Bank Of Canada And OSFI Release Findings Of Joint Pilot Project On Climate Change Transition Risk Scenarios – Climate Change – Canada – Mondaq

Last week, the Bank of Canada (the BoC) and the Office of the
Superintendent of Financial Institutions (OSFI) released their
joint final report on their pilot climate scenario analysis project
titled Using Scenario Analysis to Assess Climate
Transition Risk. According to the BoC and OSFI “[the] pilot was an important step in helping Canada’s financial
sector improve its ability to analyze economic and financial risks
affecting financial institutions that could arise from climate
change.”

Background

In late 2020, the BoC and OSFI jointly launched a climate
scenario analysis pilot (the Pilot) to better understand the risks
to the financial system that could arise from a transition to a
low-carbon economy, or “transition risk”. Transition risk
is the risk inherent in changing strategies, policies or
investments as society and industry work to reduce their reliance
on carbon and the impact on our climate.

For the Pilot, the BoC and OSFI partnered with six Canadian
financial institutions (the Co-operators Group Limited, Intact
Financial Corporation, Manulife Financial Corporation, Royal Bank
of Canada, Sun Life Financial and TD Bank Group – the
FIs).

The FIs analyzed and assessed credit and market risk related to
selected elements of their balance sheets related to the transition
to a net-zero/low-carbon economy. The insurer FIs analyzed credit
risk to their bonds and corporate loans portfolios and market risk
to their equity portfolios, whereas the bank FIs analyzed credit
risks to their wholesale loans portfolios.

According to the BoC and OSFI, the objectives of the Pilot were
to:

• build the capability of regulatory authorities and FIs to do
  climate transition scenario analysis;
• support the Canadian financial sector in improving its
  assessment and disclosure of climate-related risks; and
• contribute to the understanding of the potential exposure of
  the financial sector to climate transition risk.

What is climate change scenario analysis?

Climate change scenario analysis allows financial institutions
to better understand and quantify the risks and uncertainties they
may face under different hypothetical climate futures. The Pilot
considered four climate scenarios over a 30-year horizon (from 2020
to 2050):

• baseline (2019 policies) — a baseline
  scenario consistent with global climate policies in place at the
  end of 2019.
• below 2°C immediate — an immediate
  policy action toward limiting average global warming to below
  2°C.
• below 2°C delayed — a delayed policy
  action toward limiting average global warming to below
  2°C.
• net-zero 2050 (1.5°C) — a more
  ambitious immediate policy action scenario to limit average global
  warming to 1.5°C that includes current net-zero commitments by
  some countries.

Lessons learned from the pilot

According to the BoC and OSFI:

• The Pilot provided both financial authorities and participating
  financial institutions with a foundational experience in using
  climate scenario analysis to identify, assess and understand
  climate-related transition risks to the Canadian economy and
  financial system.
• The different climate scenarios employed for the Pilot outlined
  a number of potential material risks to the economy and the
  financial system.
• The analysis concluded that, while every sector needs to
  contribute to the climate change transition, negative financial
  impacts emerged for some sectors (e.g., fossil fuels) and benefits
  emerged for others (e.g., electricity).
• Finally, the analysis showed that delayed climate policy action
  increases the overall economic impacts and the risks to financial
  stability of a sudden repricing of assets.

BoC and OSFI’s next steps

According to the report, the BoC and OSFI plan to further expand
the Pilot to include:

• assessment and analysis of “physical risk”, such as
  the risk posed from increasing the frequency of extreme weather
  events due to rising average temperatures
• expanding the scope of the analysis to include other financial
  institutions and other assets
• exploring systemic risk considerations, and
• working toward improving and standardizing risk assessment
  methodologies.

While pension plans were not a part of the Pilot, and no mention
was made of expanding the Pilot to pension plans at this time,
climate change scenario analysis is a tool that pension plan
administrators could use to assess and monitor climate change risk.
Indeed, certain activist groups appear to be advocating for
scenario analysis as part of an administrator’s fiduciary duty.
While neither regulators nor courts have taken a position on
scenario analysis to assess climate risk, it is a tool in an
administrator’s tool kit. As guidance from pension regulators
on ESG and climate change in particular evolve, it is likely that
scenario analysis will play a role.

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