Second of two parts

IN BRIEF:

• ​Firms should leverage innovative technologies to improve their ESG reporting processes and enhance their oversight and understanding of risks within less transparent markets, networks and ecosystems.

• ​Regulators have recently expressed heightened concerns about the concentration of risk within non-bank financial institutions (NBFIs), fearing that it could spill over into the regulated sector and threaten the stability of systemically important institutions.

The financial industry’s growing reliance on technology is heightening the risk of failure points linked to unregulated third-party connections. These weaknesses can be targeted by malicious entities, or as evidenced by a major IT outage in July 2024, can also occur from non-malicious factors.

This article explores comprehensive strategies for enhancing resilience against vulnerabilities and external threats based on insights from the 2025 EY Global Financial Services Regulatory Outlook. It serves as the last article in a series addressing the key issues facing the banking and financial sector in 2025 and beyond.

The first part of this article discussed the increasing regulatory focus on operational resilience in the financial sector due to recent disruptions, including conflicts and IT failures, prompting firms to enhance their risk management practices. This second part discusses the growing emphasis on nature-related risks and the need for firms to understand these implications for their business strategies, while also addressing the rise of non-bank financial institutions (NBFIs) and the associated regulatory challenges.

SUSTAINABLE FINANCE
Environmental, social, and governance (ESG) reporting related to emissions, climate risks, and sustainability is increasingly becoming standard practice among major corporations. Globally, various markets, including Australia, Switzerland, and Hong Kong, are set to adopt IFRS sustainability standards beginning in 2025, with over 20 countries expressing interest in aligning with the International Sustainability Standards Board (ISSB) standards over time.

There is a growing focus on nature-related risks, biodiversity and human capital, although regulatory frameworks addressing these risks are still in their infancy. Initiatives such as the Network for Greening the Financial System’s (NGFS) preparatory work on nature-related financial risks through a conceptual framework for central banks and supervisors, the Taskforce on Nature-related Financial Disclosures’ (TNFD) efforts to align with the Global Reporting Initiative (GRI) through an interoperability mapping resource, the European Financial Reporting Advisory Group’s (EFRAG) contributions, and the ISSB’s plan to incorporate biodiversity risks into their 2024-26 work agenda all signal an expanding emphasis on environmental factors beyond climate change. This shift aims to better understand the implications for financial stability and inform future regulatory measures. However, it may take time before firms are subject to specific requirements regarding biodiversity and nature-related risks. The ISSB has also included in its research and standard-setting projects the risks and opportunities related to human capital.

The voluntary carbon market is gaining traction as an alternative approach to achieving net-zero transition goals. While regulatory gaps present reputational and operational challenges, initiatives like The Core Carbon Principles and the issuance of the International Organization of Securities Commissions (IOSCO) final report on Voluntary Carbon Markets (VCMs) seek to enhance credit quality and transparency in this space.

The Core Carbon Principles provides a set of 21 Good Practices aimed at ensuring financial integrity in this space, ranging from regulatory treatment, market participants skills and competencies, standardization, transparency and disclosure, to secondary market trading, integrity, reports, derivatives standards, risk management, market surveillance and monitoring, as well as disclosure of use of carbon credits. On the other hand, the IOSCO’s final report on VCMs focuses on promoting financial integrity on VCMs, offering “Good Practices” to guide regulators and market participants.

As the emphasis on biodiversity and natural capital increases, firms must prioritize understanding the associated risks and opportunities to evaluate potential implications for their business strategies. Organizations should explore how innovative technologies, such as artificial intelligence, can facilitate accurate and timely reporting to comply with regulatory requirements. By leveraging these advancements, firms can enhance their reporting processes and better align with the evolving landscape of sustainability expectations.

NON-BANK FINANCE
According to the Financial Stability Board (FSB), NBFIs, often referred to as “shadow banks,” represented over 47% of the assets in the global financial system in 2022, a rise from 42% in 2008. NBFIs encompass both regulated and unregulated entities that provide “bank-like” products and services, such as credit and payments, but without the same prudential oversight as traditional banks. In the US, NBFIs are responsible for originating and servicing most residential mortgages. While their role in facilitating capital markets is acknowledged, regulators have recently expressed heightened concerns about the concentration of risk within NBFIs, fearing that it could spill over into the regulated sector and threaten the stability of systemically important institutions.

Supranational organizations and domestic regulators continue to express their concerns, yet achieving international coordination remains a challenge. The FSB has urged countries to advance reforms aimed at mitigating threats to financial stability posed by NBFIs and has released a consultation report addressing “leverage-related vulnerabilities” within these institutions by the end of 2024. Recently, prudential authorities in the UK and EU have pointed out that some banks exhibit a poor understanding of and inadequate risk management regarding their exposures to the private finance segment.

Firms must prepare for increased supervisory scrutiny targeting risk management procedures and exposures to less transparent markets, such as private finance, where regulators are typically concerned about counterparty risk, concentration risk, and liquidity risk. By enhancing data analytics and aggregation capabilities, organizations can better identify and monitor significant exposures and concentrations, including established and emerging nonfinancial risks related to digitalization and technology adoption within institutions, ecosystems and networks.

During the 2024 Regional Systemic Risk Dialogue co-hosted by the BSP and the International Monetary Fund, BSP Governor Eli Remolona noted that the organizers took the “the road less traveled” by focusing on the non-bank financial sector and technology innovations. He cited the multi-dimensional nature of systemic risks and the case of the non-bank financial sector, in which he recognized that “there is much diversity within (this) sector, just as there are interlinkages between non-banks and banks.” He described technology as “an enabler for the non-bank financial market… something that banks have embraced, and… is redefining the demands of the consumer.”

BUILDING RESILIENCE
In light of the evolving regulatory environment, financial institutions must proactively enhance their operational resilience and risk management practices, both within the institution and ecosystems of customers and service providers. As the focus on sustainability and biodiversity intensifies, firms should leverage innovative technologies such as AI to improve their ESG reporting processes as well as manage risks and identify opportunities. With the growing prominence of NBFIs, organizations must also enhance their oversight and understanding of risks within less transparent markets and ecosystems to ensure financial stability and compliance in an increasingly complex and interdependent landscape.

By embracing these challenges, the financial sector can emerge stronger and more resilient, paving the way for a sustainable and secure future.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Christian G. Lauron is the financial services organization (FSO) leader of SGV & Co.