How Are Financial Institutions in Canada Disclosing Their Management of Climate-Related Risks?

Article Summary: This article reviews the management of climate-related risks by Canada’s Federally Regulated Financial Institutions (FRFIs), based on a benchmark study by Mazars Canada. It reveals that while FRFIs are making progress in incorporating climate considerations at governance levels, there is a significant need for improvement in strategic planning and risk assessment. The study indicates a lack of depth in understanding and addressing climate impacts financially, with only a few institutions offering detailed strategies. Major challenges include quantifying Scope 3 financed emissions and integrating climate risks into existing risk management frameworks. The article calls for increased collaboration and innovation to enhance climate risk management and reporting among Canadian financial institutions.

Climate change can have devastating consequences on both individuals and business, which can significantly affect the financial system. Financial institutions, therefore, face mounting pressure to comprehensively understand and mitigate negative impacts on their operations, strategies and business model. 

Federally Regulated Financial Institutions (FRFIs) in Canada are making good progress in understanding and integrating climate-related risks. However, further actions are substantially needed, particularly around strategy and risk management. A study conducted by Mazars Canada titled “Climate-related financial disclosures of Canadian financial institutions – a benchmark study of banks and insurers”, evaluated publicly disclosed climate-related reports from a sample of 9 FRFIs against expectations outlined in OSFI’s B-15 Climate risk guidance. 

FRFIs have made good progress in embedding climate-related considerations into roles and responsibilities at Board and executive levels.

Establishing robust governance structures around climate-related matters is essential to effectively manage associated risks and opportunities. 67% of FRFIs sampled disclosed updates on climate-related responsibilities for all their Board committees. However, details regarding the nature of climate-related reporting reviewed by the Board were limited. It is important to define Board-level climate-related metrics that are aligned with risk appetite. Thresholds to prompt appropriate actions should also be established. These metrics and associated thresholds should be appropriately cascaded throughout the organisation. 

At an executive level, 56% assigned primary responsibility for climate-related matters to multiple senior management positions including Chief Executive Officer (CEO), Chief Risk Officer (CROs) and General Counsel & Legal. Accountability mechanisms should be implemented to ensure effective execution of these responsibilities. While 78% disclosed that climate-related matters were incorporated into executive remuneration, only 22% provided information on the metrics and methodologies used. 

Financial institutions should ensure Board members and senior executives possess sufficient knowledge and competencies to effectively carry out their climate-related responsibilities. A climate risk training program should be implemented to address any identified knowledge gap. 

Understanding the strategic and financial impact of climate-related risks is at its infancy. 

Understanding the materiality of climate-related risks is vital for informed strategic decision making. Among sampled FRFIs, 78% disclosed their assessment of sectors likely to be most impacted by climate-related risks. 33% revealed their process to determine materiality of climate risk impacts. However, only 11% outlined how climate-related risks and opportunities can manifest in the short-, medium- and long-term. 

Climate-related risks present significant opportunities for financial institutions to expand their product and service offerings as they support clients in transitioning to sustainable practices. 78% have diversified their offerings to include sustainable loans, investments, and advisory services.

Integration of climate-related risks is gradually progressing, with the initial focus being on credit risks.

Financial institutions should identify transmission channels through which physical and transition risks can manifest and assess their impacts. 44% of FRFIs disclosed how they incorporate climate-related risks into existing risk definitions. Climate-related risks should be embedded into existing risk processes, including quantitative risk metrics like Expected Credit Loss (ECL), Value at Risk (VaR) and Risk-Weighted Assets (RWA).  

Climate scenario analysis offers a forward-looking assessment of how climate risks may affect business strategies and financial performance over time. 78% disclosed the scenarios and portfolio segments analyzed in their climate-scenario analysis. However, 33% provided justification for conclusions reached on materiality of climate risk impacts. None expressed quantitative scenario analysis results.

Quantifying Scope 3 financed emissions is a significant challenge, with FRFIs relying on estimates and proxies.

Conducting a baseline emissions assessment is an essential starting point for establishing credible long-term net-zero targets, which should be subsequently translated into interim targets. All FRFIs sampled had interim targets for scope 1 and 2 emissions, with 33% setting interim Scope 3 targets for identified high-impact sectors. 

Data availability, verification and usability pose significant challenges and resulted in low data quality scores for Scope 3 financed emissions. Financial institutions should bolster their client engagement efforts and offer trainings, advisory and technology solutions to enhance clients’ capabilities in measuring and reporting total emissions. Additionally, there should be a deeper understanding of methodologies and assumptions used by third-party data providers, such as ESG rating agencies.

Conclusion

Financial institutions should prioritise investments in building methodologies and remediating data gaps. They should adopt a coordinated and collaborative approach in implementing a holistic climate risk program. This will enhance efficiency, support upskilling, and promote innovation.

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