OSFI response to draft Guideline B-15 consultation feedback

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Type of publication: Result summary
Date: March 7, 2023

A. Introduction

In May 2022, the Office of the Superintendent of Financial Institutions (OSFI) issued its draft Guideline B-15 Climate Risk Management (the guideline) for public consultation. The guideline sets OSFI’s expectations for federally regulated financial institutions’ (FRFIs) management of climate-related risks. It aims to support FRFIs in developing greater resilience to, and management of, these risks.

OSFI received over 4,300 submissions from a wide range of respondents, including FRFIs, federally regulated pension plans (FRPPs), non-regulated entities and other organizations, and individuals. See Table 1 for the breakdown by respondents.

OSFI thanks all respondents who submitted comments.

B. Background

Climate change and the global response to the threats it poses have the potential to significantly impact the safety and soundness of FRFIs, and the financial system more broadly. These risks, also known as “climate-related risks”, may manifest over varying time horizons, and are likely to intensify over time, especially if the global economy undergoes a disorderly transition. They can drive financial risks, such as credit, market, insurance, and liquidity risks. They can also lead to strategic, operational, and reputational risks. In severe instances, climate-related risks can threaten the long-term viability of a FRFI’s business model.

Building resilience against climate-related risks requires FRFIs to address vulnerabilities in their business models, their overall operations, and ultimately on their balance sheet. It entails forward-looking approaches that are holistic, integrated, and built on reliable empirical data and sound analyses.

As outlined in OSFI’s January 2022 letter outlining its seven climate-related initiatives, OSFI’s principal objective is to support FRFIs in their efforts to build awareness and capabilities in managing climate-related financial risks. Our initiative on the guideline advances this objective by setting expectations to improve FRFI readiness to manage climate-related risks and to enhance the safety and soundness of these institutions.

C. Next steps

OSFI recognizes that climate risk management and climate-related financial disclosure practices are evolving. While actions may be challenging now, the risk of waiting poses greater threats, considering the evolving landscape of climate change and its potential impact on the safety and soundness of FRFIs and by extension, the stability of the broader financial system.

Recognizing the urgent need for action and the evolving nature of climate risk management, OSFI publishes the first iteration of final Guideline B-15 today, with plans to review and amend the guideline as practices evolve and standards harmonize including, among other things, refining Chapter 2 of the guideline after considering the final International Sustainability Standard Board (ISSB) Standard IFRS S2 Climate-related Disclosures.

D. Key themes from the consultation

While OSFI received a diverse range of comments and recommendations to consider, respondent feedback can be generally categorized into four key themes:

• OSFI’s approach to climate-related risks
• OSFI’s expectations related to climate-related financial disclosures
• incorporating proportionality and materiality considerations into the guideline
• the adequacy of climate-related capital and liquidity requirements

This section summarizes the feedback received through the public consultation, as well as OSFI’s responses.

1. OSFI’s approach to climate-related risks

Respondents generally support OSFI’s principles-based policy response to climate-related risks. However, many respondents recommended that OSFI issue binding rules, rather than guidelines, to FRFIs. They suggested that OSFI apply greater pressure on FRFIs to adopt a double materiality lens when addressing climate-related risks. They also suggested that OSFI set stronger rules around capital requirements and transition plans, as well as rules to ensure bank financing activities are aligned with and respect Indigenous rights. Examples of these recommendations include:

• implement prudential penalties to FRFIs that compromise or delay capital allocation to infrastructure projects that are intended to respond to or address climate risk
• establish and require increased risk weights for assets that are not aligned with Canada’s climate commitments
• set real limits on fossil fuel financing and introduce consequences for institutions that violate regulations
• require financial institutions to submit 1.5℃-aligned climate plans with interim 5-year targets and penalties for non-compliance

OSFI’s response

OSFI approaches climate risk management through the lens of its legislative mandate. OSFI contributes to public confidence in the Canadian financial system through the regulation and supervision of FRFIs and FRPPs.

OSFI guidance is generally principles-based with expectations that can be applied proportionately to FRFIs and FRPPs of varying size, nature, complexity, and risk profile. By developing principles-based guidance wherever possible, OSFI focuses on achieving positive risk outcomes at FRFIs and FRPPs, rather than formal compliance with detailed rules. Regulatory guidance is supported by strong risk-based supervision and sound supervisory judgement that is focused on early intervention. When OSFI identifies weaknesses through its supervisory activities, it promptly advises FRFIs if there are material deficiencies and take corrective measures or require that they be taken to expeditiously address the situation.

OSFI continues to assess whether its regulatory capital framework captures the unique features of climate-related risks. It is also developing a standardized climate scenario exercise for FRFIs and broadening stakeholder engagement with a diverse group of stakeholders as part of its response to this risk.

2. OSFI’s expectations related to climate-related financial disclosures

Respondents agreed that climate-related financial disclosures are important for transparency. However, respondents also suggested OSFI delay the guideline for the following reasons:

Harmonize disclosure expectations/timelines with those of relevant standard setting bodies and regulators, and key initiatives

To facilitate consistency and comparability of disclosures, some respondents requested that OSFI delay implementation of the guideline by at least one year to harmonize its disclosure expectations and implementation timelines with those of standard setting bodies such as the International Sustainability Standards Board (ISSB) and the Canadian Sustainability Standards Board (CSSB), other domestic regulators, such as those under the Canadian Securities Administrators (CSA), and with key initiatives such as the Partnership for Carbon Accounting Financials’ (PCAF) and the Glasgow Financial Alliance for Net Zero (GFANZ), when their guidance/frameworks are finalized.

Permit an iterative and progressive approach to disclosures

Some respondents highlighted challenges with data and methodology as barriers to providing reliable and complete disclosures and recommended that OSFI accept qualitative disclosures initially and allow FRFIs to increase the level of quantitative disclosure over time.

Mitigate the potential for unintended consequences of disclosures

Given the current climate data limitations and nascency of methodologies and measures, some respondents commented that premature disclosures could prove counterproductive and increase the risk of incorrect decisions made. Other respondents were concerned that some of OSFI’s draft disclosure expectations could put some FRFIs at a competitive disadvantage. Lastly, some respondents suggested that OSFI embed safe harbour provisions for forward-looking statements and align these provisions with those of the CSA.

Multiple respondents also made recommendations for OSFI to adopt the definition of materiality from the International Financial Reporting Standards (IFRS), to align timing and location of disclosures with those of FRFIs’ financial statements, to require audit-level assurance, and to allow FRFIs to leverage non-FRFI parent company-level climate-related financial disclosures to meet the guideline expectations.

OSFI’s response

OSFI agrees with respondent feedback and will aim to refine disclosure expectations to be consistent with that of the ISSB. OSFI believes that timely transparency of FRFIs’ climate-related risks and risk management is necessary to help foster confidence in the Canadian financial system. The disclosure expectations in the guideline are intended to facilitate this transparency by requiring public disclosures by all in-scope FRFIs.

While OSFI acknowledges the challenges that FRFIs face in navigating the evolving landscape of climate-related disclosure, it expects FRFIs to work towards refining and increasing the robustness of their climate-related disclosure practices. Accordingly, OSFI endeavors to publish climate-related disclosure guidance which meets users’ need for timely transparency and enables progression of FRFIs’ disclosures over time.

3. Incorporating proportionality and materiality considerations into the guideline

Some respondents requested that OSFI embed the concept of proportionality throughout the guideline to provide flexibility to FRFIs of different risk profile, sizes, complexities, and exposures. They noted that the current expectations may be too onerous for smaller institutions with very limited or non-material climate risk exposures. Examples of these expectations includes climate-related financial disclosures, the Climate Transition Plan, the identification, collection and use of climate-related risk data, and climate scenario analysis. Respondents also recommended OSFI implement the guideline using a phased-in implementation approach.

Some respondents also suggested that the guideline should only apply to material climate-related risks. Furthermore, they requested that OSFI provide more flexibility and time particularly for smaller FRFIs to measure and report on Scope 3 greenhouse gas (GHG) emissions, as the materiality of these emissions should drive how FRFIs manage climate-related risks.

OSFI’s response

As noted in the guideline, there is no one-size-fits-all approach for managing climate-related risks given the unique risks and vulnerabilities that will vary with a FRFI’s size, nature, scope, complexity of its operations and risk profile. Consistent with OSFI’s principles-based approach to regulatory policy development and supervision, it will consider proportionality when assessing compliance with the final guideline.

As it relates to materiality, the FRFI’s Risk Appetite Framework (RAF) should guide the risk-taking activities of the FRFI, taking into account its risk profile in line with the Corporate Governance Guideline. The RAF should consider the material risks to the FRFI, as well as the institution's reputation vis-à-vis policyholders, depositors, investors, and customers.

Of note, climate-related risks are transversal, emerging risks that could materialize beyond a FRFI’s standard planning horizon, where quantification could be challenged by the sufficiency of empirical data, measurement, and modelling techniques. As shown in the 2022 Bank of Canada-OSFI pilot project (PDF), the transition to a low-GHG economy will entail important risks for some economic sectors in all scenarios, and that mispricing of transition risks could expose financial institutions and investors to sudden and large losses. While some FRFIs may have assessed their climate-related risk to be non-material based on current available data, measurement, and methodologies, these conclusions can evolve as the external environment changes and as data, measurement, and methodologies evolve.

4. The adequacy of climate-related capital and liquidity requirements

Some respondents viewed OSFI’s existing capital framework and guidance (Guidelines E-19 Internal Capital Adequacy Assessment Process (ICAAP) and the Own Risk and Solvency Assessment (ORSA)) as suitable to assess capital requirements for climate-related risks. While these respondents were supportive of OSFI’s approach, they pointed out some challenges to consider:

• Respondents highlighted that the time horizon for climate-related scenarios can extend over a much longer period (30 years) as compared to the time horizons typically used for standard capital planning in the ORSA and ICAAP (one to three years).
• Some respondents commented that data, methodological and measurement challenges associated with climate-related scenario analysis can produce incomplete results for determining risk-based capital and could have unintended capital consequences.
• Some respondents highlighted that liquidity is not a key risk for the insurance sector while others questioned whether there is a need for a separate chapter on capital and liquidity in the guideline given existing capital guidance and frameworks are appropriate.
• Some respondents wanted OSFI to be more prescriptive and provide additional guidance in its climate-related capital and liquidity expectations.

Other respondents supported immediate actions on capital such as imposing higher regulatory capital requirements on high GHG emitting assets to reflect the risks these assets pose to the financial system which cannot be addressed at the institution level.

OSFI’s response

OSFI continues to assess whether its regulatory capital framework captures the unique features of climate-related financial risks. Recognizing that a FRFI’s climate-related risks varies with the FRFI’s unique circumstances, it expects that FRFIs will continue to evaluate and measure their capital available to protect against material risks, including climate-related risks, and reflect their assessments in the banks’ ICAAP or the insurers’ ORSA.

As it relates to liquidity risk and the insurance sector, while the nature and relevance of liquidity risk to insurers will vary depending on the exposures of each insurer, liquidity risk can be a key risk due to physical and transition risks. For example, insurers may experience sudden cash outflows due to increased severity and frequency of natural disasters. Not only can these disasters cause widespread damage to the insurers’ assets, but they can also result in volatile claims experience. Insurers may also experience liquidity risks due to its exposure to stranded assets, which can lead to inadequate liquid resources and the need to dispose of these assets at unfavorable terms.

E. Conclusion

OSFI thanks all respondents who submitted comments. As OSFI continues to advance on its seven climate-related initiatives, it encourages stakeholders to subscribe to OSFI’s email notifications for future updates to stay informed and engaged on these initiatives.