Financial institutions

Financial Institutions and Climate Change: OSFI Guidance on Managing Climate Risks

What do you want to know

The Office of the Superintendent of Financial Institutions (OSFI) published a draft guideline (the Guideline) on Climate Risk Management on May 26, 2022. The guideline sets out OSFI’s expectations for federally regulated financial institutions (IFF) regarding the management of climate-related risks, which OSFI broadly categorizes as physical risks and transition risks. See BLG’s article on climate finance at COP26 for more information on climate-related risks. The Guideline proposes to require FRFIs to analyze and publish forward-looking strategies that are holistic, integrated, and grounded in reliable empirical data and analysis, providing a prudent framework to support FRFIs as they develop greater resilience and better management of climate-related risks.

The guideline refers to the recommendations (the TCFD Recommendations) developed by the Task Force on Climate-related Financial Disclosures (TCFD), as well as the climate change reporting indicators proposed by the International Sustainability Standards Board (ISSB) in its draft climate reporting standard, which is also subject to public consultation.

In addition to requiring disclosure based on TCFD recommendations and ISSB climate parameters, the guideline requires FRFIs to use climate scenario analysis to continually:

  • inform business strategies
  • develop and disclose a climate transition plan
  • disclose its net zero commitments, if applicable

OSFI will develop a standardized climate scenario analysis exercise to assess aggregate physical and transition risk exposures and compare FRFI approaches to climate scenario analysis.

FRFIs will be required to run these scenarios and report their results to OSFI. With respect to disclosure, FRFIs must disclose the information required by the guideline within 180 days of the end of the fiscal year, but they have discretion as to where to disclose it.

In response to the Guideline, FRFIs should rethink their strategies and operations from a climate risk lens to ensure regulatory compliance in the near future.

OSFI intends to review and modify the guideline as practices evolve and standards harmonize. OSFI welcomes public comments on the guideline by August 19, 2022 and intends to issue a final guideline by early 2023, along with an unattributed summary of the comments received and the response from the OSFI to these.

How we got here

In 2019, the Expert Panel on Sustainable Finance highlighted the importance of integrating climate-related risks into the oversight, regulation and supervision of the Canadian financial system. In its final report, the committee recommended that the Bank of Canada and OSFI, as appropriate, formally integrate climate risk into the oversight of FRFIs and provide clear guidance on related regulatory expectations.

Following the Committee’s recommendation, the Bank of Canada and OSFI have collectively:

Expected results

OSFI expects at least three outcomes for FRFIs when implementing the guideline:

  • Result 1: The IFF understands and mitigates the potential impacts of climate-related risks on its business model and strategy.
  • Result 2: The IFF has appropriate governance and risk management practices to manage identified climate-related risks.
  • Result 3: The IFF remains financially resilient through severe but plausible climate risk scenarios, and operationally resilient through disruption from climate-related disasters.

Overview of guidelines

The guideline has two chapters and five appendices. The first chapter describes OSFI’s governance expectations; risk management; analysis of climate scenarios and stress tests; and capital and liquidity adequacy. OSFI has included principles for each of the four categories, along with clarifying notes on each principle.

Effective Disclosure Principles

The TCFD recommendations set out seven principles for effective disclosure that it expects any entity seeking to provide TCFD-compliant disclosure to follow. Disclosures must:

  • represent relevant information (TCFD principle 1)
  • be precise and complete (TCFD principle 2)
  • be clear, balanced and understandable (TCFD principle 3)
  • be consistent over time (TCFD principle 4)
  • be comparable between companies in a sector, industry or portfolio (principle 5 of the TCFD)
  • be reliable, verifiable and objective (principle 6 of the TCFD)
  • be provided in a timely manner (principle 7 of the TCFD)

Chapter 2 of the guideline uses the same principles of effective disclosure as the TCFD, with two differences: (1) the guideline does not include principle 7 of the TCFD, and (2) with respect to principle 5 of the TCFD, the guideline recommends that disclosures be appropriate to the size, nature and complexity of the IFF.

Where the Rubber Touches the Road: The Appendices

Some of the more prescriptive obligations are described in the annexes to the Guideline. In particular, Appendix 2-1 indicates that OSFI’s expectations for financial disclosure related to climate risk include:

  • Expectations based on the TCFD recommendations and the draft ISSB climate disclosure standard on governance, strategy, risk, metrics and targets (the four pillars of the TCFD recommendations); GHG emissions; ISSB cross-sector metrics (which require disclosure of Scope 1, Scope 2 and Scope 3 GHG emissions for all entities, regardless of the sector in which they operate); and the ISSB’s industry-specific measures for banks and insurers;
  • A climate transition plan; and
  • Net zero commitments, if the IFF has made one or more.

Appendix 2-2 sets out the minimum expectations for climate-related financial risk disclosure by category of FRFI. With respect to GHG emissions, only Tier 2 and Tier 3 small and medium-sized deposit-taking institutions, as well as all other federally regulated insurers, are exempt from reporting Scope 3 emissions. IFF should use the Partnership for Carbon Accounting Financials’ Global GHG Accounting and Reporting Standard for the Financial Sector or comparable industry standard (if applicable) for disclosing Scope 3 emissions associated with IFF loans and investments.