The Office of the Superintendent of Financial Institutions (OSFI) is currently focusing on one impact of climate change that it describes as a “severe but plausible risk”: Transition risk. What is it? Transition risk is the risk of economic change created by the shift to a low-carbon economy.

Assistant Superintendent of Insurance Supervision Neville Henderson discussed the implications of this risk during a speech at the Canadian Institute of Actuaries annual conference on June 16.

“While there remains debate about the definitions of green vs brown assets, and disclosing the risks associated with them, OSFI is taking the approach of doing its homework within the Canadian and global context. We see this as an essential part of setting the right prudential expectations that will have a positive long-term effect on financial institutions’ resilience,” he told the audience of actuaries.

First the good news  

First, Henderson praised the property and casualty insurance industry for its efficient management of physical risk for decades. Then came the rebuke: the sharp increase in P&C premium pricing has led to coverage gaps both in Canada and around the world.

“As the public self-insures these events, the ultimate cost will be a major burden to society and ultimately to the government. One study has demonstrated that providing a combination of public and private protection decreases the economic impact and shortens the recovery period after a major catastrophic event. The conclusion is that these events can be more effectively managed though combinations of public and private enterprises,” he said.

He added that federal governments continue to consider how to address climate risks through long-term investments in “green” infrastructure, and by determining protections against climate-related catastrophes. “These are some of the direct implications but we all must also consider how quickly these measures will be put in place and how quickly the transition to a lower carbon footprint will affect the broader economy and society,” he says.

Pilot project to come  

Henderson announced that in November 2021, the Bank of Canada and OSFI plan to launch a pilot project to use climate-change scenarios to better understand the risks to the financial system related to a transition to a lower-carbon economy. The project has a three-fold aim:

  • Gain knowledge in the area of climate scenario analysis and help the Canadian financial sector better communicate climate risk. 
  • Better understand the extent to which the financial sector may be exposed to the risk of transitioning to a low greenhouse gas economy. 
  • Gain a better understanding of the governance and risk management practices applied by financial institutions to climate change risk and opportunities.

Six financial institutions were invited to participate in this project: RBC, TD, Manulife, Sun Life, Intact and The Co-operators.

Three scenarios will be studied. One foresees business as usual, which creates a continued rise in emissions and temperatures. Another scenario assumes a smooth transition with immediate policy action to limit warming to 2° Celsius, as called for in the Paris agreements. The last scenario assumes that this action is delayed to 2030, with a resulting steep transition.

Up to the end of 2021, OSFI will assess the impacts, challenges and lessons learned from the pilot exercise, Henderson said. OSFI will also gather information on institutions’ existing climate-related governance and risk management practices. The Office plans to publish a report summarizing the findings by the end of the year, Henderson said. In early 2022, OSFI intends to issue expectations on climate risk management for discussions with its regulated industries.