Canada has taken a bold step forward in setting regulatory expectations for climate risk management within its financial sector. With the ninth-largest GDP in the world, Canada’s decisions have global implications. This move to establish rigorous climate-related risk management and disclosure requirements for Canadian financial institutions will have ripple effects throughout the global economy.
Canada’s new climate risk management guidelines send a strong message that not only is the impact of climate change financial risk, but the impact of climate change on the Canadian financial system is also systemic risk.
Canada’s new guidelines send another strong message: Scope 3 matters. The disclosure requirements for greenhouse gas (GHG) emissions include Scope 3, specifically financed emissions, facilitated emissions, and insured emissions.
This means that federally regulated financial institutions in Canada will have to disclose not only their own emissions, but also the emissions of the companies they finance or insure. Just as climate change has global financial impacts, the Canadian guidelines will also have global impacts: financial institutions based in Canada will soon be asking for emissions data from counterparties around the world.
What did Canada do?
On March 7, the Canadian Office of the Superintendent of Financial Institutions (OSFI) released Guideline B-15: Climate Risk Management, which will govern the means and methods by which the financial sector in Canada is required to manage and disclose climate-related risk.
In establishing these guidelines, Canada’s OSFI aims to ensure that financial institutions in Canada are ready for both the “physical risks” (e.g., an increased frequency of extreme weather events) and “transition risks” (e.g., financial risks due to changing government regulations) associated with climate change. See here for a full primer on the difference between physical and transition risks.
What entities does Canada’s new guideline cover?
The Climate Risk Management guideline applies to federally regulated financial institutions (FRFIs) in Canada. Two core types of institutions comprise FRFIs: banks and insurers. OSFI subdivides each of those two groups (banks and insurers) by size/importance, leading to 4 total categories of FRFIs:
- Domestic Systemically Important Banks (D-SIBs) - this category includes the largest banks, including Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and Toronto-Dominion Bank
- Small and Medium-Sized Deposit-Taking Institutions (SMSBs) - smaller banks considered less critical to the health of the Canadian financial system
- Internationally Active Insurance Groups (IAIGs) headquartered in Canada - a narrow group of large insurers, including Sun Life Assurance Company of Canada, Manufacturers Life Insurance Company, Canada Life Assurance Company, and Intact Financial Corporation
- All Other Federally Regulated Insurers - all federally regulated insurers that do not fit into the “IAIGs headquartered in Canada” group. This includes Canadian branches of foreign insurers.
What does this mean for Canadian financial institutions?
The guidelines will directly impact over 400 financial institutions in Canada, requiring them to (1) establish governance and risk management processes to identify, monitor, and respond to the physical and transition risks associated with climate change, (2) incorporate that information into their strategy, scenario analysis and stress testing processes, and capital and liquidity adequacy analyses, and (3) provide disclosures about their climate-related financial risks.
Consistent with the Task Force on Climate-Related Financial Disclosure (TCFD), the disclosure requirements break down into four pillars: governance, strategy, risk management, and metrics and targets. The Climate Risk Management guideline requires the largest banks and insurers to start reporting on their climate-related governance, strategy, risk management, and metrics for fiscal year 2024. Smaller banks and insurance companies will start one year later, covering fiscal year 2025. Full details about the minimum disclosure requirements are available in Annex 2-2 of the Climate Risk Management guideline.
We’ll focus here on the GHG emissions disclosure requirements. The Climate Risk Management guideline requires disclosures of Scope 1, 2, and 3 emissions. It assumes the use of the GHG Protocol Corporate Standard, Corporate Value Chain (Scope 3) Accounting and Reporting Standard, and the Partnership for Carbon Accounting Financials (PCAF) standards. If the entity uses a different reporting standard, it must disclose how that standard compares.
The expectations for scope 3 specifically include the disclosure of financed, facilitated, and insured emissions. For all four categories of FRFIs, the Scope 3 requirements will be effective one year after the starting point for the other disclosures. Below is a summary of the implementation timeline for GHG emissions disclosure requirements.
Why does this matter for non-financial institutions inside Canada?
Non-financial companies inside Canada should expect to receive requests about their emissions profiles from financial institutions subject to the new rules. To calculate their scope 3 financed emissions, banks and insurers will need to collect emissions data from companies they lend to or insure. Therefore, companies in Canada doing business with Canadian banks and insurers will face increasing pressure to have their own carbon emission management systems in place to collect and report this data.
Why does this matter for companies outside of Canada?
Companies outside of Canada will be affected in two ways. First - and most importantly - companies outside of Canada that do business with Canadian banks and insurers will likely see requests for data on their emissions profiles. As part of the requirement to measure Scope 3 financed emissions, Canadian financial institutions will need to collect data from businesses around the world. Just like companies in Canada, companies outside of Canada that do business with Canadian banks and insurers will likely also face increasing pressure to share data on their GHG emissions. The second impact on foreign entities is more direct: these new guidelines will directly impact foreign insurers with Canadian branches.
Wrapping it up
With this guideline, Canada joins the growing global movement towards stronger regulation for the financial sector and for financial markets regarding climate-related risk. It also joins the growing recognition of the importance of scope 3 emission information not only to investors, but also to the resilience of financial markets. Importantly, the Climate Risk Management guideline also leaves open a path for enhancing the guidelines as global standards and expectations evolve, including the forthcoming IFRS International Sustainability Standards and potential future developments on transition plans, scenario analysis, and capital adequacy and liquidity.
This strong step forward is also a stepping stone on the path to finalizing the broader corporate climate disclosure rules that Canadian securities regulators proposed in 2021. As companies inside and outside Canada gather, analyze, and share emissions information with Canadian banks and insurance companies, carbon accounting practices, data availability, and data reliability will all evolve and mature.
Combined with the recent announcement requiring major government suppliers to disclose their GHG emissions, Canada has shown its commitment to building resilience and driving markets forward in understanding and responding to the financial risks of climate change.