Solvent wind-down (SWD) is regulated by the European Bank Recovery and Resolution Directive (BRRD) and supervised by the Single Resolution Board (SRB). Banks must demonstrate, by means of an SWD plan that they can exit their trading activities in an orderly manner while avoiding posing risks to the stability of the financial system. The SWD guidance¹ sets out the necessary steps and initiatives for banks to take, structured along seven dimensions² from the Expectations for Banks publication³, to ensure they are resolvable and to demonstrate their preparedness for a potential resolution.

Winding down requirements

Banks with material trading books⁴ are expected to develop a granular plan to prove their capability to wind-down their trading books. Winding down trading books requires careful planning and analytical capabilities, including:

• An SWD plan outlining the different segments⁵ and associated exit strategies for its trading activities and the potential financial implications. The plan should include an initial snapshot (taken ‘today’) providing a description of the trades and desks as the starting point of the wind-down period and a target snapshot providing positions targeted for the ‘rump’ portfolio, i.e. the positions that remain in the trading book after the wind-down period. Furthermore, the plan should determine the exit, risk-based and operational costs, and assess the impact on liquidity and risk-weighted assets (RWA).
• Information provision on SWD planning, such as the capacity to update the plan on a regular basis and in a timely manner, using business as usual (BaU) tools, systems, and infrastructures as much as possible.
• Constructing an SWD playbook that focusses on governance, HR and communication as defined in the Financial Stability Board’s (FSB) discussion paper. The FSB paper⁶ sets out considerations related to the solvent wind-down of the derivative portfolio activities of a G-SIB that may be relevant for authorities and firms for both recovery and resolution planning. The playbook should provide clarity on the necessary steps and actions taken during the wind-down period, including, identification of the parties involved in the decision-making, their responsibilities and communication with relevant stakeholders.

The SWD plan outlines the technical aspects of winding down the trading book while the SWD playbook describes the process of how to execute the exit strategy. Banks are expected to initially provide the day-one requirements for the SWD plan and playbook. Thereafter, the SWD plan and playbook need to be expanded and improved to meet the steady-state requirements. This entails a comprehensive upgrade, providing a more granular analysis and the ability to update the exit strategies based on the latest balance sheet within five working days. Note that the bank management could decide to wind down only a few desks. The SWD plan could therefore include multiple scenarios in which different parts of the trading book are wound down.
By 2021, all G-SIBs received instructions from the SRB to work on SWD planning as a Resolution Planning Cycle (RPC) 2022 priority. Other banks have been identified and approached by the SRB in the course of 2022 following a further assessment of the significance of their trading books, to work on SWD planning as an RPC 2023 priority.

SWD of the trading books

When resolution is triggered, the bank must execute its SWD plan which consists of the four phases indicated in Figure 1. During the first phase, staff and clients are informed and the SWD plan is updated based on the latest trading book status. Then, during the passive wind-down period, trading desks start the preparations to wind down their trading books. During this period, no active trading is allowed, unless specifically requested by the client. During the active wind-down period, exit strategies are executed, while not being able to access the over-the-counter (OTC) market. The bank is required to update their sensitivities (Greeks), costs of winding down, operational costs, and impact on liquidity and RWAs on a quarterly frequency for the full wind-down period. Finally, after two years, most of the trading activities should have been wound down and the few remaining trades that could not be sold, are managed until they mature or are terminated.

Averages can be useful metrics if you want to understand the changes over time in a certain population or data set, like housing prices, consumer confidence, or the indebtedness of corporates. The above story, however, shows – in a rather harsh way – that an average isn’t always the best metric to go by. The increasing use of ESG ratings² seems to suggest that this lesson is not sufficiently understood.

In recent years, sustainability has taken center stage in the financial sector. Triggered by (among others) the European Commission’s Green Deal, to fight the threats from climate change and environmental degradation, in November 2020, the European Central Bank published clear expectations on the way banks should manage climate-related and environmental risks. Another example is the introduction of the Sustainable Finance Disclosure Regulation (SFDR) that requires banks and asset managers to disclose information on how they integrate sustainability risks and potential adverse sustainability impacts in their investment process.

To put these new expectations and regulations into practice, extensive use is being made of ESG ratings. These aim to measure the performance of a company on Environmental, Social, and Governance (ESG) aspects; a bit like how credit ratings measure a company’s Probability of Default (PD). Stemming from the breadth of ESG topics, the number of indicators underlying an ESG rating typically dwarfs the number of indicators used to determine credit ratings. More than 100 indicators is not exceptional. These can range from environmental indicators like the company’s level of greenhouse gas emissions, water usage, and pollution, to social and governance indicators like the number of accidents in the workplace, the use of child labor, and the presence of anti-corruption policies. Not surprisingly, academic literature shows that ESG ratings differ considerably between rating providers.³

In practice, an ESG rating often is the (weighted) average of all individual indicators. This may not give the best indication of the ‘depth of the river’: Tesla Inc. may score rather well on certain environmental aspects, being the frontrunner in electric vehicles. From a social and governance perspective, however, it may not be considered best-in-class. Consequently, averaging the scores over the E, S, and G pillars does not lead to a proper understanding of the sustainability risks involved in this company. Or think of it this way: is child labor (negative score) less of a problem if a company’s employees enjoy freedom of association (positive score)?⁴

The issue also surfaces within the three ESG pillars as a wide range of indicators will be considered to determine a company’s performance for any of the three pillars. As an example, a Kuwait-based oil drilling company will likely score not so well on greenhouse gas emissions, but may obtain a good score on deforestation (given the lack of trees in the desert to begin with). Again, blindly averaging all environmental indicators will not lead to a very useful metric for the environmental performance of the company, nor will it help understanding to what climate risks a company is exposed to.

To truly understand a company’s sustainability risk profile, it is therefore important to assess all (material) indicators individually. Only in this way it is possible to properly address the multifaceted nature of ESG. Those who use only the aggregated ESG rating risk drowning.

Footnotes:

1 “Behar proverbs” – Classified and arranged by John Christian – 1891 – page 120 

2 In this column, an ESG rating is defined as a single (aggregated) measure for the performance of a company with respect to environmental, social, and governance factors. 

3 “Aggregate confusion: the divergence of ESG ratings” – Berg et. al – 15 April 2022 

4 Freedom of association grants employees the right to join a trade union. 

We’re excited to announce that Zanders, the leading consulting firm specializing in treasury, risk and finance, is expanding its services to include Blockchain consulting. As the world of finance rapidly evolves, we recognize the need to keep pace with emerging technologies. This prompts us to offer innovative blockchain technology consulting and solutions to Corporates and Financial Institutions to help them stay competitive in their market.   

Disruption of the financial sector

Blockchain technology has been disrupting the financial sector and beyond, and we believe that it has the potential to transform the way businesses operate. It has the potential to revolutionize financial markets through changes in the product offering, as well as the market infrastructure. With our new Blockchain consulting services, we aim to guide our clients through the complexities of this technology and help them leverage it regardless, whether you wish to issue a digital asset, assess the impacts of the BCBS (Basel Committee on Banking Supervision) Crypto Standard on your capital requirements or understand how crypto assets impact your existing treasury and risk management and governance processes. 

Our services

Our Blockchain consulting services will cover a range of topics, including education, proof of concepts, strategy consulting, governance, treasury, risk assessment and ESG. We understand that every client has unique needs, and we will work closely with them to tailor our services to their specific requirements. Possible topics of interest for your organisation may include: 

Proof of concept 

We help clients develop proof of concepts to test the feasibility of Blockchain solutions. Our team of experts will work with clients to design and build prototypes that can be tested in real-world scenarios. We support from the idea to the implementation.  

Strategy 

Our strategic Blockchain advise provides valuable guidance to clients. We jointly work with our clients to develop Blockchain strategies that align with their overall business goals and help them prioritize their Blockchain initiatives as part of our Blockchain Strategy Explorer. The Blockchain Strategy Explorer is a guided, in-person 1-day workshop free of charge, to improve your Blockchain knowledge and define your Blockchain strategy. 

Treasury 

Blockchain and the exposure to crypto assets impact not only the front office but also treasurers. Zanders provides the advice as well as the tools to thoroughly integrate crypto assets into your daily operations. Furthermore, we jointly develop strategies that make best use of this new asset class. 

Risk management 

With the onset of the BCBS Crypto Standard on 1st January 2025, the capital requirements for holding digital as well as crypto assets is more clearly defined. We support financial institutions in assessing the impact of this regulatory change on capital and developing a suitable strategy. 

Governance 

Governance is a critical component of any Blockchain implementation. We help clients establish governance frameworks that ensure that their Blockchain strategies are secure, compliant, and aligned with best-market practices.  

Environmental, Social and Governance (ESG) 

The importance of ESG considerations is growing in the business world. We help clients evaluate the environmental and social impact of their Blockchain solutions and ensure that they are in line with their ESG objectives. Among other things, we play a key role in increasing the transparency of carbon markets by providing advice on the tokenization of carbon credits. 

Education 

Our education services help clients gain a deeper understanding of Blockchain technology, its potential applications, and its limitations. We provide training sessions and workshops that will enable clients to make informed decisions about whether to implement Blockchain solutions. 

Meet the team 

Zanders already has a well-positioned, diversified blockchain team in place, consisting of blockchain developers, blockchain experts and business experts in their respective fields. In the following you will find a brief introduction of four of our lead Blockchain consultants. 

Do you need support or help in the field of Blockchain, Digital Assets or Web3? 

We are thrilled to offer Blockchain consulting services and look forward to working with our clients to help them leverage this technology to transform their businesses. If you are interested in learning more about our services, please contact us directly.  

Artificial Intelligence versus Machine Learning

Anyone familiar with the functionalities of SAP is aware of its intelligent ’machine learning’ capabilities. This system looks for patterns in the user’s behavior and creates recommendations and shortcuts to optimize the experience and relieve labour-intensive and repetitive clearing processes. Artificial Intelligence, however, would revolutionize the experience entirely. For example, Microsoft is currently developing AI integrated with Excel which will negate the requirement for users to remember different formulas or spend hours putting together various graphs. Soon, it will be possible to input a request to the application; it will know where to source data from and will create the analysis automatically.

If we were to translate this to SAP, we could be looking at a world where T-Codes are no longer needed and where the user can ask the system a question or request a task to be performed. For example, instead of going about creating an invoice or needing to explain to management why a forecast isn’t aligned, we can ask the system to do it for us. Answering the questions will become more efficient, if the right questions are asked…

The future of analysis and development

Technologies like ChatGPT and future AI systems are set to transform the typical workflow of treasury professionals as well as wider business analysis across the world. Predictive analysis will allow businesses to make even more informed and intelligent decisions through improved models. While SAP already utilizes data upload from market sources such as Reuters and Bloomberg, we can expect to see a more intelligent system providing users with risk models, investment recommendations and better-informed risk models.

These help treasurers and companies at large make more accurate and strategic decisions regarding cash management and borrowing. There’s also less capacity for error through the assistance of AI; treasurers will be able to utilize automated next level financial reporting tools, saving organizations time and also ensuring regulatory requirements are abided by. Finally, treasurers will get to work with greater cash management optimization, a fundamental part of their roles; allowing businesses to keep borrowing to a minimum and ensuring cash is available when its needed.

A better experience for clients

This additional reduction in repetitive tasks will provide more time for solving complex tasks and establishing better relationships with clients. It should also provide the space for more innovative and expanded analysis. The social experience between consultants and clients will also become even more important; whereas computers will explain things very directly, the empathetic and open-minded consultant will be able to provide solutions in a manner that will be easier to digest. Trust in new technology, particularly among the ever-prudent treasury community, will also remain pivotal. It’s hard to foresee a future where a Head of Treasury will take a response from a computer that they do not agree with and just move on.

Where are we right now with ChatGPT and SAP?

It is without a doubt that the future of treasury technology and SAP in particular is exciting. It will be up to the leaders of organizations to work collaboratively with consultants to ensure such benefits afforded by advancements in AI will be taken advantage of.

For now, though, we are still in the infant stages of what is an exponentially growing piece of tech. The limitations of ChatGPT and its potential for collaboration with SAP focus on privacy and trust. OpenAI is quite open (excuse the pun) about the fact that one should not enter delicate data into the system as it cannot guarantee that such information’s integrity and privacy can be maintained. Furthermore, it is based on the data from the internet of 2021 – so therefore, it is somewhat out of date.

This is a developing story, not a settled one. The future has not happened, rather it is happening and as many are saying: We will not be replaced by AI – we will be replaced by those that embrace AI.

Meeting business needs

Often Corporate Treasury requires support and expertise in designing the future business process and how the SAP Treasury system and architecture can meet business needs. One of the biggest challenges here is to find a trade-off between the different business requirements and the standard capabilities of SAP and its interfaces.

One of the main drivers of the custom requirements is hidden in the existing user experience. The end users/stakeholders got used to the old TMS functionality and behaviour, which is not the same in the new SAP system.

An experienced and independent consultant would first recommend leveraging the TMS standard functionality and proposing solutions to meet the business requirements with minimum custom functionality. In this case, the consultants often run TMS DEMO sessions in the new SAP Treasury; pre-configure the TMS and provide proof-of–concept solutions to provide evidence of certain complex functionality that can be aligned with standards.

Why is standard functionality important?

There are six reasons why we think the standard functionality is so important:

1. It is supplied out–of–the–box and pre-designed by the system provider. Consequently, less time is needed to design the business process compared to design bespoke solutions.
2. It is used by other clients and the system provider already analyzed the user experience of the solution. Hence, there is a higher level of quality assurance.
3. SAP supports its own products and any enhancement of the TMS must be done by the system provider with minimum regression impact (impact on the current and working functionality).
4. A client can raise SAP expertise internally or hire an external consultant to support the known functionality. There is no dependency on the knowledge of custom functionality.
5. It provides easier business process standardization and scaling among different countries/regions.
6. It helps to find treasury employees with known SAP Treasury experience, the knowledge can be taken from the market.

Nevertheless, it is quite hard to drop custom bespoke solutions; sometimes it must be applied in the design and implemented for the clients.

Sometimes custom solutions are needed

There are some reasons to implement custom solutions in a treasury system’s architecture:

1. Strict and complex client requirements which cannot be met by standard functionality. There is no workaround in the standard. The most common example is cut-off time logic for POBO payments or calculation of internal FX rate types, among others.
2. Standard functionality is not yet released to clients. However, it is crucial for a client to get it as soon as possible.
3. Custom SAP functionality is already in place but needs to be enhanced.

Recommendations for the custom solutions

If a custom solution is inevitable, we have a couple of best practices.

Firstly, avoid the hardcoding of multiple conditions in the ABAP code. Instead, move the maintenance of the conditions to either custom or standard tables which can be supported by functional SAP support personnel or even by business users. Once a minor change in the conditions is needed there will be no need for a developer.

Secondly, leverage the use of SAP functional modules, programs, BAPIs and BADI etc. This makes the custom code more stable and leaves it less exposed to regression risks during the next system upgrade.

Also, avoid replacing significant pieces of the standard functionality with custom-developed ones which do not bring significant improvements. Supporting such SAP TMS becomes complex and expensive.

To conclude

We recommend that you minimize the volume of the custom solutions during TMS systems implementation. A good balance should be found between business requirements versus SAP standard functionality.

SAP continuously improves its solutions in response to customer feedback, changes in financial standards, regulatory requirements, technology trends, etc. Therefore, it is important to conduct the TMS audit from time to time to see if old and custom functionality can be scrapped since there is standard functionality already available.

If you need an audit of your treasury systems, have challenges with custom solutions or need help with the system design, please feel free to approach us. We have extensive experience in enhancing treasury technology and improving treasury functions.

Key takeaways:

• In November 2022, a law was approved that requires all Swiss firms above a minimum size (hence including financial institutions) to disclose climate-related information in line with the recommendations from the Task Force for Climate-related Financial Disclosures (TCFD) as of 1 January 2024. This comes on top of the existing law that came into force on 1 January 2022, requiring all firms to disclose more broadly their management of risks to the environment, social engagement, employee interests, human rights and avoidance of corruption (for the first time as part of their annual disclosure over 2023).
• In January 2023, Swiss supervisory authority FINMA published additional guidance in which it highlights its expectation that banks and insurance companies in Switzerland proactively engage with the recent guidance and recommendations issued by the BCBS and IAIS. FINMA will intensify its supervision of the measures that institutions are taking to address climate risks and it will expand this to cover a larger number of institutions (current focus is on the largest institutions, those in FINMA categories 1 and 2). In November 2022, FINMA also published recommendations for improvements of disclosures about climate-related financial risks by category 1 and 2 institutions to satisfy existing climate-related disclosure rules, which came into effect on 1 July 2021.
• In December 2022, the Swiss Federal Council (‘Bundesrat’) published its action plan ‘Sustainable Finance in Switzerland – Areas for action for a leading sustainable financial centre 2022-2025’. The action plan contains 15 initiatives to improve the availability of comprehensive and comparable sustainability data for the full Swiss economy, enhance transparency in the financial sector with respect to climate and biodiversity risks, promote impact investments and green bonds, and support international initiatives for the pricing of environmental damage.

Disclosure requirements in line with the TCFD

From 1 January 2024, all firms above a minimum size¹ are legally required to disclose climate-related information in line with the recommendations from the Task Force for Climate-related Financial Disclosures (TCFD) (see media release). An overview of the TCFD disclosure recommendations can be found in this separate article.

This law provides details on climate-related reporting requirements in relation to a law that entered into force on 1 January 2022². This earlier law requires firms to disclose their management of risks in relation to climate change and the environment, social engagement, employee interests, human rights and avoidance of corruption. Firms have to report on this for the first time as part of their annual disclosure over 2023, at the latest by end of June 2024. This law is based on, and in some aspects extends, the EU directive 2014/95 on Corporate Social Responsibility (CSR) reporting from 2014³.In addition, this law requires firms that import and/or process minerals from conflict or high-risk regions as well as firms which offer products or services for which the use of child labour in its supply chain is likely, to establish and report on due-diligence measures that have been implemented to manage these risks in line with international agreements.

FINMA: Guidance with respect to the management of climate risks

FINMA issued additional guidance for the management of climate risks by banks and insurance companies in January 2023⁴. This guidance follows the publication of documents by international supervisory bodies in the financial sector, specifically:

• ‘Application paper on the Supervision of Climate-related Risks in the Insurance Sector’ by the International Association of Insurance Supervisors (IAIS) in May 2021 (See IAIS)
• ‘Principles for the effective management and supervision of climate-related financial risks’ by the Basel Committee on Banking Supervision (BCBS) in June 2022 (See BCBS Principles and for a summary, see our recent article)
• ‘Frequently asked questions’ by the BCBS in December 2022 (See BCBS FAQ), intended to facilitate a globally uniform interpretation of the existing Pillar 1 standards in relation to climate risk⁵.

In the guidance, FINMA reiterates that climate risks in the form of transition, physical, legal and reputational risks should not be seen as separate risk categories, but as risk drivers for existing risk categories. It further emphasizes that banks and insurance companies are expected to implement the recommendations as contained in the above papers by the BCBS and IAIS. The areas of the recommendations are summarized in the table below.

In its supervision of climate-related risks, FINMA is currently focusing on the institutions in FINMA categories 1 (currently UBS and Credit Suisse, no insurance companies) and 2 (currently Raiffeisen, PostFinance and the Zürcher Kantonalbank (ZKB) as well as five insurance companies). FINMA is also gathering initial experiences with climate scenario analysis. Over time, FINMA intends to generally intensify its supervision of the measures that institutions are taking to address climate risks and it will expand this to cover a larger number of institutions.

Institutions in supervisory categories 1 and 2 were already subject to climate-related disclosure rules from FINMA as of 1 July 2021, as embedded in the disclosure circulars 2016/1 (for banks) and 2016/2 (for insurers). The required disclosure covers:

• The governance structure in place to identify, assess, measure and monitor climate-related financial risks
• The impact of climate-related financial risks on the business and risk strategy as well as on the existing risk categories in the short, medium and long term
• Risk management structures and processes to identify, assess and manage climate-related financial risks
• Quantitative information (metrics and targets) employed, including the measurement methodologies used

In November 2022, FINMA issued an evaluation of climate-related disclosures by these institutions in their 2021 annual reports against the disclosure rules. FINMA concludes that the institutions largely met the disclosure obligations but observes that it is still difficult for readers to get a clear picture about the effective relevance of climate-related financial risks for the individual institutions. According to FINMA, it proved difficult to find the specific disclosures on climate-related financial risks in the annual and/or other (e.g., sustainability) reports and it expects institutions to more clearly present this. Furthermore, FINMA suggests the following improvements:

• More specific information on how climate risk is managed as part of the overall governance structure. This should include internal reporting of climate-related financial risks, which FINMA views as a part of embedding them in the internal governance
• More detailed information on how climate-related risks impact the business and risk strategy, including the results of a materiality assessment and differentiation of short-, medium- and long-term impact
• More transparent information about the risk management structures and processes in place to identify, assess and manage climate-related financial risks
• Clarification of the connection between climate-related financial risks and the metrics and targets that are disclosed, and which (sub)portfolios are covered by the metrics

FINMA notes that the disclosures did not give sufficient transparency about the criteria and assessment methods by institutions to evaluate the materiality of climate-related financial risks.

Swiss Federal Council: Sustainable Finance Action plan 2022-2025⁶

The Sustainable Finance Action plan 2022-2025 of the Swiss Federal Council (“Bundesrat”) is written against the background of fulfilling the 17 UN Sustainable Development Goals (SDGs) by 2030. However, the focus is on risks and opportunities in relation to the mitigation of climate change in line with the Paris Agreement and of biodiversity loss. The action plan consists of 15 measures in four main areas:

A: Sustainability data from all sectors of the economy

B: Transparency in the financial sector

C: Impact investments and green bonds

D: Pricing of environmental damage

An overview of the individual actions, grouped by main area, is shown in the following chart.

Source: Swiss Federal Council, Sustainable Finance in Switzerland – Areas for action for a leading sustainable financial centre, 2022–2025, 16 December 2022 (media release)

Below we summarize each of the 15 actions on which the Swiss government will focus, following the numbering in the graph above. Some of the actions will benefit investors and involve additional effort from financial institutions (such as those leading to additional rules or disclosure requirements in actions 1, 5, 7, 8 and 9) while others aim to benefit financial institutions (such as actions 2, 3 and 10). Some actions will affect or benefit society at large (actions 6 and 11 to 15).

A – Sustainability data from all sectors of the economy

1. This action corresponds to the law with climate-related financial disclosure requirements according to the TCFD recommendations, which we described earlier in this article. In addition, the Federal Council will continue to follow and participate in international discussions regarding biodiversity-related financial disclosures.

2. The Swiss government will increase the availability of data about the climate-friendliness of buildings in Switzerland (CO₂ emissions, energy efficiency and alignment with the Swiss climate goals) in the Gebäude- und Wohnungsregister (GWR)

3. Support the introduction of a green fintech classification system (see website), which can help existing players in the Swiss financial sector to obtain access to and/or process sustainability related data in a more efficient manner.

B-  Transparency in the financial sector

4. The Swiss government encourages financial institutions to join international Net-Zero-Alliances. Furthermore, it collaborates in the international Climate Data Steering Committee (CDSC) to establish a database to create transparency about the commitment of reduction in greenhouse gas emissions of individual financial institutions.

5. In December 2022, the Federal Council recommended that financial institutions and pension funds publish information on how their client engagement strategy and the exercise of equity voting rights aligns with the own net-zero strategy.

6. The government will continue to conduct regular, voluntary climate tests of the financial sector, to provide transparency how the financial sector as a whole aligns with achieving the goals of the Paris agreement (results of the 2022 test can be found on this website).

7. Already in 2020, the Federal Council recommended that financial institutions publish the methods and strategies employed for taking account of climate and environmental risks when managing clients’ assets, in accordance with the existing legal duties of loyalty and due diligence.

8. In June 2022, the Federal Council recommended that financial institutions use comparable and meaningful information about alignment of financial investments and client portfolios with global (net-zero) climate goals. To support this, it introduced the ‘Swiss Climate Scores’ (see Climate Scores website). These Swiss Climate Scores comprise indicators for both the current and prospective alignment with global (net-zero) climate goals, which are summarized in the table below.

9. Establish rules to avoid greenwashing of financial products and services, ensuring that products and services that are labeled as sustainable are aligned with, or contribute to the achievement of at least one specific sustainability goal.

10. Promote sustainable finance education

C. Impact investments and green bonds

11. Promote impact investments in developing countries, for example by establishing the ‘Sustainable Development Goals (SDG) Impact Finance initiative’ in 2021 and the goals of the ‘Swiss Investment Fund for Emerging Markets (SIFEM) 2021-2024’.

12. Examine, in collaboration with the industry and FINMA, how financial market legislation can be amended to promote the expansion of impact investments.

13. Issue green Swiss Confederation bonds.

D – Pricing of environmental damage

14. Active support of multi-lateral initiatives to establish an equitable global carbon price.

15. Investigate what role the federal government can play to exploit opportunities for the Swiss financial market in the area of CO₂-compensation.

In conclusion

Pressure on firms in Switzerland is increasing to be more transparent on how climate and environmental risks are identified, assessed and managed as part of the regular course of business. Zanders has supported various financial institutions on climate and environmental risk-related topics in the EU as they need to adhere to detailed expectations from the European Central Bank (ECB) and the European Union (EU). If you want to learn more, please contact us or call at +41 44 577 70 10.

Footnotes

[1] At least 500 FTE and a balance sheet total of at least CHF 20 million and/or revenues of at least CHF 40 million on a consolidated basis

[2] See media release.

[3] Within the EU, this is generally referred to as the Non-Financial Reporting Directive (NFRD). On 5 January 2023 the Corporate Sustainability Reporting Directive (CSRD) entered into force, succeeding the NFRD (details can be found here). The CSRD extends the scope of the companies covered to all large and all listed companies, requires the audit (assurance) of reported information and strengthens the standardisation of reported information by empowering the Commission to adopt sustainability reporting standards.

[4] See FINMA

[5] The EBA published a discussion paper on the inclusion of environmental risks in Pillar 1 capital requirements, see EBA and for a summary EBA summary https://zandersgroup.com/en/latest-insights/are-climate-change-risks-properly-captured-in-the-prudential-framework/.

[6] See media release

Key takeaway:We recommend that firms begin collecting data and amend internal processes that enable them to disclose climate-related information in line with the recommendations of the Task Force for Climate-related Financial Disclosures (TCFD)

Background

The Task Force for Climate-related Financial Disclosures (TCFD) was established by the Financial Stability Board (FSB) in December 2015 to develop climate-related disclosures that “could promote more informed investment, credit [or lending], and insurance underwriting decisions” and, in turn, “would enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.” The TCFD finalized its recommendations in June 2017¹ and, based on the subsequent experience, published implementation guidance in 2021².

In line with this goal, the recommendations and implementation guidance are intended for all financial and non-financial organizations with public debt or equity. However, the TCFD encourages all organizations to implement the recommendations. An increasing number of firms are doing so and indicate explicitly as part of their annual report or financial filing where they have disclosed information in relation to individual TCFD recommendations³.

Climate-related risks and opportunities

To be able to disclose relevant climate-related information, an organization first needs to understand its exposure to climate-related risks and the opportunities that the execution of the Paris Agreement offers. Hence, it needs to evaluate the potential negative impacts of climate change on its own operations and the full value chain (covering both physical and transition risks) as well as the opportunities it offers for new products, services and markets. Subsequently, the impact of the identified risks and opportunities on revenues, expenses, assets and liabilities, and capital and financing needs to be assessed. This is summarized in the following chart.

Source: TCFD, Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures, October 2021, page 9.

Appendix 1 of the TCFD implementation guidance provides examples how climate-related risks and opportunities can impact the financial statements.

The TCFD Recommendations

The TCFD has issued 11 recommendations in four main areas: Governance, Strategy, Risk Management, and Metrics and Targets. These are summarized in the table below.

Source: TCFD, Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures, October 2021, page 15.

For banks, insurance companies, asset owners, asset managers and non-financial industries that are more likely to be financially impacted by climate-related risks⁴, the TCFD provides additional guidance for some of the recommended disclosures.

For banks, the additional guidance entails:

• Describe significant concentrations of credit exposure to carbon-related assets through the lending and financial intermediary business (Strategy – sub a).
• Characterize their climate-related risks in the context of traditional banking industry risk categories such as credit risk, market risk, liquidity risk, and operational risk (Risk Management – sub a).
• Disclose GHG emissions for their lending and other financial intermediary business activities where data and methodologies allow, calculated in line with the Global GHG Accounting and Reporting Standard for the Financial Industry developed by the Partnership for Carbon Accounting Financials (PCAF Standard) or a comparable methodology (Metrics and Targets – sub b).

Metrics and targets: Additional guidance

For the metrics, the TCFD provides the following suggestions for all organizations:

Targets can be established by specifying the planned reduction or increase in each of the metrics over a chosen time horizon, including a comparison to regulatory requirements, market constraints or other goals.

In conclusion

As the TCFD recommendations are increasingly used as basis for climate-related disclosure standards in national laws and regulatory guidance, firms are advised to start collecting data and amend internal processes that enable them to disclose climate-related information in line with these recommendations. Zanders has supported various financial institutions on climate-related topics that have a bearing on the TCFD disclosure recommendations. If you want to learn more, please do not hesitate to contact us or call at +41 44 577 70 10.

Footnotes

[1] TCFD, Recommendations of the Task Force on Climate-related Financial Disclosures, June 2017, see TCFD Recommendations

[2] TCFD, Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures, October 2021, see TCFD Publications

[3] TCFD, 2022 Status Report, October 2022, see TCFD Publications

[4] Comprising the following sectors: energy, transportation, materials and buildings, and agriculture, food and forest products.

[5] TCFD, Guidance on Metrics, Targets and Transition Plans, October 2021, see TCFD Publications

Banks’ economic values of equity (EVE) are most likely negatively affected by the rise in rates. The impact is dependent on the duration of equity taken by the bank; the higher the equity duration, the larger the decline in EVE when rates rise (and hence a higher EVE risk). On the other side, choosing a high equity duration would lock in consistent income over a longer period of time (lower earnings risk), whereas a low equity duration results in earnings fluctuating with market rates (high earnings risk). As a result, eliminating both EVE risk and earnings risk at the same time is hard to achieve. Selecting the appropriate equity duration (or more in detail, key rate durations) is a balancing act between acceptable levels of EVE risk versus earnings risk. This decision depends on the bank’s risk appetite, internal risk limits and regulatory limits (SOT limits). Finally, due to EBA’s introduction of the NII SOT (supervisory outlier test on earnings risk), banks will need to put more emphasis on earnings risk, by assessing the impact of mitigation measures on the size of earnings risk relative to capital.

Levers to consider

Since today’s rate environment is materially different from years past, banks should re-evaluate their ALM strategy and, in particular, actively manage residual interest rate risk going forward. For banks, the following levers are important to consider:

• Adapting the interest rate risk limit framework to the new reality. This includes an assessment whether or not it is necessary to amend the overall equity duration and corresponding key rate durations. Especially, the introduction of the NII SOT by EBA will incentivize banks to amend existing limits on earnings risk or set new ones. The preferred target equity duration and corresponding key rate duration profile will be the result of a study where the impact of alternative equity durations is assessed against the bank’s risk appetite, and EVE and earnings risk limits. Once decided, it will be necessary to [i] adapt the hedge (derivative overlay) according to the new equity duration and key rate duration profile set as targets and [ii] manage the overlay over time in such a way that the realized key rate duration profile remains within the limits set around the target key rate profile and equity duration. Since the risk limit framework is part of the broader ALM framework, the ALM framework could be subject to a review as well.
• Reassessing key behavioral assumptions in the banking book. Although behavioral models are reviewed periodically, banks should consider recalibrating the behavioral models, especially after a shift in paradigm from negative to positive interest rates. Since behavioral assumptions are used to forecast cashflows, they should be set in a forward looking way (possibly using an expert overlay) and thus reflect the new rate environment. In this way, banks will understand how their behavioral models for mortgage pre-payments and non-maturing deposits impact the IRRBB key metrics and resulting equity duration going forward. Amendments in behavioral models can alter the size and structure of a derivative overlay.
• Brushing up the product palette and reviewing the range of banking products. Banking products that have not been attractive in a low and/or negative interest rate environment during the past years could very well become more attractive again for clients in a different (high) interest rate environment. At certain interest rate levels and steepness of the yield curve, clients could favor floating rate over fixed term instruments, short-term over long-term instruments, or vice versa. Volume shifts between banking products can gradually alter the balance sheet composition over time and materially change the interest rate risk profile of the banking book. Therefore, banks should consider adapting their product palette (and corresponding price setting) to the new interest rate environment. Also, banks should consider offering alternative banking products to clients to be able to benefit from risk offsets between assets and liabilities. This can be done by e.g. refurbishing specific products that have been on the shelf for a while now.
• Managing the duration of the liquidity buffer portfolio (more) actively in conjunction with the desired interest rate risk profile set by the revised ALM strategy. Investments in bonds with maturities consistent with the ALM strategy can bring the equity duration closer to the desired level and reduce the size of a potential derivative overlay.
• Strengthening the risk system capabilities to be able to provide management the requested transparency in a timely manner. It requires scenario analyses to determine the impact of strategic ALM decisions on the key risk metrics, both internal and regulatory risk limits and SOTs as well as other balance sheet metrics (e.g. capital and capital ratios). Scenario analyses include the roll-over of the bank’s balance sheet and hedges for a certain period (e.g. 1-5 years) under various scenarios regarding market rate, client rate (commercial margins) and balance sheet assumptions.

How can Zanders support banks in meeting these challenges?

Zanders is a trusted advisor in helping banks review their ALM/hedge strategy. Drawing on expert knowledge in ALM, we help banks conduct strategic ALM studies and holistic balance sheet management assessments using our proprietary tooling. These typically include impact studies of:

• alternative hedges (derivative overlays);
• changes in key behavioral assumptions;
• changes in balance sheet composition or
• other possible measures to mitigate the residual interest rate risk.

Using our holistic approach, we provide transparency and support banks in understanding the impact on future EVE risk, earnings (NII) and earnings risk, as well as other key metrics such as capital ratios, leverage, liquidity and funding (LCR and NSFR) ratios under different scenarios.

Are you interested in Strategic ALM and Holistic Balance Sheet Management? Contact Jaap Karelse, Erik Vijlbrief (Netherlands, Belgium and Nordic countries) or Martijn Wycisk (DACH region) for more information.

In a recent report by the Association of Certified Fraud Examiners (ACFE), Occupational Fraud 2022: A report to the nations, it is estimated that organizations lose about 5% of their revenue each year due to employees committing fraud against their employer. It is estimated that more than USD 4.7 trillion is lost worldwide to occupational fraud.  Of these, most cases were identified through a tip to a hotline and most were not detected until 12 to 18 months later. The longer the fraud was undetected, the higher the loss. But organizations do not only fight fraud internally; external threats are also on the rise. As businesses evolve and processes are automated and digitalized, fraud activities become much more complex.

Data and modeling approach to fraud prevention

To effectively prevent fraud, it first needs to be identified. Traditionally, employees are trained to identify anomalies or inconsistencies in their daily work environment. It is still crucial that your employees know what to look for and how to spot suspicious activities. But due to the complexities and vast amounts of information available, and because fraudsters are becoming more sophisticated, it becomes much more difficult to determine whether a potential customer is a fraudster or a real client.

The good news is that digitalization and increased data availability provides the opportunity for data analytics. It is important to note here that it does not completely replace your current processes; it should be used in addition to your traditional prevention and/or detection methods to be more effective to proactively identify and prevent fraud in your organization.

Benefits of data analytics

Traditionally, sampling was done on a population to test for fraud instances, but this may not be as effective because it only looks at a small population. Because fraud numbers reported usually being small (but with a large monetary impact), it is possible to overlook valuable insights if only samples of populations are investigated. Ideally, all data should be included to identify trends and potential fraudulent activities, and with data analytics that is possible. By analyzing large amounts of data, organizations can identify patterns and trends that may indicate fraudulent activity. It can help to improve the accuracy of fraud detection systems, as they can be trained to recognize these patterns.

Data analytics can increase efficiency by reducing false positives and false negatives and assists organizations to automate parts of the fraud detection processes, which can save time and resources. This allows the business to focus on other important strategic objectives and tasks such as customer service and product development.

By using data analytics to identify and prevent fraudulent activity, organizations can help to protect their customers against financial losses and other harm. Customer trust and loyalty are built when organizations show they are serious about the welfare and safety of their customers.

Detecting and preventing fraud

Reality is that preventing fraud upfront or in an early stage is much more economical and beneficial than having to detect fraud after the fact, as investigations are time-consuming and the fraud is not always easy to proof in court. Moreover, by the time it is detected, a loss may have already been incurred. Using data analytics to identify fraudsters and fraudulent activities earlier, can protect the bottom line by reducing financial losses and improving the organization’s overall financial performance.

By using analytics to detect and prevent fraud, organizations can demonstrate to regulatory bodies that they are taking compliance seriously. Reporting suspicious transactions and activities to regulatory bodies is a key component of complying with anti-money laundering and counter-terrorism financing legislation, and analytics can assist with identifying these transactions and activities more effectively.

Data analytics can be used to prevent fraud at onboarding, detect it in the existing customer base, and to make your operational processes more efficient. More specifically, data analytics can be used and leveraged as follows:

• Identifying outlier trends and hidden patterns can highlight areas and/or transactions that are more vulnerable to fraud.
• Automating identification of exceptions removes manual intervention and makes the identification criteria more consistent.
• Traditional physical reviews using limited resources to investigate is time-consuming. Data analytics can be used to prioritize the ones with the highest impact and risk, e.g. investigate the suspicious transactions with the highest value first.
• Combining data from different data sources to feed into a model provides a more holistic view of a customer or scenario than looking at individual transactions or applications in isolation.
• Both structured and unstructured data can be used to prevent and detect fraud.
• Fraud propensity model scoring can run automatically and generate results to be reviewed and investigated in real-time or near real-time.
• Analyzing relationships between various entities and customers using Social Network Analysis (SNA). Traditionally, networks/links were identified by the investigator while building a case. By using analytics, less time is needed to identify these relationships. Also, it identifies valuable links previously unknown, as additional levels of relationships can be examined.
• Specific modus operandi identified by the organization’s internal fraud team can be translated into data models to automate identification of similar cases. (See Case study below)
• Applying a fraud model to the organization’s bad debt book can assist with your collections strategy. Fraudsters never intended to pay and focusing your collection efforts on them wastes time and valuable resources. Most efforts should be on those cases where money can be collected.

Case study

The Zanders data analytics team has experience with applying data analytics within a company to identify customers who create synthetic profiles at point of application. By working closely with investigators, a model was developed in which one out of every three applications referred for investigation was classified as fraudulent.

The benefit of introducing analytics was twofold – from an onboarding- and existing customer point of view. The number of fraudsters identified before onboarding increased, preventing (potential) losses. Using the positive identified frauds at point of application, and checking the profile against the existing book, helped to identify areas that were more vulnerable where investigation should be prioritized.

The project proved that:

• Data analytics is valuable and combining it with insights from the operational teams is powerful.
• The buy-in from the stakeholders made the model more effective. If the team investigating the alert does not trust the model or does not know what to look for, there will be resistance in investigating the alerts.
• Taking your internal fraud team on a data and analytics journey is a must. They need to understand the impact that their decisions and captured outcomes can have on future models.
• Challenges with false positives (within business appetite and investigation capacity) are a reality, but having a model is better than searching for a needle in a haystack. Learning from the results and outcomes of the investigations, even if they were false positives, will enhance your next model.
• One size does not fit all. Fraud models need to be tailored to the business’ needs.

Conclusion

While using data analytics to identify fraudulent activities is an investment, organizations need to outweigh the benefit of incorporating data analytics in their current processes against the potential losses. Fraud not only results in monetary losses, it can lead to reputational damage and have an impact on the organization’s market share as customers will not do business with an organization where they don’t feel protected. Your customers also expect great customer service and implementing proactive fraud prevention measures increases confidence in your organization.

How can Zanders help your organization?

Did you find this article helpful but do you still have questions or need additional assistance? Our team of experts is ready to assist you in finding the solutions you need. Please feel free to reach out to us to discuss your needs in more detail. Whether you’re looking for advice on a specific project or just need someone to exchange ideas with, we are here to assis