Remarks by Superintendent Peter Routledge at the Responsible Investment Association Virtual Conference, June 7, 2022

Recognizing our stake in the distant future

Caring for the land is a beautiful concept in Indigenous cultures. It refers to the responsibility we have to hand off a better world to our successors, like the old proverb: “Blessed are those who plant trees under whose shade they will never sit.”

This is a big concept, so I’d like to shrink it down to a personal level. I have an 18-year old son who will emerge into adulthood over the coming decade or so, a period during which he will likely partner-up and perhaps have children of his own, my grandchildren. I expect they will arrive sometime in my late sixties or early seventies which means they will know me into their twenties, if longevity is to be one of my blessings, but will only feel my legacy in their adult years, long after I have shuffled off this mortal coil. Therefore, their adult life spans will cover the years following 2050, when the world’s success or failure towards the Net Zero 2050 target will be known.

Given the persistent and ominous shifts in our planet’s climate, they will likely invest my legacy with a substantial evaluation of what I did at this moment, today. Now, I hope they don’t evaluate me or OSFI as principal mitigants of global warming – we are not that, we cannot be that. But I hope they see me as a Superintendent who acted with urgency to advance sound climate risk management in the Canadian financial system. I hope they see me as a Superintendent who ensured Canada’s financial system would sustain its resilience in the face of a global economic transition away from Greenhouse Gas Emitting energy sources.

The world is pursuing a climate change response independent of Canada

A recent draft report from the UN’s Intergovernmental Panel on Climate Change (IPCC), has proposed that “Progress on the alignment of financial flows with low GHG emissions pathways remains slow. There is a climate financing gap which reflects a persistent misallocation of global capital.”

Not surprisingly, private sector investors, and many other stakeholders, have noticed this too and have, in response, demanded an intensified focus on climate-related risks at the institutions in which they invest. As a result, financial institutions have come under intense scrutiny globally, a scrutiny never more evident than at the Conference of Parties in Glasgow last year (COP26). In advance of that conference, more than 450 firms from across the global financial sector, representing over $130 Trillion in assets, aligned with one another in the Glasgow Financial Alliance for Net Zero, or GFANZ. In addition to this financing achievement, the COP26 Glasgow Climate Pact also secured national commitments to net zero mitigation efforts, adaptation efforts aimed at helping nations impacted by climate change, and enhanced collaboration across nations to deliver more climate-related risk management commitments. This global coalition recognizes that limiting global temperature increases to 1.5 degrees Celsius above pre-industrial levels will require entire economies to transition, including Canada.

In our view, the most important conclusion to draw from these facts is that nations of the world are attempting to mitigate the physical and transition risks produced by climate change and these responses will have a profound impact on Canada, its economy and financial system. More to the point, Canada will be far more influenced by the climate-related actions taken by other nations of the world than it will influence the global movement towards climate change adaptation.

How should OSFI respond?

This creates a new challenge for OSFI, and for the financial sector writ large. We know Canadian businesses and households will have to adapt as global climate change risk management efforts change the relative values of what Canada currently exports. We know that our financial system must do two things in response to this reality – (1) finance the transitions that Canadian businesses and households must make, and (2) weather the volatility inherent in this rather massive economic transition.

So, this prompts the question: How will OSFI, a financial system regulator, incorporate these existential climate change-related risks into our mandate?

Answer & supporting arguments

The short answer to this question is that OSFI will have to dedicate resources to studying the issue, proposing constructive way forwards, and engaging with our regulated constituents and Canadians with frequent and predictable periodicity.

Here is the good news: we have already begun. Over the last year, OSFI accelerated its focus on climate risk as part of its Blueprint for Transformation, we completed an in-depth climate scenario study with the Bank of Canada which has informed our approach, and we have created a new Climate Risk Hub and team, structured on four dimensions:

1. Policy and Risk Management
2. Scenario Analysis and Risk Quantification
3. Data Analytics, Measurement and Disclosure
4. Stakeholder Engagement

Policy and risk management

The Hub’s first major deliverable was the release of draft Guideline B-15 on Climate Risk Management, which we published just last month. The draft Guideline seeks stakeholder feedback on OSFI’s expectations for climate risk management by Federally Regulated Financial Institutions – or what we call FRFI’s. It outlines principles-based expectations on climate-related governance, risk management, and disclosure practices of institutions. We expect the Boards and Executives of FRFI’s to develop and implement rigorous oversight and risk management frameworks to address climate-related risks. This includes ensuring appropriate alignment between climate-related performance outcomes and compensation structures. I would ask our colleagues at FRFI’s to engage with us on this guideline – we are breaking new ground here and we need constructive engagement and debate over how to design and apply a climate risk management guideline that our regulated constituents see to be prudent, responsible, and reasonable. Please begin work on this now, if you haven’t already done so. We will welcome public comments to draft Guideline B-15 before August 19, 2022.

Scenario analysis and risk quantification

OSFI’s scenario analysis work has already begun. We collaborated with the Bank of Canada to complete a scenario analysis pilot project to assess climate transition risks. The work involved six Canadian financial institutions, who considered the impact of intentionally adverse, but plausible climate transition scenarios. The scenarios highlighted that meeting climate targets will lead to significant structural changes for the Canadian and global economies, and that delaying climate policy action increases the overall economic impacts, and risks to financial stability. The report also highlights that when delayed climate policy action is combined with additional macroeconomic stress events, or shocks, the impact is much more acute and disorderly. This is particularly true for countries such as Canada, which rely heavily on greenhouse gas emission-intensive fossil fuel extraction for domestic needs as well as exportation. Canada’s reliance on fossil fuels to support the broader economy will present transition challenges that may impact domestic GDP outputs, particularly if investments in green technology industries do not make significant advances and provide a sufficient offset.

We are continuing our collaboration with the Bank of Canada. Upcoming projects will analyze the impacts of flooding on residential mortgage portfolios and the impacts of transition risk on wholesale loan and securities portfolios. As we develop our capacity to model climate risk scenarios, we plan to run standardized climate scenario exercises for regulated institutions so we can ensure we’re all working from the same playbook.

Our scenario analysis work will help us decide if additional capital resiliency is necessary to address climate-related financial risk and to maintain public confidence, and stability in the financial system. Other regulators are starting to evaluate capital resiliency as well – notably the Bank of England. They have come to a number of interesting conclusions. One is that capital may not be suitable to address the causes of climate change, such as greenhouse gas emissions. But they also found that capital could be effective in addressing the consequences of climate change – to address both physical and transition risks. We, at OSFI, believe we must address these questions as well, particularly given Canada’s economic dependence on the natural resources sector. We need to ask ourselves whether climate-related risk are already sufficiently incorporated within our capital regime, or whether we need to modify existing capital tools, or develop new ones.

OSFI’s traditional approach has been to develop banking capital requirements called Pillar 1 requirements, using historical data to identify and risk-weight assets and exposures to ensure capital adequacy. However, the financial sector currently lacks the necessary climate-related data, particularly for transition risk, to undertake this analysis. Developing a Pillar I solution will be a multi-year undertaking that will require us to be innovative and forward-looking in our approach.

The option of a Pillar 2 capital buffer offers a more expedient stop-gap. OSFI’s most visible Pillar II buffer is the DSB – the domestic stability buffer, which totals 2.5% of each of Canada’s large bank’s - or what we call D-SIB’s – risk weighted assets. Notably, the DSB only applies to the banking sector, so we would need to be thoughtful on how we might apply any future climate-related capital buffer expectations across all regulated sectors.

Data analytics, measurement and disclosure

Identification of new data needs for the purposes of understanding exposures and stress-testing them won’t be sufficient by itself. The draft guideline I mentioned also establishes expectations for financial disclosures that are aligned with emerging global standards. These disclosure standards are being established by the Financial Stability Board (FSB) through their Task Force on Climate-Related Financial Disclosures (TCFD), as well as the International Financial Reporting Standards Foundation (IFRS), and their International Sustainability Standards Board (ISSB). A veritable alphabet soup of acronyms, to be sure. Adapted for the Canadian context, the purpose of these climate risk-related disclosures is to provide transparency to market participants on the climate-related risks that Canadian FRFIs face and how they are managing those risks. The aim of this transparency is to maintain public confidence and contribute to the overall stability of the Canadian Financial system.

Stakeholder engagement

Lastly, and to round out the functions of OSFI’s new Climate Risk Hub, OSFI will need to engage stakeholders in an unprecedented way. Climate risk cuts across many different industry sectors that make up the Canadian economy. So, we will be expanding our traditional engagement model to hear from those most impacted by the impending transition to a greener economy, particularly those from emission intensive sectors that rely on FRFIs for financial services or that make up a notable portion of FRFIs’ investment portfolios. OSFI is mindful that we serve all Canadians in all regions; to them we pledge transparency and open-mindedness. We know that the adaptation costs will not fall evenly across the country and we have a duty to all Canadians to understand the impacts on to their local economies. This means that we will ultimately deliver agile, expedited climate risk management policies in a manner that minimizes outcome asymmetries across Canada.

We have come to no firm conclusions on capital, and need industry input to ensure we get smart and effective regulations relating to climate risk management. We are open to all outcomes, including an outcome in which we determine that we already have sufficient capital resiliency to weather potential volatility in the 2030s. But we need FRFIs to do their own scenario analyses – and we know they are willing participants in this enterprise. As I alluded earlier in my remarks, it is not incumbent on OSFI, or even on the Investment Industry, to become principal mitigants of climate change. We understand our role, and we believe that we are staying in our lane – but we also recognize that to effectively address issues that transcend geographic, political and industrial boundaries, we must begin adapting to the reality and risks of climate change right now.

The steps I have outlined today are among the first that we take. We take them with an eye on the distant future. Think back to our grandparents (if you are a gen-x-er like me) – the generation that overcame a great depression and vanquished Fascism in Europe – that generation made tremendous personal sacrifices and took grand collective risks so that our generation’s present (their distant future) would be better.

We hope to bequeath to our grandchildren and their grandchildren something similar. A future in which climate change and global warning do not present existential risks to their well-being; a future that arrives without too much financial disruption and with new opportunities associated with newer technologies and industries that power our world. I welcome input on our work to date, and where we need to go from here. With that, I am pleased to open the floor to any questions.