Canada is joining other countries in enforcing ESG disclosures to manage and mitigate the impact of climate risk on its financial system and on the wider economy.
- The Canadian regulator has published new requirements for federally regulated financial institutions (FRFIs) to manage and disclose climate-related risks.
- Reporting for major banks and insurance companies will begin with the fiscal year 2024 reporting period, with smaller institutions to start in the following year.
- Regulators in most major economies are in various stages of setting mandatory ESG reporting requirements, having recognised the potential impact of physical and transition climate risks.
The Canadian financial industry regulator, the Office of the Superintendent of Financial Institutions (OSFI) has published a draft version of its Climate Risk Management guideline. It outlined the expectations placed on federally regulated financial institutions (FIs) relating to the disclosure of physical and transition climate risks on their operations.
The regulator also introduced mandatory climate-related financial disclosures aligned with the international Task Force on Climate-related Financial Disclosures (TCFD) framework, in its bid to increase transparency and public confidence in the Canadian financial system. The guidelines apply to all FRFIs, except branches of foreign banks.
What is OSFI trying to achieve?
The OSFI’s main aim is to help FRFIs manage these risks and develop greater resiliency to the impact of climate change on their operations.
The regulator recognised that specific approaches to managing climate-related risks will vary based on the size, business exposure and complexity of operations. In their implementation, FRFIs were instructed to interpret the guidelines from the perspective of being prudent in managing risks, while also competing effectively.
Structuring the guidelines to be interrelated helped to make them mutually reinforcing. Providing increased transparency through disclosures, for example, is expected to improve the quality of an FRFI’s climate-related governance and risk management practices.
The OSFI said it expects the guidelines to provide three potential outcomes for FRFIs: mitigating potential effects of climate risk on their business model and strategy; establishing proper governance and risk management practices; remaining financially resilient and operationally sound in the face of severe and disruptive climate scenarios.
Superintendent Peter Routledge said: “The final version of Guideline B-15 balances the concerns of stakeholders in all regions of Canada and remains in line with the expectations of global and domestic investors who fund Canadian federally regulated financial institutions.”
What is expected of the FRFIs in the new guidelines?
The OSFI’s guidelines cover two main areas of FRFI operations – governance and risk management, and the amount and level of disclosures required. The latter will inform stakeholders of the level of transparency provided by the FI relative to climate-related risks.
On governance and risk management, the regulator wants to ensure that FRFIs have the proper accountability structure in place, and have included assessments on the impact of both physical and transitional climate risks in their business model and strategy.
Monitoring and reporting on these impacts using a risk appetite framework can also be augmented by running stress tests and scenario analysis. This can help make adjustments to the risk profile of an institution’s portfolios and ensure that it has enough capital to address the needs of investors and regulators in the event of climate disasters.
To ensure that the disclosures from FRFIs adequately provide transparency and clarity, the guidelines established parameters for reporting the relevant data. This means that the disclosures should be specific and comprehensive about how current and future climate risks and opportunities will affect the individual FRFI.
There is also a need for the disclosures to be clear, understandable and balanced between qualitative and quantitative information, so as to be consumed by a variety of stakeholders and the public. Disclosures should also be verifiable and consistent, and the amount of data or information provided should be proportionate to the size of the entity.
The OSFI has set an effective reporting period of fiscal years ending on or after 1 October 2024 for larger banks and insurance companies, and 2025 for small and medium-sized banks. Scope 3 disclosures for large banks and insurers are expected for fiscal years ending on 1 October 2025, and in the following year for small and medium-sized banks.
How does Canada compare with the rest of the world in setting mandatory disclosures?
Regulators in most major economies are forging ahead with plans to mandate ESG disclosures with the exception of the US, where proposed legislation could slow, and perhaps even dilute, implementation of the SEC’s proposed disclosure rule. The EU appears to be furthest along in codifying its disclosure rules, with the UK following closely behind.
The Japanese Financial Services Agency, meanwhile, will require listed companies to provide ESG-specific disclosures with their financial statements starting with the fiscal year ending 31 March 2023. Remaining in Asia, the Securities and Exchange Board of India has launched a consultation to decide on ESG disclosure frameworks across listed companies and FIs, having already mandated that the top 1,000 listed companies make ESG disclosures on a mandatory basis from the financial year 2022-23.
While most of the developed world recognises the importance of managing climate-related risks, the largest economy in the world, the US, has politicised setting ESG disclosure requirements. What began as a backlash against a few major banks in a handful of states has now reached the national stage, with Republican senators waging war against ESG investing plans.
Hope for a climate-favourable resolution to the US anti-ESG stance may be waning, but could be boosted by the actions of Canada, its second-largest trading partner and neighbour, which has recognised the material risks posed by climate change.