OSFI.Climate

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Reading: “Climate Risk Management,” March 2023. Official Link

Author: OSFI (Office of the Superintendent of Financial Institutions Canada)

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BA Quick-Summary: Climate Risk Management This reading applies to FRFIs (Federally Regulated Financial Institutions) and sets rules for managing climate-related risks including: Governance & Risk: Must integrate climate risks into strategy and risk systems. Scenario Testing: Use climate scenarios and stress tests to assess resilience. Disclosures: Annual, phased disclosures on climate risks, plans, and emissions.

Pop Quiz

What are the key drivers of flood risk in Canada?

Study Tips

Key Insight:

• This is OSFI's first climate-sensitive prudential framework
• Two risk types to master: Physical risks (weather events) and Transition risks (low-carbon shift)
• Focus on the 3 expected outcomes and how they drive all requirements

Study Strategy Summary:

This guideline represents Canada's approach to climate financial risk - principles-based, forward-looking, and comprehensive. It's structured in two reinforcing chapters.

Key things to focus on:

• 2 Climate Risk Types: Physical & Transition (plus liability risks)
• 3 Expected Outcomes: Business Model, Governance, Resilience
• 5 Governance Principles: Structure, Business Model, Risk Management, Scenarios, Capital
• 6 Disclosure Principles: Relevant, Specific, Clear, Reliable, Appropriate, Consistent

Estimated study time: a few hours

Overview: Climate Risk Framework

🌪️ Why Climate Risk Matters to Financial Institutions

Climate risks are unique because they:

• Manifest over varying time horizons
• Can intensify over time
• Drive traditional financial risks (credit, market, insurance, liquidity)
• Can threaten business model viability

Two Main Risk Categories:

📍 Physical Risks:

• Acute: Extreme weather events (floods, hurricanes)
• Chronic: Long-term shifts (sea level rise, temperature changes)
• Indirect: Public health impacts

🔄 Transition Risks:

• Policy/regulatory changes
• Technology advancements
• Market sentiment shifts
• Customer preference changes

⚖️ Liability Risks:

• Climate-related insurance claims
• Litigation for failure to manage climate risks

The 3 Expected Outcomes

MEMORIZE These 3 Outcomes

1. Business Model & Strategy

  * Understand climate impacts
  * Mitigate risks to business model
  * Identify opportunities

2. Governance & Risk Management

  * Appropriate structures
  * Effective practices
  * Clear accountability

3. Financial & Operational Resilience

  * Withstand severe scenarios
  * Maintain operations during disasters
  * Adequate capital/liquidity buffers

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Chapter 1: Governance and Risk Management

The 5 Governance Principles

5 Principles [Hint: GBRSC]

Principle 1: Governance Structure

Key Requirements:

• Board oversight of climate risks
• Senior Management accountability
• Consider compensation linkages
• Clear roles and responsibilities

💡 Exam Tip: Senior Management includes CEO, CFO, CRO, CCO + executives for rating/underwriting

Principle 2: Business Model Integration

Requirements:

• Identify climate impacts on strategy
• Develop Climate Transition Plan
• Assess plan achievability under scenarios
• Set internal metrics/targets (e.g., GHG)

Principle 3: Risk Management Framework

Integration Requirements:

• Climate risks in Risk Appetite Framework
• Climate risks in ERM Framework
• Climate risks in Internal Control Framework
• Clear roles across business lines

Key Process Elements:

• Data collection (physical + transition)
• Tools and models implementation
• Monitoring and reporting systems
• Risk concentration tracking

Principle 4: Scenario Analysis

Unique to Climate Risk - Forward-looking is essential!

Scenario Analysis Uses:

• Assess strategy resilience
• Identify risk factors
• Estimate exposures/losses
• Test risk management adequacy

Requirements:

• Multiple plausible scenarios
• Various time horizons
• Both physical AND transition risks
• Understand methodologies/limitations

OSFI Standardized Exercises:

• Mandatory periodic completion
• Enables peer comparison
• Results reported to OSFI

Principle 5: Capital & Liquidity

Integration Points:

• ICAAP (banks)
• ORSA (insurers)
• Liquidity stress testing
• Buffer adequacy assessment

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Chapter 2: Climate-Related Financial Disclosures

Purpose of Disclosures

Transparency drives better risk management!

Who Benefits:

• OSFI (prudential supervision)
• Depositors/policyholders
• Investors/analysts
• Public confidence

The 6 Disclosure Principles

Lots of fluff here but I think it can be simplified to 6 concise points

MEMORIZE: [Hint: RSCRAC]

• Relevant: Current/future impacts specific to FRFI
• Specific & Comprehensive: Detailed exposure/management info
• Clear & Balanced: Understandable to various users
• Reliable & Verifiable: High-quality, neutral, traceable
• Appropriate Size: Proportional to FRFI complexity
• Consistent: Enable inter-period comparisons

Disclosure Content (4 Categories)

Category	Key Elements	Implementation
Governance	Board oversight, Management roles	2024/2025
Strategy	Risks/opportunities, Business model impacts, Transition plan	2024/2025 (Plan TBD)
Risk Management	Process integration, Scenario analysis use	2024/2025
Metrics & Targets	Climate metrics, GHG emissions, Progress tracking	Phased 2024-2029

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GHG Emissions Requirements

There's a lot of material in the annex, which you can read. I believe everything but the GHG emissions are unique to this paper and I'll write up more on them below.

Scope 1 & 2 (Implemented First)

Requirements:

• Separate disclosure (Scope 1 & location-based Scope 2)
• Absolute gross emissions
• Measurement approach disclosure
• GHG Protocol or comparable standard

Scope 3 (Delayed to 2028)

Complex Requirements:

• All 15 categories considered
• Category 15 mandatory (Investments)
• Separate reporting:

 * Financed emissions (loans/investments)
 * AUM emissions (asset management)
 * Insurance-associated emissions (P&C)

💡 Don't combine financed, AUM, and insurance emissions!

Key Definitions

Term	Definition	Exam Focus
Physical Risk	Financial risk from climate events	Acute vs. Chronic
Transition Risk	Risk from low-GHG transition	Policy, tech, market
Climate Transition Plan	Guide for managing climate risks	Now mandatory!
D-SIBs	6 largest Canadian banks	Earlier implementation
IAIGs	4 largest insurers	Sun Life, Manulife, Canada Life, Intact
Category 15	Investment emissions	Includes financed, AUM, insurance

Annex Highlights

Annex 1-1: Related OSFI Guidance

• Corporate Governance
• Stress Testing (E-18)
• ORSA/ICAAP (E-19)
• Third-Party Risk (B-10)
• Model Risk (E-23)
• Operational Risk (E-21)

Annex 1-2: Transmission Channels

Risk Event	Impact Type	Example
Physical damage	Credit risk	Higher LGD on damaged collateral
Regulation change	Transition risk	Stranded assets
Climate litigation	Liability risk	Board legal action

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Practice Questions

Conceptual Questions:

What are the 3 expected outcomes OSFI wants FRFIs to achieve?

How do physical and transition risks transmit to traditional financial risks?

What must a Climate Transition Plan include?

Why are climate scenarios essential (vs. historical data)?

Disclosure Questions:

When must D-SIBs start disclosing Scope 1 & 2 emissions?

What are the 6 disclosure principles?

How should Category 15 emissions be reported?

Practice Questions Answer Key

Conceptual Questions

Q: What are the 3 expected outcomes OSFI wants FRFIs to achieve?

Answer: The 3 Expected Outcomes

1. Business Model & Strategy

  * The FRFI understands and mitigates against potential impacts of climate-related risks to its business model and strategy

2. Governance & Risk Management

  * The FRFI has appropriate governance and risk management practices to manage identified climate-related risks

3. Financial & Operational Resilience

  * The FRFI remains financially resilient through severe, yet plausible, climate risk scenarios, and operationally resilient through disruption due to climate-related disasters

Q: How do physical and transition risks transmit to traditional financial risks?

Risk Type	Transmission Channel	Impact
Credit Risk	Physical damage to collateral	Higher loan-to-value and loss given default (LGD)
Market Risk	Perception of heightened risk	Mark-to-market investment/trading losses
Insurance Risk	Increased weather-related claims	Higher insurance losses and reinsurance costs
Liquidity Risk	GHG-intensive portfolios	Diminished funding demand, challenges rolling over debt
Operational Risk	Physical damage to premises	Business disruption and operational losses

Q: What must a Climate Transition Plan include?

Climate Transition Plan Requirements

The Climate Transition Plan must:

• ✓ Guide FRFI's actions to manage increasing physical risks from climate change
• ✓ Address risks associated with transition to low-GHG economy
• ✓ Align with business plan and strategy
• ✓ Include assessment of achievability under different climate scenarios
• ✓ Specify how progress will be measured (e.g., internal metrics and targets like GHG emissions)

Q: Why are climate scenarios essential (vs. historical data)?

Why Forward-Looking Scenarios Are Critical

Climate scenarios are essential because:

• Historical data is not predictive for climate risks
• Climate risks manifest over long time horizons that exceed historical data
• Relationships are non-linear with potential tipping points
• Multiple plausible futures exist that cannot be extrapolated from past
• Climate change represents unprecedented shifts requiring forward-looking analysis

Disclosure Questions

Q: When must D-SIBs start disclosing Scope 1 & 2 emissions?

Answer: Fiscal year-end 2024

• Implementation: FY-end 2024
• Disclosure deadline: 180 days after fiscal year-end
• Applies to: D-SIBs and IAIGs headquartered in Canada

Q: What are the 6 disclosure principles?

The 6 Disclosure Principles - RSCRAC

1. Relevant

  * Information specific to current/future climate impacts on the FRFI

2. Specific & Comprehensive

  * Detailed exposure and risk management information

3. Clear & Balanced

  * Understandable to range of users, appropriate mix of qualitative/quantitative

4. Reliable & Verifiable

  * High-quality, neutral, traceable information

5. Appropriate (Size)

  * Proportional to FRFI's size, nature, and complexity

6. Consistent

  * Enable meaningful inter-period comparisons

Q: How should Category 15 emissions be reported?

⚠️ CRITICAL: Report Separately - Never Combine!

Emission Type	Description	Implementation Date
Financed emissions	Loans and investments	2028
AUM emissions	Assets under management • Breakdown by Scope 1, 2, 3 • Include $ amount of AUM • % of total AUM included	2029
Insurance-associated emissions	P&C underwriting portfolios	2028

Quick Reference Summary

Topic	Key Point	Remember
3 Outcomes	Business/Governance/Resilience	Foundation of guideline
Risk Transmission	Climate → Traditional risks	Through multiple channels
D-SIBs Timeline	FY 2024 + 180 days	Earlier implementation
Disclosure Principles	RSCRAC (6 principles)	Guides quality disclosures
Major Delays	3-4 year delays	Scope 3, Financed, Industry metrics

Common Pitfalls

⚠️ Avoid These Mistakes!

• Confusing risk types - Physical ≠ Transition ≠ Liability
• Combining emissions - Keep financed/AUM/insurance separate
• Ignoring proportionality - Requirements scale with FRFI size
• Overlooking integration - Climate risk affects ALL risk types

Final Exam Strategy

High-Probability Topics:

• The 3 expected outcomes (conceptual foundation)
• Physical vs. Transition risks (with examples)
• The 5 governance principles
• The 6 disclosure principles
• Implementation timeline (especially delays)
• GHG emissions scopes and Category 15
• Climate Transition Plan requirements

Remember: This is OSFI's first climate-sensitive prudential framework - expect questions on WHY it's needed and HOW it differs from traditional risk management

POP QUIZ ANSWERS

Population growth, urban development and climate change