Financial risks associated with nature: definition and regulation

Climate change and the resulting deterioration in biodiversity are creating new risks throughout the world. It is a phenomenon that impacts both businesses and the financial sector, banks and insurance companies alike. International bodies are addressing the issue and defining standards. In Switzerland, the notion of nature-related financial risks is emerging, and regulations will evolve to provide a framework for the concept.

Are there any Swiss regulations governing nature-related financial risks?

FINMA has just opened a hearing on a new circular specifically devoted to nature-related financial risks. The circular follows the recommendations of international standard-setting bodies. It is aimed at banks and insurance companies. The public consultation will run until 31 March 2024. The circular should come into force at the beginning of 2025.

The aims of this circular are as follows:

  • scope of application of the provisions, not forgetting the need for proportionality for small banks ;
  • definition of the concept of nature-related financial risks ;
  • requirements for banks (credit risk, market risk, liquidity risk, reputational risk and operational risk) ;
  • requirements for the insurance sector (market, credit, liquidity, asset-liability management and operational risks).

What are nature-related financial risks?

According to the definition given by FINMA in its future circular, “these risks correspond to the risk of direct or indirect financial loss or any other negative consequences for the institution in the short, medium and long-term resulting from its exposure to risks of this nature”.

FINMA defines nature-related financial risks on the basis of the global understanding of climate and environmental risks of internationally recognised standards.

More specifically, FINMA is in line with the definition given by the Network for Greening the Financial System (NGFS). It agrees with the NGFS on the relevance of an integrated approach to climate risks and other nature-related risks, such as biodiversity loss.

Finally, this nature-related financial risk could have been included in emerging risks. However, this is no longer the case, as new regulations have been introduced imposing new requirements on banks. Every bank subject to these regulations will have to identify and assess its exposure.

According to FINMA, what exactly are the risks of nature?

FINMA continues its definition by describing the nature-related risks that affect banks and insurance companies and their services and activities. It refers to :

  • Acute or chronic physical risks, or both, arising from climatic phenomena such as floods, droughts, fires, storms and global warming.
  • Transition risks arising from changes in environmental management, such as decarbonisation and technological or behavioural developments.

What is the NGFS (Network for Greening the Financial System)?

In French, the NGFS stands for “réseau pour le verdissement du système financier”. The network comprises 114 central banks and financial supervisors. It has been in existence since 2017. The main objectives of the NGFS are as follows :

  • accelerate the deployment of green finance ;
  • issue recommendations to central banks on the role they can play in climate change.

In particular, the NGFS has defined nine strategies that central banks can adopt to bring their monetary policy into line with global climate objectives. One of these is called TF “nature-related risks”.

What does FINMA have to say about a sustainable financial system?

In its publications on the theme of Economy and Consumption, FINMA discusses the sustainable financial system. In order to ensure that ecosystems function properly for future generations, today’s economy must evolve towards a more sustainable model that makes more efficient use of resources. Thus “the Federal Council considers that (…), the theme of sustainable development allows:

  • not only to reduce the impact of environmental risks on financial stability;
  • but also to exploit commercial opportunities for the Swiss financial centre”.

FINMA is continuing its discussions by tackling issues such as :

  • biodiversity and the financial market ;
  • the global Taskforce on Nature-related Financial Disclosures (TNFD).

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