Climate risk management: An overview of recent key developments for financial institutions

On July 4, 2024, the Autorité des marchés financiers (AMF, Quebec’s financial services regulator) published the final iteration of its “Climate Risk Management Guideline” (the Guideline). The Guideline's objective is to strengthen the resilience of the financial sector and the financial institutions it regulates regarding the impacts of climate change.

The Guideline applies to licensed insurers, financial services cooperatives, licensed trust companies and other licensed deposit-taking institutions under the AMF’s jurisdiction, but does not apply to reporting issuers generally. Going forward, the institutions subject to the Guideline are expected to consider climate-related risks as part of their integrated risk management processes.

Following the precedent established by the Office of the Superintendent of Financial Institutions (OSFI), the AMF incorporated and supplemented the most recent recommendations from standard-setting bodies regarding climate risk disclosure. These include the IFRS S1 (general requirements) and S2 (climate-related requirements) standards developed by the International Sustainability Standards Board. In the insurance sector, the International Association of Insurance Supervisors recommendations and the Basel Committee on Banking Supervision principles for effectively managing and monitoring climate-related financial risks were also considered by the AMF.

The Guideline puts in place a timeline, which starts applying to financial institutions for their fiscal year 2024 or 2025 depending on how they were categorized by the AMF – the AMF used several indicators, including the size, level of complexity and net assets of the financial institutions. In July 2024, all concerned financial institutions should have been informed of their categorization by an e-mail from the AMF.

This article summarizes the expectations set out in the Guideline, the upcoming phases in applying the Guideline, as well as the interplay with the popular IFRS S1 and S2 voluntary standards.

Importing from, but also expanding beyond, the most popular voluntary disclosure frameworks

The Guideline integrates the IFRS S1 and S2 standards with tailored adjustments for the financial sector. This is a forced deviation from the AMF’s initial strategy to align with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), which has officially been disbanded to be replaced by the IFRS S1 and S2 standards.

As a result, any financial institution captured by the Guideline that previously reported in accordance with the TCFD framework will have a few adjustments to make – mainly, adding to the existing disclosure. How extensive will this effort be?

To this end, the IFRS Foundation has released a comparison of the requirements under IFRS S2 and the recommendations of the TCFD.¹ Essentially, the IFRS S2 standard builds upon the TCFD recommendations by introducing new requirements, including requirements for companies to disclose industry-based metrics, to disclose information about their planned use of carbon credits to achieve their net greenhouse gas emissions targets and to disclose additional information about their financed emissions.

Moreover, as further explained below, the Guideline goes beyond the original scope of the TCFD recommendations or IFRS S1 and S2 standards by introducing two additional pillars that are more specific to financial institutions, namely: (i) capital and liquidity adequacy; and (ii) the fair treatment of clients.

AMF expectations pursuant to the Guideline

In its Guideline, the AMF indicates its expectations pertaining to climate-related risks and opportunities under six pillars:

1. Governance: within the scope of its responsibility, the board of directors is expected to demonstrate competence and independence in its assessment of climate-related risks. It is the board of directors' responsibility to ensure climate risk issues and challenges are taken into account when drawing up major action plans, integrated risk management policies, annual budgets and performance targets, when monitoring progress against objectives and targets, and when developing compensation policies for senior management and other key positions. The roles and responsibilities of executives should also be clearly defined.

The financial institution should consider the impact of climate change and the transition to a low-carbon economy in its strategy. To this end, the financial institution should implement a transition plan that aligns with its business plan, strategy, and risk appetite. This transition plan should serve as a guiding framework for managing physical² and transition³ risks associated with a low-carbon economy.

2. Integrated risk management: strategies, policies and procedures should be put in place to effectively identify and assess climate change-related risks, and to manage those risks in accordance with the integrated risk management framework, transition plan, and risk appetite of the financial institution. The financial institution should establish a climate change-related risk mitigation plan and maintain regular monitoring and reporting on internal targets regarding its risk management.

3. Climate scenarios and stress testing: the financial institution should analyze climate scenarios to assess the impact of climate risks on its risk profile, strategy and business model over an appropriate time horizon. This analysis should take the form of an assessment of plausible future situations and the risk exposure related to them. Furthermore, the financial institution should conduct standardized climate scenario analysis and, upon request, provide the results to the AMF.

On this point, we also note that OSFI published the Standardized Climate Scenario Exercise, on September 10, 2024. This document explains how federally regulated financial institutions and federally regulated pension plans can complete standardized climate scenario exercises and report their results to OSFI. Considering the collaboration between OSFI and AMF on climate change matters, this document could be relevant for a financial institution in meeting the Guideline’s expectations.

4. Capital and liquidity adequacy: while conducting its internal capital adequacy assessment process, the financial institution should consider the impact of climate-related risks. It should maintain an adequate level of capital and liquidity to ensure the coverage of its exposure to climate change-related risks.

5. Fair treatment of clients: the financial institution should consider the climate-related risks throughout the entire lifecycle of a product it offers, and keep clients informed of potential risks related to transition risks and the impact of extreme weather events. In line with its risk appetite, the financial institution should design products adapted to the risks associated with climate change and consider elements such as the needs and interests of its various target client groups, and an appropriate product withdrawal or modification process.

The Guideline states the underwriting process should be updated regularly to take into account climate change-related risk factors as well as the special needs of certain customer groups.

It is also the responsibility of financial institutions to ensure customers are provided with clear and accurate information regarding the potential climate change-related risks associated with the products they are considering purchasing.

6. Climate-related financial risk disclosures: in regard to communication, the financial institution should publicly disclose, on a consolidated basis, its key governance and integrated risk management elements, as well as its climate scenarios and crisis simulations related to climate change.

The AMF has established five principles for effectively communicating climate risk information: (i) it should be relevant, specific and comprehensive; (ii) it should be clear, balanced, and understandable; (iii) it should be neutral; (iv) it should be appropriate to the financial institution's size, nature, and complexity; and (v) it should be consistent with the financial institution’s other publications.

It is the financial institution's responsibility to provide climate change-related financial disclosures in a report to shareholders, if it is public, or in a separate report if it is not.

It is expected that financial institutions will make disclosures pertaining to their greenhouse gas (GHG) emissions and climate change-related risk management targets and will assess their performance in relation to these targets.

OSFI’s Guideline B-15 Climate Risk Management, published in March 2023, essentially covers the same elements as the AMF’s guideline, but the latter also covers the fair treatment of clients. Federally regulated institutions subject to the Guideline will thus be subject to a similar regime in Quebec, with some additional requirements.

Timeline for applying the guidance regarding communicating information about climate change