles before July 2021. For instance, UBS AG and Credit Suisse AG (the only two banks that fall into category 1) publish a voluminous and very detailed report dedicated to sustainability every year.[7]
Therefore, the partial revision of the FINMA Circulars is not expected to lead to major paradigm shifts within the affected banks and insurance companies. However, it can be expected to be a first step by the Swiss regulator towards a more comprehensive regulation in the future.
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[1] See “Increased transparency in the context of non-financial reporting duties (Part I)”, The Bridge – Newsletter, February 2022 (https://sfgeneva.org/increased-transparency-in-the-context-of-non-financial-reporting-duties/) and “Increased transparency in the context of non-financial reporting duties (Part II)”, The Bridge – Newsletter, March 2022 (https://sfgeneva.org/increased-transparency-in-the-context-of-non-financial-reporting-duties-part-ii/), which present the recent and upcoming regulatory changes in Switzerland and in the European Union.
[2] Article 66 of the revised CO2 Act.
[3] FINMA Risk Monitor 2019, p. 12.
[4] The TCFD recommendations are available at: https://www.fsb-tcfd.org/recommendations/. The TCFD has been created by the Financial Stability Board in 2015 with the purpose of developing recommendations that could enhance market transparency and stability.
[5] “Disclosure of the climate-related financial risks: partial revision of the FINMA Circulars 2016/1 ‘Disclosure – banks’ and 2016/2 ‘Disclosure – insurers’. FINMA Explanatory Report”, May 6, 2021.
[6] The classification of banks and insurance companies into different supervisory categories takes into account, amongst other factors, balance sheet amounts (banks and insurance companies) and amounts of the assets under management (banks). Supervisory category 1 applies to banks whose balance sheet total exceeds CHF 250 billion and the assets under management exceed CHF 1,000 billion. Supervisory category 2 applies to (a) banks whose balance sheet total exceeds CHF 100 billion and the assets under management exceed CHF 500 billion and (b) insurance companies with a balance sheet total exceeding CHF 50 billion. There are currently no insurance companies classified as category 1 entities.
[7] Their respective sustainability reports for 2021 are available at the following addresses: https://www.ubs.com/global/en/investor-relations/financial-information/annual-reporting.html (UBS Sustainability Report 2021) and: https://www.credit-suisse.com/sustainability/fr/rapports.html
(Credit Suisse Sustainability Report 2021).
