Canada: Quebec's Prudential Regulator Releases Climate Risk Management Guideline

Quebec's prudential regulator, the Autorité des marchés financiers ("AMF"), published its draft Climate Risk Management Guideline (the "Guideline") for public comment on November 30, 2023. The AMF is the most recent among a growing number of Canadian prudential financial regulators providing guidance on climate risks to financial institutions. The objective of the Guideline is to bolster the resilience of Quebec financial institutions and the financial sector as a whole in the face of increasing climate risk and uncertainty. Comments on the Guideline can be submitted to consultation-en-cours@lautorite.qc.ca until January 30, 2024.

The Guideline applies to authorized insurers, financial services cooperatives and credit unions, authorized trust companies and other authorized deposit institutions, regardless of size, nature, complexity or risk profile. These institutions are expected to consider climate-related risks in their risk management processes, including adopting forward-looking approaches to climate risk which are holistic, integrated and built on reliable empirical data and analyses.

The Guideline considers the overarching disclosure recommendations of the Task Force on Climate-Related Financial Disclosure (TCFD) of the Financial Stability Board (FSB)¹. When drafting the Guideline, the AMF also considered the recommendations of the Association of Insurance Supervisors and Bank for International Settlements in the management of climate related risks.²

The Canadian federal prudential financial regulator, the Office of the Superintendent of Financial Institutions (OSFI) issued Guideline B-15: Climate Risk Management ("OSFI's Guideline B-15") in March 2023. See our publication on OSFI's Guideline B-15 here. The Guideline has similar principles and a similar framework to OSFI's Guideline B-15 in that both are aligned with the TCFD.

In contrast to OSFI's Guideline B-15, the Guideline contains specific detailed guidance on the fair treatment of clients in relation to climate risk impacts on product design, the underwriting process, product marketing, product advertising and disclosures to clients. Otherwise, the Guideline contains less detail than OSFI's Guideline B-15 and, unlike OSFI's Guideline B-15, does not contain varying deadlines depending on revenues and assets for Québec financial institutions to adopt climate risk management frameworks or publish climate related disclosure.

The Guideline is rooted in a number of expectations that, in the AMF's view, financial institutions should be meeting for the effective management of their climate risks. The AMF organizes these expectations in the following way:

1. Governance expectations

1.1 Role and responsibilities of the board of directors

1.2 Role and responsibilities of senior management

1.3 Strategy

2. Integrated risk management expectations

2.1 Identification and assessment

2.2 Risk mitigation

2.3 Risk monitoring and reporting

3. Expectations regarding climate scenarios and stress testing

4. Expectations regarding capital and liquidity adequacy

5. Fair treatment of clients (FTC) expectations

5.1 Product design

5.2 Underwriting process

5.3 Product marketing

5.4 Product advertising

5.5Disclosure to clients

6. Expectations for climate-related financial risk disclosures

6.1 GHG Emissions, Metrics & Targets

The AMF's Expectations

1. Governance Expectations

Members of the board and senior management have a duty to address the climate-related risks facing their financial institutions, and should have clearly defined roles and responsibilities to ensure the performance of this duty. For senior management in particular, there are additional expectations to embed climate risks into the existing management functions of the business (for example, monitoring, the risk appetite framework, internal controls and the identification of issues and opportunities).

The board is expected to monitor objectives and targets, address issues related to climate-related risks, and ensure these risks are addressed by key internal deliverables (such as budgets, action plans, or risk management policies). In addition, the board should ensure that individuals who manage climate-related risks are contributing to each of the company's three lines of defence: management, risk management and compliance, and internal audit. Finally, on an individual level, the board should ensure that its members obtain a degree of knowledge and expertise on climate-related risk management, and that remuneration for the board, senior management and other key positions reflect the individuals' work and knowledge on climate risk.

The AMF notes the importance of building business strategies to address climate change-related impacts and the transition to a lower-carbon economy. Key tenets of this strategy include: integrating the assessment of climate-related risks when setting short-, medium- and long-term funding targets and when considering the service life of assets and infrastructure, and implementing transition plans for the shift towards a lower-carbon economy. All of these business strategies should be supported by sound information, methodology and measurements shared with investors and other stakeholders.

2. Integrated Risk Management Expectations

Building on its governance expectations, the AMF expects financial institutions to adopt strategies, policies and procedures to effectively manage their climate-related risks. In doing so, financial institutions should have strategies, policies and procedures to identify, assess and manage their riskier assets and liabilities in a way that aligns with their risk appetite. In addition, financial institutions should maintain a climate risk mitigation plan, and manage their physical and transition risks though the monitoring and reporting of internal targets.

3. Expectations Regarding Climate Scenarios and Stress Testing

The AMF expects financial institutions to regularly use climate scenario analyses in their stress testing to guide strategic planning and risk management. This exercise contributes to a fulsome understanding of the impact of climate-related risks on financial institutions by assessing how an institution would handle multiple plausible future climate scenarios over various timeframes. Recognized sources of climate scenarios include the International Energy Agency, the Intergovernmental Panel on Climate Change, and the Network for Greening the Financial System. The Guideline provides that a financial institution should use at least one scenario that limits warming to the level aligned with the latest international agreement on climate change, currently 1.5 C above pre-industrial levels based on the 2015 Paris Agreement.

4. Expectations Regarding Capital and Liquidity Adequacy

The AMF expects financial institutions to hold sufficient capital to pay for the costs relating to their climate-related risk exposures. Ensuring the availability of these funds entails integrating climate-related risks into the institution's internal capital adequacy assessment process or own risk and solvency assessment process, typically referred to as ICAAP (internal capital adequacy assessment process) and ORSA (own risk and solvency assessment) for deposit institutions. Financial institutions are also expected to integrate a range of institution-specific and market-wide climate stress events when assessing the adequacy of their capital and liquidity buffers.

5. Fair Treatment of Clients ("FTC") Expectations

The AMF believes that it is important that clients of financial institutions be made aware of the increased frequency of extreme weather events and the consequences of physical and transition risks of climate change. With its focus on market conduct and FTC, the Guidline contains significant additional expectations to those in OSFI's Guideline B-15. The AMF expects a financial institution to consider FTC through a climate change risk lens in its products' life cycle, and pay particular attention to clients' needs and interests, including in connection with product design, the underwriting process, product marketing, product advertising and disclosure to clients.

These expectations also apply to the financial institution where an intermediary is responsible for the offering of the financial institution's product. For example, as part of the product approval process, the insurance company should ensure its products provide coverage for natural disasters, such as floods and forest fires, that are tailored to and reflect the needs of clients.

With regard to the product life cycle, firstly, the product design should rely on the clients' needs and interests, while being tailored to changes in climate-related risks. In doing so, the product should not exploit consumer biases and should include documentation catered to the financial literacy of the target client group. Secondly, the product marketing should be done by individuals who are trained in understanding the product features which pertain to climate change and severe weather events, and how they affect the target client groups. Thirdly, product advertising must be clear, accurate and not mislead on the product's associated climate risks.

The AMF also encourages financial institutions to become more involved in guiding clients towards greater awareness of their individual risk tolerance and greater understanding of the qualities of the products. The AMF expects disclosure to clients on climate-related risks before, when and after a financial product is purchased. This approach is contextual and will differ depending on the financial knowledge of the client. It will entail detailed explanations from financial institutions and their selling intermediaries to enable clients to understand the product and whether it suits their needs and climate risk tolerance. Disclosure of climate-related risks to clients after a product is purchased should be timely and enable clients to determine whether the product they hold is still suited to their needs and interests.

Insurance companies should regularly review and update their underwriting process to formalize and support the climate-related risk factors and criterial used. When an insurance company plans to alter or remove a product from the market, it should determine whether doing so will cause foreseeable harm to its clients. If so, insurance companies should take action to mitigate such harm, such as by refraining from abruptly removing the product from the market or by assisting clients in finding other products.

6. Expectations for Climate-related Financial Risk Disclosures

The AMF expects financial institutions to disclose certain elements of their climate-related risk management, such as their governance, climate scenarios and climate-related stress testing. The purpose of this is twofold: to strengthen public confidence in the Quebec financial system and to ensure that the public is informed of the institution's risks which may affect them. The financial institutions may determine the type of report used to in the disclosure, whether a report to shareholders or as a stand-alone report.

The AMF proposes five principles of disclosure for institutions to follow for the effective disclosure of climate risks:

1. Provide relevant, comprehensive information pertaining to the impact of climate-related risks and opportunities on the financial institution's markets, businesses, strategy, financial statements, and other relevant business activities.
2. The information disclosed should be understandable to the general public while also being sufficiently detailed to serve sophisticated stakeholders.
3. The information disclosed should be reliable, verifiable and objective to ensure that the financial institution maintains neutrality in its disclosures.
4. The information disclosed should be appropriate for the size, nature and complexity of the financial institution.
5. The information should be disclosed consistently, allowing stakeholders to monitor and understand the financial institution's actions and the way the institution is impacted by climate-related risks. The frequency should be annual at minimum and should be made public no later than 180 days after fiscal year end.

6.1 GHG Emissions, Metrics & Targets

The AMF places particular emphasis on the need to monitor and disclose greenhouse gas ("GHG") emissions. The financial institution is expected to comply and disclose information pertaining to the calculation of its absolute Scope 1³ and Scope 2⁴ GHG emissions in accordance with the GHG Protocol: A Corporate Accounting and Reporting Standard.

Given that the calculation of absolute Scope 3 GHG emissions⁵may be more laborious and may require obtaining information from various stakeholders, the AMF recommends financial institutions undertake the work to calculate these emissions and establish a timeline to perform the calculation.

Scope 3 disclosure may require obtaining formation from various stakeholders. In that context, the Guideline suggests that the financial institution indicate the proportion of its activities that are subject to Scope 3 reporting and the means the institution intends to take to enhance its disclosure. If the calculation standard used by the financial institution for Scope 3 GHG emissions is not the Corporate Value Chain (Scope 3) accounting and Reporting Standard, the institution should disclosure how the standard used is comparable. GHG emissions and associated metrics should be provided for historical periods to allow for trend and progress analysis, as applicable. The financial institutions should also disclose the methodologies they use to calculate GHG emissions and metrics and describe their key climate-related targets whether relating to GHG emissions, water usage, energy usage or other factors.

When describing targets, the Guideline recommends that financial institutions consider including:

• Whether the target is absolute or intensity based
• Time frames over which the targets apply
• Base year from which progress is measured and
• Key performance indicators used to assess progress against targets

Footnotes

1. The FSB disbanded in October 2023 and asked the IFRS Foundation which published new standards S1 General Requirements for Disclosure of Sustainability-Related Financial Information and S2 Climate-Related Disclosures in June 2023 to take over monitoring of climate-related disclosure. See our publication on S1 and S2 here. The AMF states that the ISSB standards S1 and S2 may be taken into consideration by the AMF at a later date, in which case the Guideline will be updated.

2. See International Association of Insurance Supervisors, Application Paper on the Supervision of Climate-related risks in the Insurance Sector, May 2021; Bank for International Settlements, Principles for the effective management and supervision of climate-related financial risks, June 2022

3. Scope 1 GHG emissions are direct GHG emissions "from sources that are owned or controlled by the company, for example, emissions from combustion in owned or controlled boilers, furnaces, vehicles, etc.; emissions from chemical production in owned or controlled process equipment" (GHG Protocol).

4. Scope 2 GHG emissions are indirect GHG emissions "from the generation of purchased electricity consumed by the company" (GHG Protocol).

5. Scope 3 GHG emissions are "all other indirect emissions...[which] are a consequence of the activities of the company, but occur from sources not owned or controlled by the company. Some examples of scope 3 activities are extraction and production of purchased materials; transportation of purchased fuels; and use of sold products and services" (GHG Protocol).

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