OSFI Releases Discussion Paper and Seeks Industry Feedback on Climate-Related Risks

January 19, 2021

Brittany Greenberg

On January 11, 2021, the Office of the Superintendent of Financial Institutions Canada (“OSFI“) released a discussion paper Navigating Uncertainty in Climate Change: Promoting Preparedness and Resilience to Climate-Related Risks, to engage federally regulated financial institutions (“FRFIs“), federally regulated pension plans (“FRPPs“) and other interested stakeholders in a dialogue on the risks resulting from climate change that can affect the safety and soundness of FRFIs and FRPPs (“climate-related risks“).

OSFI is also looking for input on how FRFIs and FRPPs define, identify, measure and build resilience to climate-related risks, as well as how OSFI can facilitate their preparedness and resilience to these risks.

What are climate-related risks?

Canada’s Changing Climate Report[1] has again confirmed International Panel on Climate Change reports that our climate has warmed since 1948, and that warming is attributable to human emissions of greenhouse gases (“GHG“). The transition to a lower-GHG economy will undoubtedly affect many economic sectors that will need to shift away from fossil fuels towards other energy sources. The transition may impose costs on sectors that are heavily reliant on the production or use of coal, oil and gas, but it may also provide new investment and other economic opportunities in new energy and production technologies across all economic sectors.

OSFI identifies three overarching categories of climate-related risks, all of which will affect most sectors of the economy in some capacity:

• Physical risk arises from a changing climate and increasing frequency and severity of wildfires, floods, wind events and rising sea levels, among other things. In addition to other impacts, this can threaten the value of certain investments held by FRFIs and FRPPs.

• Transition risk arises as a result of efforts to reduce GHG emissions and a shift in the economy towards a lower-GHG footprint. This includes new government policies and increased regulation, technological advancements, and changes in investor or consumer sentiment.

• Liability risk relates to potential exposure of FRFIs and FRPPs to the risks associated with climate-related litigation. Some examples include:

• • an increase in tortious claims against FRFIs and FRPPs as perpetrators of climate change;

• • claims from investors, pension plan members or stakeholders for failing to account for possible GHG-intensive assets; and

• • liability for FRFI Boards and FRPP administrators for failing to fulfill their legal or fiduciary duties.

These risks are both complex and systemic.

How can climate-related risks impact the safety and soundness of FRFIs and FRPPs?

Climate-related risks will affect FRFIs’ or FRPPs’ business and investment strategies, with a potential to affect all asset classes across all portfolios. These risks can lead to serious financial consequences if FRFIs and FRPPs are not adequately prepared for, or do not properly manage, these exposures. Some examples of financial risks that can impact FRFI’s or FRPP’s are credit, market, liquidity and insurance risks.

How can FRPPs prepare for, and build resilience to climate-related risks?

Administrators of FRPPs should consider a wide range of factors affecting their ability to administer their plans, including risks that could impact long-term investment performance.

Develop a climate-risk appetite and strategy

Climate-related risks can materially change the investment environment for FRPPs. This may require updates to the investment objectives and strategies contained in FRPPs’ Statement of Investment Policies and Procedures (“SIP&P”).

Climate-related risks can also create lasting changes in the investment landscape. Transition risk ought to be considered by pension plan administrators in considering how a lower-GHG economy may impact the investment policy and strategy on long-term investments.

On the other hand, pension plan administrators should consider how a lower-GHG economy can create new investment opportunities that may fit into a FRPP’s SIP&P, investment objectives, and risk appetite.

OSFI acknowledged that climate-related risks may already be considered when assessing how environmental, social, and governance (“ESG“) factors influence long-term investment risk and return prospects for FRPPs, and what pension plan administrators’ fiduciary responsibilities are in respect of ESG factors.

Effective climate-related risk governance

FRPP administrators can manage climate-related risk through the use of governance policies or other risk management tools, such as scenario analysis and stress-testing.

In the context of pooled funds, where the FRPP likely has little say in the underlying investments of the fund, the FRPP administrator can assess whether and how such pooled funds manage climate-related risk in determining whether it is a suitable investment.

Managing client-related risks

Where the FRPP administrator invests directly in assets, the FRPP may consider the plan’s exposure under a variety of potential climate transition scenarios.

For FRPPs where the administrator delegates such decisions to an investment manager, the plan administrator can implement climate-related risk considerations in the investment manager’s mandate. Additionally, in choosing its investment manager, a FRPP may consider their approach to certain climate-related criteria and climate-related risk management.

Climate-Related Financial Disclosure

In Canada, securities legislation requires reporting issuers to disclose material risks, which can include climate-related risks. In addition to these requirements, many FRFIs and FRPPs are voluntarily disclosing climate-related information to external stakeholders.

In 2019, the Expert Panel on Sustainable Finance (the “Expert Panel“) recommended that a mandatory phased “comply or explain” implementation of the Task Force on Climate-related Financial Disclosures climate-related disclosure framework be implemented, including for FRFIs and FRPPs.

The Expert Panel also recommended that FRPPs be required to disclose whether and how climate issues are considered in their SIP&P and to include a rationale if such issues are not considered. It is important that FRPPs monitor the Government of Canada’s response to such recommendations, as government legislation and policy will have an impact on the investment policies and strategies for FRPPs moving forward.[2]

OSFI’s Ongoing Work on Climate-Related Risks

To advance its understanding of climate-related risks and their impact on FRFI and FRPP safety and soundness, OSFI has completed a first round preliminary quantification of transition risk exposure for FRFIs, which reinforced that the nature of vulnerability to climate-related risks varies by industry and that there is a need for more complete, comprehensive, and consistent portfolio data to enable more robust and comparable analysis.

OSFI is collaborating with the Bank of Canada on a pilot program to assess financial institutions’ potential risk exposures related to a transition to a lower-GHG economy using scenarios relevant to Canada. OSFI also participates in various efforts domestically and internationally to understand climate-related risk measurement and inform its risk management expectations for FRFIs and FRPPs. OSFI is exploring whether additional guidance or requirements are needed in its existing principles and expectations to address distinct climate-related considerations.

Finally, with respect to FRPPs, OSFI is looking at its guidance, supervisory process and reporting requirements to determine whether they need to be adapted to include climate-related considerations.

Consultation Period

In an effort to aggregate stakeholder views, OSFI put forward a series of discussion questions in Appendix A of the Discussion Paper and are soliciting responses from stakeholders by April 12, 2021.

Submissions and comments are to be sent to: Climate-Climat@osfi-bsif.gc.ca.

[1] Environment and Climate Change Canada (2019): Canada’s Changing Climate Report.

[2] Environment and Climate Change Canada (2019): The Final Report of the Expert Panel on Sustainable Finance.

 

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