Acting now on climate change is Canada’s best financial bet

A recent pilot study by the Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI) highlighted that slow action on climate change will increase the related financial risks.

The study, done over the past year with six financial institutions, modelled the effects of four different climate policy scenarios on Canada’s key economic sectors. The most important finding was generously highlighted in the press release: "Delaying climate policy action increases the overall economic impacts and risks to financial stability." In other words, dragging our heels on climate action poses an increasing threat to the financial system. That’s quite a boon in the case for stronger climate action.

No one in the financial industry likes abrupt or unexpected risks. But inaction today means sharper policy shifts in the future, aggravating the uncertainty that is already central to climate change. Slow and unclear policies cause unexpected losses, leaving industry and financial actors less time to stick their landing in the climate transition.

The World Economic Forum’s recent Global Risk Report reaffirmed that delayed climate action will be the biggest risk to businesses over the next decade. Climate damage has already brought a hefty cost, but political apprehension will only intensify the disorder and financial instability.

To avoid this muddle, Canadian regulators need to incentivize a green transition and prepare the financial sector for climate-related vulnerabilities. Regulators urgently need to bring new models and methods to the mainstream, like scenario analysis, and enforce consistency in reporting on data like greenhouse gas emissions (GHGs).

The pilot study’s participating institutions all have significant exposure to climate change. These financial institutions must evolve their climate-related governance and risk management strategies to address the threats of climate change. In doing so, they can also play a central role in seizing opportunities in the green transition. But regulators must provide coherent guidance to enable these actions.

Climate inaction is a threat for every country, but Canada’s economy is especially vulnerable. The assets of Canada’s banks, insurers, and pensions remain carbon-intensive.

The Bank of Canada and OSFI’s study clearly states that the fossil fuel sector will take the biggest hit, which reaffirms that new investments in fossil fuel expansion sabotage future economic stability in Canada. For example, the change in probability of default for an oil and gas company increases by between 150 and 200 per cent by 2050 under any scenario, with the worst impacts occurring under the delayed transition scenario.

A slower climate transition isn’t even in the best interest of the oil sector. New fossil fuel projects inherently delay the climate transition, putting Canada on the pathway to a delayed and frantic climate transition. Continuing to invest in and underwrite fossil fuel expansion projects fosters systemic risks — particularly if an investor obscures their activities as climate action through greenwashing.

This pilot study highlights that while there will be "significant negative financial impacts for some sectors (e.g., fossil fuels)" under any scenario, a quicker transition and better climate-related data can mitigate the negative effect on the whole economy.

In Canada, myriad regulators are responsible for overseeing different nooks and crannies of the financial system. This pilot study simply confirms that Canada needs to do much more to build the climate-related financial regulatory framework.

The Bank of Canada and OSFI both promised important next steps, including evaluating probable physical risks and reconsidering liquidity reserves. But the whole financial system has to pivot to mitigate the risks of climate change, which means other regulators need to keep apace.

The Canadian Securities Administrators (CSA), for one, should take note. The CSA recently proposed a draft regulation under which public companies would not have to report their GHGs or analyze business implications of different climate scenarios. This is a glaring omission.

The pilot study confirms that scenario analysis is a necessary tool for financial institutions, whether institutions are looking to do their part in the climate transition or simply insulate themselves against transition risks. The financial institutions that took part made it clear that better data can provide a necessary drop of clarity around the uncertain issue of climate change.

Quick climate action makes good financial sense. Although this pilot study is a very important first step, Canadian regulators need to speed up and create transition policies to prevent the financial system from capsizing.