The Office of the Superintendent of Financial Institutions (OSFI) recently released a discussion paper , titled Managing Uncertainty in Climate Change: Promoting Preparedness and Resiliency to Climate-Related Risk. The discussion paper addresses financial risks resulting from climate change and the potential impact on the “safety and soundness” of federally regulated financial institutions (FRFIs) and federally regulated pension plans (FRPPs). The OSFI seeks feedback from FRFIs, FRPPs and other stakeholders on how they define, identify, measure and build resilience to climate-related risks. Submissions are due to the OSFI by April 12, 2021.
OSFI has developed three categories of climate-related risks:
- Physical risks, which arise from a changing climate increasing the frequency of severe weather events that have the ability disrupt critical business operations and threaten the value of certain assets or investment holdings, such as commercial real estate.
- Transitional risks, which stem from technological advancements and increased government regulation to reduce greenhouse gas (GHG) emissions as the economy shifts towards a lower GHG-footprint.
- Liability risks, which occur as companies and their boards of directors face legal action over their perceived failure to account for and manage climate-related financial matters.
Climate-related risks can drive financial risks such as credit, market, liquidity and insurance risks for FRFIs and FRPPs. They can also lead to strategic and operational risks or reputational damage. Ultimately, mismanagement of climate-related risks can lead to financial loss beyond predictable risk estimation, affecting the safety and soundness of FRFIs or FRPPs.
Promoting Preparedness and Resilience to Climate-Related Risk
OSFI notes that climate-related risks are difficult to predict due to some uncertainty surrounding the effects of climate change which are, to some degree, foreseeable, yet difficult to quantify with a high degree of certainty. The apparent uncertainty surrounds the time horizon of climate change and the infinite number of variables that may affect its impact on the economy. Given the uncertain outlook of climate change, it would be prudent for FRFIs and FRPPs to prepare for economic uncertainty that may persist for some time. In essence, OSFI notes that climate-related risks are real, and the question is when and how the impacts will be felt by business.
To promote FRFI preparedness and resilience to climate-related risks, OSFI is exploring the role of capital requirements, the supervisory review process and market discipline. OSFI is similarly looking at FRPP guidance, supervisory processes and reporting requirements to determine whether they sufficiently account for climate-related risks.