FINMA Circular on nature-related financial risks

Sustainability considerations are increasingly taking centre stage in the ever-evolving landscape of financial regulations. Financial institutions are now required to disclose their environmental, social, and governance (ESG) impacts and dependencies of their portfolios and operations, whilst rapidly evolving regulations as part of the European Green Deal are further shaping the landscape by setting clear standards for sustainability reporting, risk management, and compliance.

The latest regulatory advancement in this context is the recently published Swiss Financial Market Supervisory Authority (FINMA) Circular on nature-related financial risks¹. The Circular serves as a crucial framework guiding Swiss financial institutions on how to manage and disclose risks linked to nature-related and biodiversity factors. As climate change and environmental degradation pose growing threats to financial stability, FINMA's forward-thinking approach aims to ensure that the financial sector remains resilient whilst contributing to the global sustainability agenda. Physical and transition risks related to climate change, for instance, increase the likelihood of asset write-downs for residential properties or cause operational disruptions in companies’ supply chains. However, these challenges also present opportunities for better investment strategies and improved risk-return profiles.

This blog delves into the key provisions of the FINMA Circular, exploring its implications for the financial industry.
 

What:
 

FINMA sets out its supervisory practice for the management of nature-related financial risks in a new Circular. The FINMA requirements are summarised into 4 main pillars:

When

Who:

All FINMA-regulated institutions with the following exceptions:

• Institutions participating in the small banks and small insurance companies’ regime, securities firms, and asset managers.
• Stress testing is only required for category 1 and 2 banks, similarly only insurers in categories 1 and 2 should incorporate nature-related financial risks into their Own Risk and Solvency Assessment (ORSA) framework.
   

How can you get started?

To effectively integrate the principles of the FINMA Circular on nature-related financial risks, we suggest conducting a comprehensive gap assessment to evaluate your organization’s readiness with respect to the aforementioned 4 pillars.

Governance

Evaluate the current governance structures and practices, including roles and responsibilities in overseeing sustainability initiatives and risk management. The following maturity levels are currently observed across the financial industry:

• Basic integration: ESG responsibilities are assigned on an ad hoc basis to existing functions (e.g., compliance, risk management), without formalised roles or committees dedicated to ESG matters.
• Systematic integration: Formal ESG roles (e.g., ESG officer, sustainability manager) and committees are established, including cross-functional working groups.
• Industry leadership: ESG considerations are fully integrated into the bank's governance structure, with ESG committees reporting directly to the board of directors (e.g., Chief Sustainability Officer).
   

Risk identification, materiality assessment and scenario analysis

Analyse the processes to identify nature-related risks and to quantify their impact on key risk parameters. The following maturity levels are currently observed across the financial industry:

• Qualitative assessment: Identify nature-related risks and quantify their potential impact on financial risks in a qualitative fashion, based on industry insights and input from business experts.
• Quantitative assessment: Model the financial impact of nature-related risks, using initial scenario analysis and establishing a link between risk parameters (PD, LGD) and ESG risk drivers (e.g., EBITDA/interest expense, loan-to-value).

Risk management

Review how nature-related risks are currently integrated into your overall risk assessment and management processes, ensuring that they are adequately monitored and mitigated. The following maturity levels are currently observed across the financial industry:

• Basic integration: ESG considerations are only addressed for the most material areas such as mortgage and corporate lending, or on an ad hoc basis, often in response to specific events (e.g., natural catastrophes).
• Advanced integration: ESG is fully integrated into the bank’s risk identification, materiality assessment, risk monitoring, risk mitigation, and reporting processes using advanced tools and methodologies (e.g., scenario analysis, quantitative modelling).
   

Stress testing

Assess the adequateness of current scenario generation and stress testing capabilities to understand the potential impacts under various environmental stress scenarios and time horizons. The following maturity levels are currently observed across the financial industry:

• Expert-based approach: Sensitivities/parameters are estimated by benchmarking and business experts.
• Top-down modelling approach: Macro-sensitive scalars or other transformations (e.g., Z-factor model) of baseline risk parameters (PD, LGD).
• Bottom-up modelling approach: Macro-sensitive functional models (e.g., carbon elasticity model) for risk parameters (PD, LGD).

As a next step, financial institutions should develop a roadmap based on the identified gaps and the target operating model in order to achieve compliance with the FINMA Circular.
 

How we can help
 

The definition of a robust governance and risk management framework with integrated risk quantification and stress testing capabilities are the cornerstones to effectively manage nature-related financial risks in light of current and upcoming sustainability regulations.

Deloitte has successfully supported numerous institutions in Switzerland and Europe in addressing sustainability requirements and we would be delighted to assist your organisation to achieve compliance and ensure long-term resilience in the face of environmental challenges.

Thank you to the key contributors to this article: Cederic Van Renterghem, Piero Lorenzini and Greta Cenotti.

1 Nature-related financial risks encompass both climate-related financial risks and other types of nature-related risks such as biodiversity risk.