Recent years have seen regulatory institutions around the world introduce mandatory corporate disclosure regimes related to climate and environmental, social and governance (“ESG“) matters, largely as a response to the increasing materialization of ESG risks, in particular global heating and climate-driven natural catastrophes, as well as the growing awareness of the importance of full and transparent disclosure of the impact these risks have on corporations’ business and financial stability. They are also intended to create transparency around the effect that rapidly changing legislation and government policy in respect of environmental matters, such as the prioritization of renewable energy over fossil fuels, have on corporate entities within certain sectors. 

The global trend towards disclosure regimes of this kind is rapidly accelerating. In Switzerland, a number of initiatives have been introduced that represent first steps towards the corporate disclosure of ESG risks. Most recently, the Swiss Financial Market Supervisory Authority FINMA (“FINMA“) introduced a new climate risk disclosure regime earlier this year. This article first examines the requirements and impact of FINMA’s new regime, and follows by situating this initiative within the broader context of Swiss and international ESG disclosure regimes. 

By Deirdre Ní Annracháin (Reference: CapLaw-2021-61)

1) Overview of FINMA’s New Climate-related Risk Disclosure Regime

The new climate risk disclosure regime implemented by FINMA takes the form of a revision to two FINMA circulars: Circular 2016/1 “Disclosure – Banks” (“Offenlegung – Banken“) and Circular 2016/2 “Disclosure – Insurers” (“Offenlegung – Versicherer“). The revisions were announced by way of a press release on 31 May 2021 and entered into force as of 1 July 2021. 

The rationale for the new regime is based on FINMA’s mandate of supervising compliance with the legal requirements that apply to the financial market sector. As part of this mandate, FINMA is required to protect creditors, investors and insured parties and to protect the functioning of the financial markets. FINMA has indicated that the introduction of the new disclosure regime is part of its efforts to order to fulfil this mandate, in particular by increasing transparency in the marketplace. Specifically, the new disclosure regime is intended to be a first step towards meaningfully identifying, measuring and managing climate-related risks. The requirement to clearly identify climate-related risks should result in increased transparency which, over time, will bring about improved comparability between different entities, thereby strengthening the protection afforded to creditors, investors and insured parties. 

The new disclosure regime introduced by the revisions apply only to large banks and insurance companies (Supervisory Category 1 and 2 entities). At least for the time being, other entities under FINMA supervision are not subject to the new requirements. 

The rules introduced by the new regime require disclosure in the annual reporting (for banks) or in the financial condition report (Bericht über die Finanzlage) (for insurance companies) of information in respect of the management of climate-related financial risks. Specifically, the disclosure must include: 

– the central features of the entity’s governance structure which serve to identify, assess, manage and monitor climate-related financial risks, and to report on these risks; 

– a description of the short-, medium- and long-term climate-related financial risks, their impact on the entity’s business and risk strategy, and their impact on existing risk categories; 

– the risk management structures and processes for the identification, assessment and management of climate-related financial risks; and

– quantitative information (key figures and targets) in respect of climate-related financial risks, as well as the methodology applied in calculating these. 

Affected entities must also disclose the criteria and assessment methodologies they used in assessing the significance of climate-related risks. 

The above set of requirements is clearly based on a principle-oriented approach, as is generally FINMA’s practice. FINMA has indicated in its explanatory report (see Offenlegung klimabezogene Finanzrisiken: Teilrevision der FINMA-Rundschreiben 2016/1 “Offenlegung – Banken” und 2016/2 “Offenlegung – Versicherer (Public Disclosure)” – Erläuterungen; “Explanatory Report“) that it does not intend to specify the requirements in any greater detail than as set out above. This is to grant affected entities discretion on how to implement the requirements in light of their individual size, complexity, structure, business activities and risks. In particular, affected entities may determine themselves how extensive their disclosure should be and how this should be integrated into their existing reporting framework. 

However, FINMA has provided some guidance on how to interpret and apply the new disclosure requirements in practice (see Explanatory Report). As a starting point, FINMA has emphasized that the new rules are based heavily on the disclosure framework set out by the Task Force on Climate-related Financial Disclosure (“TCFD“), a body established in December 2015 by the Financial Stability Board, which is an independent international entity that promotes financial stability. FINMA has indicated that the majority of Category 1 and 2 entities in Switzerland (i.e. the entities that are subject to the new disclosure regime) have already voluntarily committed to comply with the TCFD disclosure principles, and that therefore for entities who already comply with the principles, no significant additional impact is to be expected. 

In addition, in its Explanatory Report, FINMA has expressed its view on the following topics of questions that may be of concern to entities that are required to comply with the new regime:

a) Definition of climate-related financial risks

An important question for entities subject to FINMA’s new regime is what exactly the term “climate-related financial risks” means. FINMA notes that there is no express legal definition of the concept that it can rely on. However, given the close alignment of the new disclosure regime with the TCFD standards, FINMA will rely on the latter to offer some insight as to what the term encompasses. 

According to the TCFD standards, climate-related financial risks can be loosely grouped into two categories of physical risks and transitional risks. Physical risks include economic damage caused by climate-related natural catastrophes and by changing climate conditions. For example, climate change can result in increased claims against insurance companies; meteorological conditions such as decreased snowfall in mountain and ski regions can trigger a loss in value of a bank’s mortgage portfolio and increase its credit risk; and operational disruptions to key service providers in vulnerable regions can result in multi-sectoral outages. 

On the other hand, transitional risks comprise the disruptive impact that climate laws and regulation, changing customer preferences or new technology breakthroughs can indirectly have on financial institutions. For example, new laws or guidelines in respect of CO₂ emissions can trigger asset value adjustments and impact banks’ and insurers’ market risk; increasingly stringent energy standards can reduce the value of real estate and, concurrently, increase the risk of mortgage defaults; and the creditworthiness of companies in unsustainable sectors such as the coal and oil industries can fall, thereby increasing counterparty default risks. 

Any of these risks can directly or indirectly increase the risk profile of a bank or insurer, and their impact may be significant. Without appropriate disclosure, however, the extent of the potential impact of materialized climate-related risks on these entities may not be readily perceived by external stakeholders and the investment community. 

Incidentally, FINMA has made clear that “climate-related financial risks” should not be considered as a new category of risk that entities are required to disclose. Instead, entities should describe the impact of climate-related financial risks on existing risk categories (e.g. credit, liquidity, market or operational risks), as well as the effect these risks have on the entity’s business strategy and risk profile. In doing so, the entity should specify not only whether the identified risks are short-term, mid-term or long-term in nature, but also what it deems “short”, “mid” and “long” term to mean in terms of years.

b) Prominence of disclosure in respect of climate-related governance structures

A key element of FINMA’s new disclosure regime is the description of the governance structures that are used to identify, assess, manage and monitor climate-related financial risks. However, the rationale for placing such emphasis on governance structures may not be immediately clear. 

FINMA explains that its emphasis on governance structures is due to the central importance of internal governance in establishing a “tone from the top”. It is this “tone from the top” which largely determines the quality and scope of an entity’s engagement with climate-risked financial risks. FINMA further clarifies that, in addition to disclosing how climate-related financial risks are identified, assessed and monitored, the relevant reporting channels must be disclosed, as must the responsibility taken by the board of directors for climate-related financial risks.

c) Rationale for the inclusion of quantitative information

Under FINMA’s new regime, entities are required to disclose quantitative information (key figures and targets) in respect of climate-related financial risks. They are also required to disclose the methodology applied in calculating these figures and targets. The rationale for these requirements has been justified by FINMA on the grounds that there are currently several different methodologies by which quantitative information on climate-related risks can be calculated. Therefore, disclosure of the methodology actually used by each individual entity will assist in making the quantitative information more comprehensible, while still giving the entity a degree of discretion in which methodology to choose. 

d) Assessment of “significance”

FINMA does not provide any guidance as to how the significance of climate-related financial risks should be assessed by disclosing entities. Instead, however, as set out above, it requires disclosure of the criteria and methodologies used in assessing the significance of climate-related risks. This, it explains, is because there is no established, standardized or internationally-recognized methodology for measuring the significance of such risks. Therefore, as a departure from the approach taken by other FINMA disclosure requirements (where insignificant risks do not need to be disclosed), if a climate-related financial risk is deemed to be immaterial, the entity in question must still disclose the methodology and criteria used to reach such conclusion. 

According to FINMA, this rule is intended to promote serious contemplation of the significance of climate-related risks. It is also designed to prevent entities from making a blanket denial that any material risks exist.

2) Landscape in Switzerland and Internationally

The new disclosure regime introduced by FINMA should not be viewed as an isolated measure. Instead, it is part of a global shift towards the introduction and standardization of mandatory climate-related and ESG disclosure regimes. 

In this respect, the European Union has been at the forefront of many of the most recent developments. Since 2014, its Non-Financial Reporting Directive (Directive 2014/95/EU, “NFRD“) has required a degree of disclosure for certain large, public-interest companies in respect of ESG topics. More recently, the EU has introduced a new ESG-based legislative agenda that rests on three main pillars: first, a proposal made in April 2021 to introduce a Corporate Sustainability Reporting Directive. This is intended to would amend and improve the existing ESG-related disclosure rules set forth in the NFRD, including by extending the scope of the NFRD and specifying in greater detail the information to be reported. Second, the Taxonomy Regulation (Regulation (EU) 2020/852), which became entered into force on 12 July 2020, introduces a system for classifying environmentally sustainable activities and requires entities to disclose key indicators about the environmental sustainability of their operations. Third, the Sustainable Finance Disclosure Regulation (Regulation (EU) 2019/2088), which entered into force on 10 March 2021, introduced a sustainability risk disclosure framework for asset management firms and financial services institutions.  

The United States has also taken steps to introduce a mandatory ESG disclosure regime. Specifically, in March 2021 the U.S. Securities and Exchange Commission (“SEC“) announced that its examination priorities would include a greater focus on climate-related risks (see https://www.sec.gov/news/press-release/2021-39) and that it was establishing a Climate and ESG Task Force within its Division of Enforcement (see https://www.sec.gov/news/press-release/2021-42). The SEC proceeded to initiate a process to seek feedback from market participants on mandatory climate disclosures (see https://www.sec.gov/news/public-statement/lee-climate-change-disclosures). It has since then repeatedly indicated that the introduction of an ESG disclosure regime is imminent. This action by one of the most powerful regulatory authorities in the world serves as a clear indication of the spotlight that will be placed on ESG-related disclosure rules in the coming years.  

Within Switzerland, certain measures have also been introduced that indicate a shift towards the increased ESG disclosure. It is true that the Responsible Business Initiative (Konzernverantwortungsinitiative), which in 2020 proposed a far-reaching set of ESG disclosure obligations, and the proposed CO₂ law (CO₂-Gesetz), which in 2021, inter alia, would have required FINMA and the Swiss National Bank to regularly review the financial risks connected with climate change and to report on their conclusions, were both defeated and will not enter into force. 

However, the softer alternative to the Responsible Business Initiative – the Gegenvorschlag – will enter into force on 1 January 2022. This change in law will introduce an obligation on certain large companies domiciled in Switzerland to publish an annual ESG report, as well as an obligation on all Swiss companies that import minerals from conflict or high risk areas, or whose products or services may have a connection to child labour, to carry out certain due diligence processes on their supply chain and to report on these processes. 

In addition, FINMA on 3 November 2021, FINMA published guidance on preventing and combatting greenwashing (see FINMA-Aufsichtsmitteilung 05/2021 Prävention und Bekämpfung von Greenwashing). In its guidance, FINMA described what it considered greenwashing to consist of in the context of Swiss collective investment schemes and indicated that greater transparency would be required for sustainability-related Swiss collective investment schemes. FINMA also outlined the factors that it would take into account when assessing the organisational structure of institutions that manage sustainability-related collective investment schemes. 

Further, in 2017, Switzerland’s main trading exchange, SIX Swiss Exchange, introduced the possibility for listed companies to inform it on a voluntary basis that they have opted to produce an annual sustainability report in accordance with an internationally recognized standard. Currently, 30 companies listed on SIX Swiss Exchange have opted in to this regime. 

It is therefore clear that in Switzerland as in the rest of the world, the trend is moving towards the introduction of increasingly stringent ESG-related disclosure obligations.

3) What is next?

FINMA has been clear in stating that its new disclosure regime should be considered as a first step towards a potentially more comprehensive climate-related disclosure regime. Prior to the publication of the new rules, it carried out a consultation process with stakeholders and market participants, several of which urged FINMA to adopt a more expansive regime (see Rundschreiben 2016/1 “Offenlegung – Banken” und 2016/2 “Offenlegung – Versicherer (Public Disclosure)” Teilrevision: Bericht über die Ergebnisse der Anhörung vom 10. November 2020 bis 19. Januar 2021). The proposals included a potential extension of the rules to other (smaller) types of supervised entities, the requirement to carry out and publish “scenario analyses” based on different assumptions, such as global heating of 2°C or greater, and the suggestion that the disclosure obligations should extend not only to climate-related risks, but also “environmental risks” (e.g. biodiversity loss). Certain respondents went so far as to suggest that the disclosure requirements should encompass the overall climate impact of financial activities, and not merely climate risks, which FINMA rejected as being beyond the scope of its mandate.  

In light of these proposals, and FINMA’s position that it is open to extending the newly-introduced rules, it is likely that FINMA’s requirements in respect of the disclosure of climate-related risks will become more stringent and comprehensive in the near future. It remains to be seen to what extent some version of these requirements eventually become applicable, via other legislative means, to non-FINMA supervised entities.

Deirdre Ní Annracháin (deirdre.niannrachain@nkf.ch)