In pursuit of a climate change risk framework for Canada’s financial institutions

While the pandemic occupied the attention of governments, businesses, and the public throughout 2020, environmental, social and governance (ESG) issues, including climate change, also continued to receive significant attention.

All indications suggest that ESG issues will remain at the forefront in 2021, and for the Canadian financial services sector, recent climate change-related initiatives by regulators and government, as well as industry participants, demonstrate this ongoing focus. In this article, we discuss the gathering momentum of activity toward a climate change risk regulatory framework for the financial sector in Canada.

Regulator and government actions and the TCFD Framework

To date, there has yet to emerge a formal regulatory framework governing climate change risk analysis and reporting. While the framework for climate change disclosures developed by the Financial Stability Board (FSB) and the Task Force on Climate-related Financial Disclosures (the TCFD Framework) has received widespread support from businesses and governments¹, the federal government is still considering whether the TCFD Framework should be adopted.

Two recent initiatives from regulators and government offer insight into what direction regulators and government may take in seeking to fill the current void in climate change risk analysis and reporting:

• The Scenario Analysis Project: a pilot project by the Bank of Canada, OSFI and volunteer financial institutions to evaluate the possible effects of climate change and the transition to a low-carbon economy through scenario analysis to stress test participating financial institutions; and
• The OSFI Climate Change Consultation: OSFI’s 2021 discussion paper, Navigating Uncertainty in Climate Change: Promoting Preparedness and Resiliency to Climate-Related Risk, is the first step in a consultation process with federally regulated financial institutions (FRFIs) and federally regulated pension plans (FRPPs) to understand how climate change risks can affect the safety and soundness of FRFIs and FRPPs, and how these institutions are approaching related risk management².

The mandates of the Scenario Analysis Project and OSFI Climate Change Consultation suggest that the focus of Canadian financial services regulatory bodies is turning towards implementation of a regime based on the TCFD Framework. For example, while neither the Bank of Canada nor OSFI has settled on a standard for climate change risk disclosure or scenario analysis, both the Scenario Analysis Project and the OSFI Climate Change Consultation bear the clear imprint of the TCFD Framework respecting climate change disclosures, risk assessment, and scenario analysis³.

There are also signs that the financial services sector is independently moving towards implementation of TCFD Framework-style disclosures.

The OSFI Climate Change Consultation in particular provides valuable insight into OSFI's current views on these issues and its expectations of FRFIs regarding the ways institutions can prepare for, and build resilience to, climate related risks. For example:

• OSFI has indicated that, in order to respond adequately to the financial (e.g., credit, market, liquidity, insurance), operational, and strategic risks posed by climate change, institutions will need to revise their risk appetite and strategy, and their governance and risk management approaches and tools to take specific account of climate change risks.
• FRFI preparedness will require aligning the risk appetite for climate change risk to the FRFI's objectives. This will necessitate an understanding of the dynamic nature and scope of the FRFI's climate-related risk exposure, complemented by a strategy that adheres to the FRFI’s climate change risk appetite and that is commensurate with the nature, size, complexity and risk profile of the FRFI.
• While OSFI does not take a position on the merits of mandating climate change risk financial disclosure in the Consultation paper, it does note that it is closely following the federal government's response to the recommendation of the Expert Panel on Sustainable Finance that the government require companies to adopt the TCFD Framework (read more in our article “Sustainable finance gaining traction”).

Industry initiatives and beyond

There are also signs that the financial services sector is independently moving towards implementation of TCFD Framework-style disclosures. The Canadian Bankers Association recently disclosed that all large banks are working to implement the TCFD Framework disclosure regime, while a number of Canadian asset management operations, including those owned by the Royal Bank, the Bank of Montreal and the Bank of Nova Scotia, endorsed a submission by the Shareholders Association for Research and Education (SHARE) to the Ontario Capital Markets Modernization Task Force in support of the proposal to mandate adherence to the disclosure standards of the TCFD Framework.

These moves by members of the Canadian financial services sector to implement climate change disclosure, risk assessment, and scenario analysis on the model of the TCFD Framework are timely despite the continuing uncertainty as to final form of governmental or regulatory standards or guidance on these issues in Canada. The pressure for greater ESG disclosure increased significantly during 2020 and shows no signs of slowing. As noted in ““Pandemic-proof”?: the resilience of sustainable finance through COVID-19”, investors have embraced ESG-based investment enthusiastically as demonstrated by the 72% increase in assets under management in sustainable investment funds even in the midst of the COVID-19 pandemic. Institutional investors have also increasingly emphasized ESG factors in their investment practices and some, such as BlackRock, are taking steps, such as voting action, against companies that fall short of expectations in relation to ESG performance. An in-depth survey by the Chartered Professional Accountants of Canada of financial services market providers (including institutional investors with assets under management totaling approximately $1.9 trillion) revealed that investors want increased, relevant, and timely disclosure about governance, high-level risk management, and strategic assessment in relation to climate change risk. The survey also revealed that where climate-related financial information is material to a company, investors want relevant information to be disclosed as set out in the recommendations of the TCFD⁴.

These trends are apparent outside of Canada as well. The UK government has recently introduced measures to require large companies, pension funds, and banks to start making climate change risk disclosures in line with the TCFD Framework by 2021. This requirement will be extended to all companies in the following five years⁵. While the UK is on the leading edge of implementing TCFD Framework disclosure requirements, governments and regulatory bodies globally, including the Federal Reserve in the United States⁶, are taking similar steps towards requiring implementation of climate-change risk assessment and disclosure by companies⁷. The steps underway at Canadian FIs and Canadian financial sector regulators are therefore timely and part of a global movement toward a standardized approach to assessing and disclosing climate-change risk exposure.

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¹ See the TCFD publications “Recommendations of the Task Force on Climate-related Financial Disclosures” (June 2017); “Implementing the Recommendations of the Task Force on Climate-related Financial Disclosures” (June 2017); “The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities” (June 2017).

² See also the publication in January, 2021 of the Ontario Capital Markets Modernization Taskforce’s Final Report (the “Taskforce Report”); the final report of the CSA Climate Change Disclosure Review Project in 2018 and ensuing guidance set out in CSA Staff Notice 51-133 Environmental Reporting Guidance and CSA Staff Notice 51-358 Reporting of Climate Change-related Risks; read our “New public company guidance on material climate change-related risk disclosure” for more; and the publication of the final report of the Expert Panel on Sustainable Finance in 2019; read our “Sustainable finance gaining traction” for more.

³ Navigating Uncertainty in Climate Change: Promoting Preparedness and Resiliency to Climate-Related Risk (OSFI 2021) at paragraph 6.4.

⁴ “Progressive Investors and Corporate Disclosure: The Unstoppable Transition to a Resilient, Low Carbon Economy”. 2019 Chartered Professional Accountants of Canada. Available here.

⁵ “Companies Can No Longer Dodge Climate Risks as U.K. Raises Bar”. November 10, 2020. Available here.

⁶ “Climate Change Is a Source of Financial Risk” Federal Reserve Bank of San Francisco Feb 8 Economic Letter; available here; “Strengthening the Financial System to Meet the Challenge of Climate Change” December 18, 2020 speech by Governor Lael Brainard of the Federal Reserve at "The Financial System & Climate Change: A Regulatory Imperative" hosted by the Center for American Progress, Washington, D.C. Available here.

⁷ “Stocktake of Financial Authorities’ Experience in Including Physical and Transition Climate Risks as Part of Their Financial Stability Monitoring”. FSB 22 July 2020. Available here.