OSFI posts new guidance on climate risk stress testing

The Office of the Superintendent of Financial Institution’s (OSFI) newly released draft of Climate Risk Management may mean P&C insurers will have to include climate scenario analysis as a part of their stress testing — and it may require insurers to account for additional capital.  

Pertinent to insurers, scenario analysis for climate-related financial risks is among the principles proposed by OSFI. “The FRFI should use climate scenario analysis to assess the impact of climate-related risk drivers on its risk profile, business strategy, and business model,” the draft reads.  

OSFI notes it will be developing a standardized climate scenario analysis exercise to assess exposures to risks and compare FRFI approaches to climate scenario analysis. FRFIs will be required to apply these scenarios and report their results to OSFI. 

Another principle states FRFIs should measure and maintain their available capital and liquidity buffers to protect against climate-related risks. “The FRFI should incorporate climate-related risks into its Internal Capital Adequacy Assessment Process (ICAAP) or Own Risk and Solvency Assessment (ORSA) process,” the document reads. 

It also notes FRFIs should incorporate the impact of climate-related drivers on its liquidity risk profile. This may involve integrating “a range of FRFI-specific and market-wide severe, yet plausible, climate-related stress events when assessing the adequacy of its liquidity buffers. For example, the FRFI should consider, among other things, the impact of increased drawdowns of deposit balances and credit/liquidity lines for counterparties sensitive to climate-related risks, volatility in insurance claims experience due to climate change, etc.”  

It is yet unclear whether or not OSFI’s expectations are above and beyond what P&C insurers already do in determining capital adequacy in preparation for climate-related disasters.

Still undergoing public consultation, OSFI’s extensive guidelines establish the regulator’s expectations for how all federally regulated financial institutions’ (FRFI) will manage their climate-related risks. 

“Building resilience against climate-related risks requires FRFIs to address vulnerabilities in their business model, their overall operations, and ultimately on their balance sheet,” the draft guideline, released today, reads. 

OSFI notes its expectations of FRFIs in accounting for climate risks include:  

• The FRFI understands and mitigates against potential impacts of climate-related risks to its business model and strategy. 
• The FRFI has appropriate governance and risk management practices to manage identified climate-related risks. 
• The FRFI remains financially resilient through severe, yet plausible, climate risk scenarios, and operationally resilient through disruption due to climate-related disasters. 

In an effort to increase transparency, OSFI is also introducing mandatory climate-related financial disclosures. 

Those interested in the disclosure of an FRFI’s climate-related financial risk information may include investors, analysts and the general public, among others. “These disclosures will incentivize improvements in the quality of the institutions’ governance and risk management practices related to climate,” the news release reads.  

The disclosure guidance aligns with a commitment made by the federal government to require financial institutions to publish climate disclosures starting in 2024. 

“By providing this broad group of stakeholders with key risk and risk management information, these disclosures can build confidence in FRFI management, and enable FRFIs to attract, or maintain their access to, capital and liquidity channels.” 

The press release notes that most federally regulated financial institutions are in the “early stages of building climate-related risk assessment capabilities.”  

Public comments to draft are being sought by OSFI before Aug. 19, 2022. The regulator plans to issue the final version of this guideline by early 2023.  

More information to come.  

Feature image by iStock.com/mikkelwilliam