OSFI releases draft climate risk management guidelines

The Office of the Superintendent of Financial Institutions (OSFI) has released a draft guideline setting out its expectations for how federally regulated financial institutions (FRFIs) should manage and disclose climate-related risks. Issued May 26, Guideline B-15: Climate Risk Management (the Guideline) is not intended to be a one-size-fits-all approach; rather, the management of climate-related risks will vary with an institution’s size, nature, scope, complexity of operations and risk profile. The Guideline is open for public comment until August 19, 2022.

What you need to know

• The Guideline applies to all FRFIs, including but not limited to domestic and foreign banks carrying on business in Canada, life insurance companies, trust companies and property and casualty insurance companies.
• As proposed, each FRFI will be required to develop and implement a Climate Transition Plan “in line with its business plan and strategy, that guides the FRFI’s management of increasing physical risks from climate change, and the transition towards a low-GHG economy”. FRFIs will also be required to “mitigate the impact of climate-related disasters on their critical operations” and “maintain sufficient capital and liquidity buffers for [their] climate-related risks”.
• The Guideline sets expectations for an FRFI to use climate scenario analysis to assess the impact of climate-related risk drivers on its risk profile, business strategy and business model, and to report the results of that analysis to OSFI.
• Effective for fiscal periods ending October 1, 2023, FRFIs will be required to make annual climate-related financial disclosures in line with the Task Force on Climate-Related Financial Disclosure (TCFD) Framework. The Guideline would initially require all FRFIs to disclose their Scope 1 and 2 GHG emissions and the related risks; and D-SIBs, Category 1 SMSBs and IAIGs headquartered in Canada to disclose their Scope 3 GHG emissions and related risks. In contrast, the CSA’s proposed National Instrument 51-107 (the CSA Proposal) would require reporting issuers to disclose their Scope 1, 2 and 3 GHG emissions or their reasons for not providing such disclosure.
• The Guideline builds on the efforts of the international banking community, including the Central Bank and Supervisors Network for Greening the Financial System (NGFS), which on May 30 indicated in its 2022-2024 work program that it will focus on the development of best practices for managing climate-related risks, the design and analysis of climate scenarios and guidance for central banks on the transition to net zero.

Guideline B-15: Three expected outcomes

The Guideline sets out three expected outcomes for FRFIs to achieve in respect of their management and disclosure of climate-related risks:

1. Understand and mitigate against potential impacts of climate-related risks to their business model and strategy.
2. Have appropriate governance and risk management practices to manage identified climate-related risks.
3. Remain financially resilient through severe, yet plausible, climate risk scenarios, and operationally resilient through disruption due to climate-related disasters.

Climate-related risks addressed by the Guideline include both the physical risks of climate change, such as those resulting from the increasing severity and frequency of weather events and other physical longer term or indirect effects of climate change (for example, physical damage to collateral or outages of critical services), and transition risks stemming out of the adjustment process toward a low greenhouse gas economy (for example, reduced profitability of GHG-intensive borrowers or unexpected valuation changes in securities).

To address these risks and achieve the outcomes indicated above, the Guideline lists several expectations to be implemented by FRFIs. These expectations are divided into two chapters: Chapter 1 addresses governance and risk management expectations; Chapter 2 addresses disclosure of climate-related risks expectations.

Chapter 1: Governance and Risk Management Expectations

Chapter 1 of the Guideline sets out OSFI’s expectations about governance and management of climate-related risks by FRFIs. Among other things, the draft Guideline requires that each FRFI:

• incorporate the implications of climate change and the transition to a low greenhouse gas economy to the institution in its business model and strategy, including by developing and implementing a Climate Transition Plan that guides the management of increasing physical risks and sets internal metrics and targets such as GHG emissions;
• integrate climate-related risks into its Risk Appetite Framework, Internal Control Framework, Enterprise Risk Management framework and relevant policies and practices;
• implement tools to measure climate-related risks and develop capabilities to aggregate the data to identify and internally report on climate-related exposure;
• develop a climate scenario analysis, which uses a hypothetical future state of the world to assess the impact of climate-related risks on the FRFI’s operation, as part of its Stress Testing Framework; and
• maintain sufficient capital and liquidity buffers for its climate-related risks, by incorporating these risks into its Internal Capital Adequacy Assessment Process and Own Risk Solvency Assessment process.

According to the Guideline, OSFI will develop a standardized climate scenario analysis exercise for FRFIs to use in assessing aggregate exposures to physical and transition risks. FRFIs will be required to apply these scenarios and report their results to OSFI.

Chapter 2: Climate-Related Financial Disclosure Expectations

Chapter 2 of the Guideline requires that all FRFIs (except for subsidiaries of FRFIs that report consolidated results to OSFI) implement climate-related financial disclosures in line with the Financial Stability Board’s TCFD Framework and the International Sustainability Standards Board’s (ISSB) Exposure Draft on Climate-related Disclosures, including climate-related disclosure on governance, strategy, risk management, metrics and targets, greenhouse gas emissions, ISSB Cross-Industry Metrics and ISSB Industry-Specific Metrics for Banks and Insurers. Further, the expectations also include publication of a Climate Transition Plan (as discussed under the governance expectations) and public disclosure of any net-zero commitments made by the FRFI. These requirements generally align with the federal government’s commitment in Budget 2022 to require financial institutions to publish climate disclosures starting in 2024.

Under the current draft, the climate-related financial disclosure expectations will be effective for fiscal periods ending on or after October 1, 2023 and would require annual public disclosure by FRFIs (to be made no later than 180 days after fiscal year-end). Consistent with the CSA climate change disclosure proposal, and in contrast to the Securities and Exchange Commission (SEC) proposal, no independent external assurance of these disclosures would be required. However, disclosures are expected to be subject to internal governance processes that are the same or substantially like those used for financial reporting. In addition, larger FRFIs with more varied business lines and geographic locations, or which are systemically important, will be held to a higher standard on the volume and level of detail expected in their disclosures. The Guideline provides flexibility to FRFIs on the location and format of the disclosure but notes that possible locations include reports to shareholders that are publicly disclosed or a standalone report such as an Environmental, Social and Governance Report or Climate Risk Report.

In setting these disclosure expectations, the Guideline further entrenches the TCFD Framework as the leading disclosure framework for climate risks.

The CSA and the SEC have already proposed rules that would require TCFD-aligned disclosure from certain reporting issuers. (See our previous bulletins on the CSA proposal and the SEC proposal.) However, the Guideline goes further than the CSA proposal by requiring mandatory GHG emissions reporting in contrast to the more flexible CSA comply-or-explain disclosure model. In particular, effective for fiscal periods ending October 1, 2023, the Guideline would require

• all FRFIs to disclose their Scope 1 and 2 GHG emissions and the related risks; and
• D-SIBs¹, Category 1 SMSBs and IAIGs headquartered in Canada to disclose their Scope 3 GHG emissions and related risks².

Disclosure of Scope 3 emissions would be required for Category 2 and 3 SMSBs and other federal regulated issuers beginning in 2027.

These expectations more closely align with the SEC proposal, which would require covered issuers to disclose Scope 1 and 2 emissions, as well as Scope 3 emissions if such emissions are material to the company or the company includes Scope 3 emissions as part of a public GHG emissions reduction target or goal.

Finally, unlike the CSA proposal, the Guideline would also require D-SIBs, Category 1 SMSBs and IAIGs headquartered in Canada to disclose the amount and percentage of assets or business activities vulnerable to climate-related physical and transition risks, as well as the proportion of revenue, assets or other business activities aligned with climate-related opportunities express as an amount or a percentage.

International trends

The Guideline builds on the efforts of the international banking community to improve the management of climate-related risks. For example, on May 30, the NGFS (which counts the Bank of Canada and OSFI as members) indicated in its 2022-2024 work program that it will focus on:

• supervisory practices with respect to managing climate-related risks;
• design and analysis of climate scenarios;
• implications of climate change for monetary policy;
• guidance for central banks on transition to net zero;
• nature-related financial risks; and
• capacity building for its membership.

Through this work program, the NGFS intends to deliver on its commitment to “deepen, expand and strengthen their collective efforts towards greening the financial system, to improve the resilience of the financial system to climate-related and environmental risks, and encourage the scaling up of the financing flows needed to support the transition towards a sustainable economy”.

The European Union also recently adopted the Corporate Sustainability Reporting Directive (CSRD), which extends the scope and reporting requirements of the already existing Non-Financial Reporting Directive. Coming into effect on January 1, 2024 for the 2023 financial year, the CSRD aims to improve quality reporting by ensuring that business, including banks, report reliable and comparable sustainability information.

The Guideline is open for public comment until August 19, 2022. OSFI plans to issue the final version by early 2023.