No Climate Risk Targets for Banks, New Guides for Green Finance as 2 Federal Agencies Issue New Rules

Bankers will have to disclose but not take action on their exposure to financial risk, and the definition of “transitional” investments leading to a net-zero economy might include new spending on carbon capture and “blue” hydrogen projects, under two new reports from federal agencies over the last several days.

On Friday, the independent Sustainable Finance Action Council (SFAC) released a proposed roadmap to help the federal government decide what investments should be considered worthy in the fight against climate change, The Canadian Press reports. Then yesterday, the Office of the Superintendent of Financial Institutions (OSFI) published a final framework that it says will guide banks and insurance companies in protecting themselves from climate-related risks, CP says.

The SFAC’s taxonomy report proposes to include both widely accepted green investments like solar panels and electric vehicles, as well as a more contentious “transition” category for emission reduction efforts in heavy industry, including the oil sands. Clarity around what’s considered eligible is meant to increase investment in these areas.

“What we’re trying to do is really bring clarity to people of what is green and what is truly transition and what is not eligible,” said University Pension Plan Ontario CEO Barbara Zvan, who helped lead the SFAC taxonomy.

Environmental groups have criticized the inclusion of oil sands-related investments, as well as so-called blue hydrogen, in the transition category. They say such projects will still have significant emissions, and there are clear alternatives.

“The transition taxonomy would give a gold star for simply mitigation activities, which are not actually transition,” Julie Segal, senior manager of climate finance at Environmental Defence Canada, told CP.

Tougher Restrictions Over Time

The SFAC report says there will still be oil and gas demand for decades so it’s also important to reduce emissions on existing production. But it adds the transition category will include intensifying restrictions on the emission reduction efforts on fossil fuel projects that would be eligible.

“Transition is a lower bar, but a bar that is expected to become higher over time,” Zvan said in an interview ahead of the report’s release.

She said there’s been a lot of progress on green taxonomies internationally, but less work on the transition side, so there’s an opportunity to help shape the thinking around it.

“There’s a real opportunity for Canada to lead in this area, given our needs around natural resources, and to work with other key economies out there and regions to help create a definition that we can all leverage,” she said.

Segal said the transition category is important for industries like steel and cement that are emission-heavy but that will still be needed in a net-zero world. But she added that the inclusion of fossil projects muddies the attempt to provide clarity.

“Canada’s version is looking like an endorsement for greenwashing, rather than something that will stop it,” she said.

A close observer of the SFAC process said the criticism was premature, explaining that Friday’s document was a set of recommendations for a sustainable finance taxonomy—not the taxonomy itself—and did not identify specific technologies for inclusion in the transition category. It included illustrative examples of options that might qualify if they met three criteria—emission reductions that were significant and not just marginal, time-limited investments within a pathway to net-zero, and projects that did not lock in carbon.

“That means it cannot make it more difficult or more expensive to transition to complete net-zero,” they said. So while a carbon capture and storage (CCS) project, for example, would not be rejected outright, “to qualify it would have to meet those three criteria.”

Excluding Carbon Lock-In

The observer said specific details—like whether the assessment would factor in the Scope 3 emissions that account for 80% of the climate pollution in a barrel of oil—will be tied down during the next phase of work on the taxonomy.

But the SFAC roadmap does specifically exclude projects that “create carbon lock-in and path dependency; are at a high risk of becoming stranded in net-zero pathways due to high Scope 3 emissions and declining global demand; have Scope 1 and 2 emissions that are inconsistent with net-zero pathways; and/or those that are unable to scale in transition. Example: exploration and development of new oil fields and industrial projects that fail to significantly reduce emissions.”

The proposed rules would also disqualify any coal projects, CP says.

No Mandatory Emission Targets for Banks

Yesterday’s release from the Office of the Superintendent of Financial Institutions builds on a draft that received sharp criticism after it was published for comment last May. The earlier version of OSFI’s Guideline B-15 tried “to tackle climate risk to the financial system, but it’s ignoring the risk posed by the financial system in worsening climate change,” Segal said at the time.

The guideline is not mandatory for the federally regulated financial institutions (FRFIs) that OSFI oversees. Instead, it “aims to support FRFIs in developing greater resilience to, and management of, these risks,” the regulator wrote last spring. It was meant to encourage institutions to assess their own climate vulnerabilities “from a risk-based perspective that allows the FRFI to compete effectively while managing its climate-related risks prudently.”

In this week’s update, the regulator urges FRFIs to account for those risks in their governance and accountability structures, CP writes. The guidelines are to take effect in 2024 for large banks and in 2025 for other regulated financial institutions.

“The financial risks associated with climate change… have the potential to significantly impact the safety and soundness of individual financial institutions under our supervision, and more broadly, could affect the stability of the Canadian financial system as a whole,” said Stephane Tardif, managing director of OSFI’s Climate Risk Hub.

Tardif added that one of the main concerns is the risks associated with economic transition. “What happens if the country does not meet those targets?” he asked, adding that the Canadian economy is also susceptible to policy actions in other jurisdictions.

“We’re so dependent on exports, particularly in our extraction sectors and oil and gas sectors, that you could see our economy being impacted by what other jurisdictions are doing to try to reduce their emissions, as well,” he told CP.

The regulator said it reviewed 4,300 submissions from a wide range of respondents, including financial institutions, before publishing the document.

While the framework calls for regulated institutions to set aside funds to account for climate-related risks, it does not mandate specific targets for them to meet.

Tardif said the guidelines are purposely not “rules-based.” Instead, OSFI is directing financial institutions to quantify the climate-related risk they face, collect data, and conduct scenario analyses, then give the regulator access to that information.

“It’s not prescriptive. We’re very deliberate in that because if we give institutions a target, then they will just manage that target,” he said.

Instead, “we’ve actually asked for mandatory climate-related disclosures. The fact that they’re mandatory is going to help us benchmark institutions against each other on how they’re managing the expectations.”

Count Emissions. Then Cut Them.

But in a statement Tuesday, Segal called on Prime Minister Justin Trudeau and Finance Minister Chrystia Freeland to push the financial sector to get its investments in line with a 1.5°C climate future. She told The Mix that most of that work can be done with existing federal regulations, with no need for new legislation.

“Canada’s financial institutions should cut emissions, not just count them—in a sinking boat you have to plug the leaking holes, not just disclose them,” Segal said in her statement. “Without government leadership to align financial flows with climate targets, our economy risks sinking. Prime Minister Trudeau set climate goals which Canada can only meet if private finance flows in the right direction.”

Sen. Rosa Galvez (ISG-Quebec), whose proposed Climate-Aligned Finance Act, Bill S-243, is currently at second reading, called the guideline a “good first step in establishing strong disclosure guidelines.” But “if Canada is to meet its obligations under the Paris Agreement, or even its 2026 emissions reduction target of 20% below 2005 levels, regulators must not only require Canadian institutions to disclose their climate risks but to actively align their operations with climate commitments,” she added in a release.

Galvez said OSFI had improved on its earlier draft of the guideline by calling for 1.5°C targets and referring to net-zero scenarios by the likes of the International Energy Agency. But without legislation like hers, she warned, “it is unlikely OSFI and key market players will move towards double materiality, that is to recognize the impact that financial institutions, and indeed Canada’s entire financial system, have on the climate.”

Poor Grades Bankers’ for ‘Real Action’

The Canadian Bankers Association, a lobby group representing more than 60 domestic and foreign banks operating in Canada, said it’s assessing the guidelines and working to understand the directive’s implications.

“Climate change is a critical issue of our time and banks in Canada are committed to doing their part to address it,” spokesperson Mathieu Labreche told CP in an email. “That’s why banks are taking real action to address climate-related factors, evolving their risk management frameworks, and accelerating clean economic growth through combined efforts with their peers, industry sectors, governments, and civil society.”

Those would be the same Canadian banks that received letter grades of B- to D, with all of them recording increases in their fossil fuel lending and underwriting between 2020 and 2021, in a late November report card issued by Investors for Paris Compliance (IPC). The 29-page report [pdf] showed CIBC increasing its fossil investments by 132%, followed by the Royal Bank of Canada at 101%, Scotiabank at 87%, and TD and the Bank of Montreal both at 25%.

RBC had by far the largest fossil investment portfolio in 2021, at C$48.5 billion, followed by Scotiabank at $38 billion, CIBC at $27.8 billion, TD at $26.4 billion, and BMO at $23.5 billion. A month previously, RBC issued a long-awaited net-zero strategy that set a far softer target than the emerging international standard for financial institutions, while touting its ability to engage with clients in the fossil sector and beyond to reduce their carbon footprints.

“We know the greatest impact RBC can have to drive emissions reductions in the economy is through partnerships with our clients,” President and CEO Dave McKay said at the time.

With OSFI taking a voluntary approach in response to that kind of strategy, Segal warned last September that the draft of Guideline B-15 missed the most important connection between the country’s financial sector and climate change.

“Even looking at this from a financial perspective, the guideline fails to confront how the financial system is investing in its own climate crash,” she said at the time. “The more that financial institutions invest in oil, gas, and coal, the worse climate change is going to be, and the worse climate risk will be to those institutions. So the best way to reduce climate-related risk is to mitigate climate change.”

The agency’s decision to issue a guideline, rather than a mandatory rule, was consistent with its usual practice, Segal added.

“This is how they operate and do business, but that’s a bit of a problem in this crisis, given finance’s contribution and relationship to the crisis,” she said. “It needs to be enforceable, there needs to be accountability, but most importantly, OSFI has to take off the blinders and look at how financial institutions are worsening climate change that therefore destabilizes the entire financial system.”

Major portions of this report were first published by The Canadian Press on March 3 and 7, 2023.