Office of the Superintendent of Financial Institutions
We live in a world where even though we may share facts, not everyone will see the same risks. Fact: humans affect the climate. But, this has led to responses ranging from: “not a problem”, to “let’s act now”, and on to, “it is already too late”.
One of the issues with climate change is that even if we all shared definitions and had a common plan towards a lower carbon footprint, uncertainty would remain in how, and how fast, this would impact the broader economy.
For OSFI, this means there is a wide-range of possible scenarios to consider when assessing the impact of climate change on financial institutions’ safety and soundness and in setting the appropriate prudential response.
When confronted by change on the horizon, OSFI looks to the severe but plausible outcomes, collects information to inform its analysis and risk assessment, and then uses regulation and supervision to preserve financial institution resilience.
By definition, the sound management of climate-related risks fits clearly within OSFI’s objectives. As a result, we are taking a number of actions to look more deeply at the prudential impact of climate change in terms of physical, liability and transition risks.
Transition risks are particularly significant for Canada given its endowment of carbon-intensive commodities and their importance to the Canadian economy, and so I will speak about what we are doing to better understand and respond to these risks from a prudential point of view.
But first, let me start by recognizing that we do not have all of the answers. Part of advancing our work is through cooperating with domestic and international organizations. By working with others, we gain a better understanding of what may be appropriate in the Canadian context.
We also know that we need more than financial sector expertise to get to the best possible answers. To that end, OSFI released a discussion paper on climate-related risks.earlier this month. While I will not cover the paper today, I do hope that you will all read it and consider contributing your own expertise.
It is clear that there are many ways in which climate-related risks may become prudential priorities.Traditional credit, market, and operational risks are mixing with reputational risks that come with the increased public focus on environmental, social and governance expectations. The interplay of all of these elements need to be considered. Ignoring these trends is a recipe for poor outcomes.
But achieving good prudential outcomes requires good data. Good data drives better “what if” analysis and is more likely to result in credible risk management responses. Consistent and credible public disclosures are also important. But while our work may contribute to enhanced disclosures, our focus remains on preserving effective risk management at the institutions we oversee.
We look at existing practices, do our own homework, and help refine the expectations for what is safe and sound risk management. And by getting to the right data and information, we will be able to make the best possible decisions, which is why we are now conducting a pilot project with the Bank of Canada.
Through our pilot project we are building our analytical capabilities using climate-risk scenario analysis. The pilot project will also allow participating institutions to gain deeper insights into their own risks.
This work recognises that we need to develop risk assessment methods and identify high-quality data, in order to reliably assess the prudential risks posed by climate change. Further, by investing in analytical capabilities now we will ensure that there is a common understanding of the range of possible outcomes with which to (1) set appropriate prudential policy and (2) improve supervision of financial institutions.
There are a number of steps we need to take before we can confidently assess the financial impact of different transition scenarios.
First, we need a set of climate-related macroeconomic scenarios for Canada, detailed enough to capture cross-sector and individual institution exposures.
Second, we need to identify the various financial risks, such as credit risk, market risk, and liquidity risk relevant to the climate transition scenarios we create.
Finally, we need repeatable and consistent approaches and methodologies to assess the financial impacts. For example, asset valuation impacts or changes in corporate and household credit risks on banking loan portfolios. Further we need the financial institutions to use them in their own risk management.
We have already begun our work with the Bank of Canada to develop a Canada-specific set of transition scenarios, together with financial risk assessment methods and metrics. We are targeting to complete this step in the first half of 2021. Then by the second half of this year, using these scenarios, participants will explore the potential risk exposures on their balance sheets.
Near the end of 2021, the Bank of Canada and OSFI will publish a report containing details of the specific scenarios, methods, assumptions and key sensitivities used. By sharing this information, we will be setting the stage for sound practices in risk measurement which, in turn, can be used to inform regulatory expectations. In short, better data will yield better outcomes.
Throughout the year we will be sharing different elements of the pilot, including scenarios and methodology. We will also use these opportunities to collect feedback on adoption challenges that may come from using the pilot’s approach.
The pilot will also collect information on governance and risk-management practices for climate-related risks. In particular, we are looking at Boards’ oversight roles, the extent to which climate is part of business and capital planning, and how institutions’ risk management processes are identifying, measuring and managing climate-related risks.
This work builds upon the basics of good risk management that we already expect of our institutions, helps to raise the bar for further improvements, and sharpens the tools (e.g. methodologies, data, and benchmarking) that will help to keep up with future developments.
The more coherent, standardized and available the data, the better the chance that people will make better decisions.
While climate-related disclosures will help to inform decision-making, we are also aware that it is not possible to disclose your way out of managing a risk. And so, our other efforts are trying to get to core financial risk exposures and to understand how well these risks are being managed and what else needs to be done.
As a prudential supervisor, our response needs to consider the full spectrum of risks and responses. Our actions may include revising risk management guidance, adjusting capital expectations and/or increasing the focus or intensity of our supervision.
However, to make credible decisions on each of those areas we need more evidence to measure the risks, sufficiently. That is why we are focussing our efforts on scenario analysis.
Our objective remains on building resilience at financial institutions for the protection of depositors, policyholders and private pension plan beneficiaries. Getting the facts and working to understand the issues is our best approach to achieving this goal. That is why I am pleased to participate in this discussion panel today.