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| Financial institutions must be vigilant, otherwise they may lose everything because of imprudent environmental and social decisions. Keystone / Rank Augstein |
Climate change is compelling financial institutions to reevaluate their strategies and operations, with potentially significant impacts on their balance sheets. In a speech last June, Yves Mirabaud, chairman of the Swiss Private Banking Association, highlighted that bankers are evolving from purely financial professionals to evaluators of the environmental and social impacts of investments. Shortly after his address, the Swiss Financial Market Supervisory Authority (FINMA) mandated that banks and insurance companies transparently disclose their climate risks.
Historically, Swiss financial institutions have been allowed to self-regulate. However, FINMA's new policy underscores the importance of public transparency regarding accounting methods and climate risk.
Multiple Risks from Climate Change
Climate change poses several risks to the financial sector. The insurance industry is particularly vulnerable to natural disasters like hurricanes and floods. Banks funding polluting projects face reputational risks and potential litigation. Consequently, bankers are adjusting their risk management approaches, incorporating environmental and social factors into traditional risk and return evaluations. Financial institutions are also starting to monitor the companies they invest in more closely.
Mirabaud suggests that instead of divesting from polluting companies, banks should pressure these firms to adopt greener business models. Selling shares to profit-seeking investors won't solve the underlying environmental issues.
Rising Accountability and Public Pressure
Social movement groups frequently call on Swiss banks to be accountable for financing environmentally harmful projects, such as deforestation in the Amazon, the Siberian oil spill by Norilsk-Temel Energy, and the controversial Dakota pipeline project in the U.S. Despite Switzerland's ambition to lead in sustainable finance, these activities undermine such goals.
The Task Force on Climate-Related Financial Disclosures (TCFD) warns that changes in investor sentiment and business activities could disrupt financial markets by altering supply and demand dynamics for certain goods, products, and services. Investments once considered safe, like energy projects, may no longer be secure in the future.
Implementing New Standards
The TCFD, established by the Financial Stability Board, aims to help financial institutions align their governance, strategy, risk management, and goal-setting with increasing climate challenges. The Swiss financial sector has adopted TCFD standards for assessing climate-related risks.
Martin Raab, a board member of the fintech startup Global Green Xchange, notes that FINMA's requirement for banks to disclose climate risks may be challenging to implement. He points out the difficulty in quantifying the impact of climate events on banks' balance sheets, such as floods in Italy or droughts in Switzerland.
The Swiss branch of the World Wide Fund for Nature (WWF) welcomed the new regulatory requirements but lamented FINMA's reluctance to impose binding reporting standards. Without clear guidelines, disclosed data will vary, affecting the comparability and assessment of climate-related financial risks. WWF also urged FINMA to extend reporting obligations to all Swiss financial institutions, not just the largest ones.
The Swiss Bankers Association (SBA) believes smaller banks will eventually be included in FINMA's climate risk reporting system. Currently, the system covers five major banks, with PostFinance being the only one not yet using the TCFD model. The SBA anticipates that banks will need to make "extra efforts" to meet FINMA's requirements fully.
Costs and Benefits of Compliance
Martin Nerlinger, an assistant professor at the School of Finance at the University of St. Gallen, warns that increasing compliance requirements will raise costs. Banks will need to invest in training, processes, and IT systems. FINMA may also need to enhance its capacity to evaluate the influx of new data.
Despite the costs, financial institutions recognize that finance is crucial to achieving the Paris climate agreement goals, requiring trillions of dollars in annual capital investment until at least 2030. Rebuilding infrastructure, issuing green bonds and funds, and supporting alternative energy innovations can be profitable.
Daniele Stoffel, the Swiss Secretary of State for International Financial Affairs, recently noted that green investments tend to be less volatile than traditional ones, offering greater certainty to investors. Zeno Staub, CEO of Vontobel Bank, emphasized that integrating environmental, social, and corporate governance (ESG) standards into every investment decision is key to making sustainable finance successful.
As financial institutions adapt to these new realities, their ability to balance profitability with sustainability will be crucial in navigating the evolving landscape of climate-related risks and opportunities.