What we heard: Consultations on draft Standardized Climate Scenario Exercise methodology



Building resilience against climate-related risks requires Federally Regulated Financial Institutions (FRFIs) to address vulnerabilities in their business models, operations, and balance sheets. It entails forward-looking approaches that are holistic, integrated, and built on reliable empirical data and sound analyses.

To that end, the Office of the Superintendent of Financial Institutions (OSFI) is developing a Standardized Climate Scenario Exercise (SCSE) to be completed by FRFIs by the end of 2024. The SCSE furthers robust climate risk management, which helps OSFI promote the adoption by FRFIs of policies and procedures designed to control and manage financial risks.

Public consultation process – Part I

On October 16, 2023, OSFI published a draft of the SCSEStandardized Climate Scenario Exercise – Draft for consultation methodology and launched the first part of a two-part consultation process to support the refinement, effective implementation, and execution of the SCSE in 2024.

Part I of the consultation ran until December 22, 2023. During the consultation process, OSFI hosted a virtual information session that was attended by over 1,0​00 participants. Information session participants had an opportunity to send questions in advance and live during the question-and-answer period. At the conclusion of the consultation process, OSFI received thirty-nine comment submissions from a wide variety of organizations including FRFIs, industry groups, research organizations, consulting firms, and government partners. Submissions included thoughtful and insightful technical observations, questions, and suggestions. These types of comments are very helpful and have motivated updates to the SCSE methodology.

This document summarizes the comments received from Part I of the consultation on the SCSE.

Public consultation process – Part II

Building on the feedback received during Part I, Part II of the consultation process runs from April 11 to June 7, 2024. OSFI has published three documents for Part II of the consultation process:

During Part II of the consultation process, OSFI plans to host another information session on May 2, 2024.

Consultation feedback

The comments received on the draft SCSE methodology are summarized across eight themes. These themes generally capture views expressed in multiple comment submissions.

1. There is broad support for OSFI’s climate risk initiatives, climate scenario analysis work, and the objectives of the SCSE

Most submissions were supportive of OSFI’s climate risk initiatives, including guideline B-15, the Climate Risk Returns, and the SCSE. Of the small number that were not supportive, some expressed the view that climate risks are not material and/or outside of OSFI’s mandate. Others considered climate risks to be an existential threat and stated that OSFI should take more actions to fight climate change.

Supportive submissions generally agreed with the objectives and high-level approach OSFI is taking with the SCSE. Many of these comments included constructive suggestions regarding the implementation of the SCSE. These are captured in other themes in this document.

2. The SCSE will require significant FRFI resources — timelines should be extended, the scope of the SCSE should be narrowed, and/or the SCSE should be simplified

Submissions related to FRFI resources generally focused on the efforts needed to work with geospatial data. Other concerns pertained to the challenges associated with geocoding (i.e., finding latitude and longitude coordinates for a given address) for collateralized assets, with an emphasis on more complex multi-point geocoding. Additionally, some submissions noted that significant resources would be needed to map exposures to North American Industry Classification System (NAICS) codes, with an emphasis on counterparties that are active in multiple industry sectors.

To help address and manage their concerns regarding resource requirements, some submissions also included suggestions, such as:

  • delaying the due date of the SCSE to 2025
  • exempting smaller FRFIs from certain modules of the SCSE
  • clarifying and limiting the scope of the SCSE, e.g., by having fewer asset classes in scope
  • simplifying the SCSE, e.g., providing FRFIs with postal code level physical risk data

OSFI response

OSFI is mindful of the resources needed for FRFIs to complete the SCSE, especially given the nascency of climate risk measurement and climate scenario analysis. For this reason, OSFI has decided not to set specific expectations for FRFIs to develop or use their own climate risk models for the SCSE, given the extensive resources required to develop such models.

OSFI will not adjust the timelines for the SCSE. OSFI has aimed to support FRFIs in meeting the timelines by providing information in the updated draft SCSE methodology and draft SCSE instructions that will allow work related to industry sector classification and geocoding to start before the final version of the SCSE is released later in 2024. Additionally, we have updated the physical risk module to allow FRFIs to use simplifications and approximations where necessary for assets that would otherwise require complex multi-point geocoding. We have also included a detailed mapping from NAICS codes to SCSE industry sectors in the draft SCSE instructions. We have also introduced a materiality threshold that may help manage the resources needed to complete the SCSE.

3. Clarifications and more details are needed in all modules of the SCSE for FRFIs to successfully complete the exercise

Nearly every submission noted a desire for clarification and/or more information, including:

  • clarification of the assets/liabilities in scope of the SCSE, especially for insurers
  • expectations for mapping exposures to NAICS codes
  • clarification regarding the balance sheet approach and application of the credit risk module, e.g., using examples to illustrate how to implement the SCSE
  • expectations for geocoding and what physical risk data will be provided, and
  • how OSFI will derive financial adjustments for the credit and market transition risk modules

OSFI response

We have updated the draft SCSE methodology and/or incorporated information in the draft SCSE instructions to provide more clarity. Examples include the following:

  • including more information on the scope of assets, especially for insurers
  • including industry sector and regional sector mappings in the draft SCSE instructions
  • adding illustrative examples throughout the draft SCSE instructions
  • providing information on hazards and geographic regions for the physical risk modules

We have not included details on how financial adjustments will be determined in Part II of the consultation process. We plan on publishing financial adjustments when the SCSE is finalized, later in 2024. We will also include information on how the adjustments were derived in the SCSE final report, to be released in 2025.

4. The SCSE should consider proportionality by including exemptions or materiality thresholds

Multiple submissions suggested that small- and medium-sized banks (SMSBs) or domestic insurers could be exempted from the market risk module. Some also suggested materiality thresholds based on exposure amounts.

OSFI response

OSFI designed the SCSE to encourage capacity building for climate risk measurement and scenario analysis for all institutions, including smaller and domestic institutions. We have introduced materiality thresholds in the credit and market transition risk modules with this feedback in mind. Only FRFIs with more than $100 billion in total assets as of Q4 2023 are required to complete market risk modules. We have also added a clarification that assets that are measured at fair value through profit and loss (FVTPL) are out of the scope of the credit risk module.

5. The SCSE has several limitations that should be addressed

Most submissions noted at least one limitation of the SCSE, and in some cases, suggested that these limitations be addressed before finalizing the SCSE. Some of the limitations noted included:

  • the lack of second order impacts of transition or physical climate risks
  • not capturing liquidity or operational risks
  • limitations around climate models
  • the assumption of sectoral and regional heterogeneity for transition risks
  • not including a comprehensive quantitative assessment of the impact of hedges in the market risk module
  • not capturing physical risks outside of Canada
  • excluding non-collateralized loans for physical risks

OSFI response

We recognize that the SCSE has limitations. The SCSE methodology has been updated to include the limitations noted by participants that were not captured in the first draft. Given the foundational nature of the SCSE, we will remain mindful of its limitations when interpreting and reporting results.

6. The scenario narratives included in the SCSE should be reconsidered

Some submissions suggested that certain climate scenarios were unrealistic, too severe, or not severe enough. Others suggested that we include fewer climate scenarios in the SCSE and/or we shorten climate scenario time horizons.

OSFI response

There are differing views on the likelihood of any climate scenario actually occurring. The scenarios in the SCSE are not predictions.

For transition risk, we have removed the Current Policies scenario from the draft SCSE methodology and kept the other three climate scenarios (which will be measured against a baseline reference scenario). We see value in having results for the Net-zero 2050 scenario, given it is the most severe transition risk scenario. We also see value in having results for both the immediate and delayed action scenarios. Together, they give us a better understanding of the cost of delayed action.

We have simplified the physical risk module to a certain degree by including only two hazards: flood and wildfires. For each hazard, we plan to include one forward-looking metric based on a climate scenario, and one metric capturing average annual values. We have updated the SCSE methodology to reflect these changes.

7. OSFI should prescribe an approach for mapping exposures to NAICS codes and OSFI should define mappings from other industry code mappings to SCSE industry sectors

Some submissions suggested that OSFI would achieve better standardization by prescribing a method to map their exposures to NAICS codes, instead of relying on institutions to develop their own approach. The challenge associated with mapping complex counterparties involved in many industry sectors was noted in some submissions as well.

Other submissions noted that some FRFIs may use different industry classification systems, and mapping exposures to SCSE industry sectors using NAICS codes may be difficult.

OSFI response

One of the objectives of the SCSE is to encourage the building of FRFI capacity to measure climate risks and perform climate scenario analysis. In some cases, this objective conflicts with the SCSE’s standardization objective. With respect to mapping exposures to industry sectors, OSFI has chosen to have less standardization and rely on FRFI expertise and knowledge of their own exposures.

OSFI will not be providing mappings for other industry sector systems. We chose to map industry sectors using NAICS because:

  1. Statistics Canada and the United States Census Bureau maintain NAICS codes and update them frequently to ensure they maintain their relevance and suitability. The codes are freely available to the public, along with detailed descriptions and technical information which facilitates their use.
  2. While US and Canadian NAICS codes are updated by the respective national agencies, the codes are coordinated and standardized across both systems. The standardization of NAICS codes has enabled OSFI to develop the SCSE industry mapping, which functions within both Canadian and US systems. As a result, the NAICS mapping will be accessible to participants that have used either of these two systems.
  3. Other classification systems, such as the Global Industry Classification System (GICS), are not as granular as NAICS, especially in key transition sensitive sectors, e.g., there is no separation of oil from gas in GICS. Classification system granularity is important given the use of industry sectors in determining the financial risk adjustments.

Nonetheless, we have updated the draft SCSE methodology so that FRFIs that map exposures using other industry sector systems will be permitted to create their own mapping to SCSE industry sectors. The draft SCSE methodology also includes the NAICS to SCSE industry sector mapping methodology which could be adopted by FRFIs that choose to develop their internal mappings. FRFIs who choose this option would be expected to provide documentation of their mappings alongside the result of the exercise.

8. The market risk module should be aligned with other market risk assessments

Some submissions noted that the market risk module’s proposed discounted cash flow approach for corporate bonds is operationally challenging, and not aligned with the Basel Committee’s Fundamental Review of the Trading Book approach, which moved from a cash flow-based approach to a sensitivity-based approach. Furthermore, some comments highlighted that the market risk module’s approach to determining spreads for bonds leverages shocks from the credit risk module, and as a result, does not comprehensively capture the traded market risks.

These submissions also noted that the market risk module does not reflect the impact of hedges and recommended that the module be adjusted.

OSFI response

We have made a substantive change to the market risk module in the SCSE methodology to incorporate a sensitivity-based approach. We have also shifted to an instantaneous shock-based approach to determine the spread shocks for bonds. We believe the updated market risk module is better aligned to current risk measurement practices and will result in a better assessment of market climate transition risks.

We have not incorporated hedges into the core numerical data in the market risk section of SCSE workbook. However, FRFIs may provide OSFI an additional completed SCSE workbook that incorporates fair value hedges. We plan on incorporating questions related to hedges in the questionnaire in the final version of the SCSE and recognize this as a limitation of the SCSE. Only FRFIs with more than $100 billion in total assets as of Q4 2023 are required to complete market risk modules.