OSFI fires first salvo on climate risk

Federal financial regulators fired what amounts to their first shot today in what will be an ongoing battle to ensure that the financial industry comes to grips with the effects of climate change.

Following a public consultation that generated a massive response (over 4,300 submissions), the Office of the Superintendent of Financial Institutions (OSFI) issued new principles-based guidance that sets the regulator’s initial expectations for federally-regulated banks and insurers to address climate-related risks to their businesses.

“The guideline is OSFI’s first prudential framework that is climate sensitive and recognizes the impact of climate change on managing risk in Canada’s financial system,” the regulator said in a release.

To start, the new guidance doesn’t impose added capital charges on firms for their climate risks. Instead, it focuses on setting governance, risk management and disclosure expectations for federally-regulated financial institutions.

The guidelines’ basic goals are to ensure that financial firms properly assess and address potential climate-related risks to their business models and strategies; that they have adequate governance and risk management processes to deal with these risks; and that firms can withstand a range of possible climate risk scenarios.

At this point, the regulator’s initiative isn’t about forcing banks to set aside added capital to account for climate risks, or to drive their lending and investment decisions — which could accelerate the transition to a low-carbon economy by raising the cost of capital for high emitting sectors or companies.

For now, it’s expected that climate risk be factored into financial institutions’ efforts to evaluate their risks and set aside adequate capital under the existing capital adequacy regime.

To that end, OSFI “expects that [financial firms] will continue to evaluate and measure their capital available to protect against material risks, including climate-related risks” and that this will be reflected in their capital positions, and in their liquidity calculations.

However, the regulator also made clear that the new guidance won’t be the final word from OSFI on climate risks.

In a briefing with reporters, Stephane Tardif, managing director of OSFI’s climate risk hub, said that the guidance will evolve as climate data improves and global standards are adopted.

For instance, the forthcoming climate risk disclosure requirements — which the International Sustainability Standards Board (ISSB) expects to finalize by mid-2023 — will be incorporated into OSFI’s guidance.

The regulator also indicated that it will continue to assess whether or not the existing capital rules properly capture climate-related risks. This may, in the future, lead to specific capital requirements for climate-related risks as data and disclosure improves.

In the meantime, under the new guidance, firms will be expected to carry out their own internal climate scenario analysis, and OSFI will also subjecting them to standardized climate scenario exercises to give the regulator insight into aggregate exposures and to compare firms’ approaches to climate scenario analysis.

The new guidance will take effect by the end of fiscal 2024 for the large banks and insurers under OSFI’s oversight, and by the end of fiscal 2025 for smaller firms.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.