Seeing the Forest through the Trees: Implementation Challenges in Climate Risk Supervision

OSFI’s Assistant Superintendent, Regulatory Response Sector, Tolga Yalkin participates at the 23rd Annual International Conference on Policy Challenges for the Financial Sector

Relevance of Climate and Environmental Risk

Moderator:

OSFI published climate risk management guidelines in 2023 and just two months ago OSFI published the second consultation on Standardized climate risk scenario exercise.

Tolga, can you please tell us how physical and transition risks are impacting the financial system of Canada and how do you plan to use the Standardized Climate Scenario Exercise?

Assistant Superintendent Tolga Yalkin:

• How physical and transition risks are impacting the financial system
  • As a prudential supervisor, OSFI has a mandate to contribute to public confidence in the financial system. This includes ensuring that the financial institutions we regulate are managing the risks that could impact their safety and soundness appropriately. Among these are the physical and transition risks associated with climate change.
  • We are now seeing how the physical risks of climate changes are impacting financial institutions in Canada. For example, high severity events are increasing in frequency, and this has impacted reinsurance coverage and net retentions of P&C insurers that could result in potential earnings or even capital volatility.
  • Transition risks have also increased over the past few years given the divergence we’re seeing internationally on the reduction of GHG emissions and the resolve different jurisdictions have to move forward with the transition. This increases the risk of a more disorderly transition.
• Standardized Climate Scenario Exercise
  • Financial institutions and the regulators that oversee them need insights driven by data to be able to better manage climate risk. Our Standardized Climate Scenario Exercise, or SCSE as we call it, will shed light on the nature of the risks that financial institutions face on their balance sheets and beyond vis-a-vis climate risk.
  • The SCSE is a tool used to assess potential risks related to climate change, helping to identify vulnerabilities and prepare for future challenges. It involves analyzing different hypothetical scenarios to understand how climate-related risks might impact financial institutions themselves, their counterparties, the industry more broadly.
  • As a part of the two-phase public consultation model, we held two information sessions and will run a series of technical briefings that will examine specific topics such as physical risk (flooding and wildfires), credit risk, and market risk.
  • Institutions have until tomorrow, June 7, to submit comments on the second phase of the consultation. We will publish the final exercise this fall, have institutions complete it, and submit results before the end of the year, publishing a final report in 2025.  
  • We are pleased to be working with the Autorité des marchés financiers (AMF), which will run this exercise in parallel with some of its regulated financial institutions in Quebec.

Regulation and Supervision of Climate risk

Moderator:

Tolga, can you please tell us about OSFI’s supervisory framework over climate risk and how it is applied in the context of ongoing supervision?

Assistant Superintendent Tolga Yalkin:

• We released our new Supervisory Framework this April. It is the most significant change to our supervisory approach in 25 years. It sets out the key risk categories we are focused on: business risk, financial resilience, operational resilience, and risk governance.
• Climate risk is considered in all four risk categories because we see it as a “transverse risk” that runs throughout our assessment. Guideline B-15 articulates our expectations as to how climate-related risks should be managed.
• Our rating approach focuses on identifying the most serious risks facing an institution. There are no weights in our framework. Any category of risk has the potential to drive the Overall Risk Rating (ORR), which is an amalgam of the key risks mentioned above.
• We rate each category according to the level of risk it poses to the viability of the institution. That means that if climate risk poses a risk to the viability of the institution in any of the four categories, it can end up driving the ORR.
• For example, if an institution expanded its loan portfolio aggressively in a sector with high exposure to transition risk or has a high concentration of assets in an area exposed to increasing frequency and severity of physical risk events, this may impact our assessment of business risk, financial resilience, and risk governance. Depending on the level of risk to viability, this could lead to a ratings impact.
• Our ratings are linked to things that we want to see change at financial institutions. When we give an institution a rating that indicates opportunities for improvement, we provide outcomes we would expect to see for the rating to improve. We believe this straightforward, transparent approach helps to achieve supervisory objectives that address prudential risks.

Transition Planning, Disclosure and Nature Risk

Moderator:

NGFS published this year its survey on transition plans in EMDE countries. The findings suggest that EMDE financial institutions are in early stages of transition planning, lacking some capabilities compared to advanced economy peers, and facing several challenges in terms of varying objectives, lack of enabling environment and potential unintended consequences.

Tolga, can you please share your views on transition plans – how to make them more credible and how to best utilize them in the supervisory framework?

Assistant Superintendent Tolga Yalkin:

• Financial institutions must address the risks that climate change poses to their safety and soundness. A critical step involves the creation of transition plans outlining how they will manage the shift to a low-emission economy and navigate increasing physical risks.
• I chaired the Networking for Greening the Financial System’s workstream on supervision for 2 years. My team co-led the development of work on transition plans.
• This April, the NGFS published three reports, one of them which examines the credibility of financial institutions’ transition plans and processes. I believe credibility is central to our approach to assessing transition plans.
• At a high level, assessing the plan’s credibility involves looking at five elements:
  • Governance (the board and senior management’s oversight and governance over the transition plan)
  • Engagement (whether the institution’s engagement with its clients and investees is commensurate with the risks to which they could be exposed)
  • Risk analysis (the robustness of the institution’s risk analyses, considering its risk appetite for specific clients and investees based on their climate risk exposures)
  • Viable action (whether the institution has set out actions that align with its overall strategy and if actions are consistent with any climate goals it has)
  • Monitoring and reviewing (whether the institution has established appropriate internal controls and metrics or KPIs to monitor, review, and update the plan as it is executing on it)

Moderator:

The Basel Committee for Banking Supervision has recently concluded a consultation on disclosure of climate related financial risk. The document is interoperable with IFRS S2/TCFD Recommendations, even though some quantitative disclosure requirements reflect banks’ business model specificities (‘financed emissions’, ‘facilitated emissions’).

Tolga, as OSFI has recently issued guidelines on climate risk management, that includes a chapter on disclosure, I wonder if you could share your view on this topic. How can financial institutions improve transparency in reporting their climate-related risks? What are the main impediments to banks for reporting adequate disclosures?

Assistant Superintendent Tolga Yalkin:

• How financial institutions can improve transparency in reporting climate-related risks
  • Disclosures are critical when it comes to banking supervision. This is reflected in the international work on Pillar 3 of Basel III. What gets disclosed gets managed and scrutinized. Ensuring that different stakeholders have access to information encourages additional discipline for the management of risks that prudential supervisors are concerned with.
  • Guideline B-15 sets out mandatory disclosure expectations for all federally regulated financial institutions that will help them prepare for, and build resilience to, climate related risks. We believe our approach strikes a pragmatic balance aimed at ensuring the prudent management of climate risk.
  • Our office has also issued new climate regulatory returns to collect standardized data on emissions and exposures from financial institutions. The data that we will collect will enable us to better design regulate and supervise financial institutions.
• Main impediments to banks for reporting adequate disclosures
  • Last year we issued a questionnaire to financial institutions asking them to self-assess their readiness to meet the expectations set out in our Guideline B-15.
  • What we heard is that financial institutions are preparing to report on most categories of the expected climate-related financial disclosures, but that they are least prepared to publicly disclose Scope 3 GHG emissions. This aligns with the challenges institutions reported around their ability to properly collect, measure, and report this information.
  • We proportionally phased in disclosure requirements in Guideline B-15 based on the size and complexity of our institutions, so the largest most complicated financial institutions will start to have to disclose in 2025, and then we phase those in depending on the type of disclosure.
  • We will continue to monitor the progress of other regulators, such as the Canadian Securities Administrators (CSA), and standard setters, such as the Canadian Sustainability Standards Board (CSSB), as they finalize their Scope 3 GHG emissions disclosure expectations.