If you are not in the financial sector, you may have never heard of the Office of the Superintendent of Financial Institutions Canada (OSFI). However, the OSFI plays an essential role in protecting your rights as a financial system user, as they set risk management guidelines for regulated financial institutions (FRFIs) and federally regulated pension plans (FRPPs). With the climate crisis becoming a concern for investors, the OSFI is working to establish guidelines on how FRFIs and FRPPs must manage and disclose their climate-related risks which will impact multiple sectors of the economy, including commercial real estate.
Climate adaptation has been an important priority for the Canadian federal government in recent years. Canada is warming twice as fast as the global average, and Canadians are experiencing firsthand the effects of climate change in the form of more frequent and severe heat waves, flooding and wildfires. The federal government launched the country’s first ever National Adaptation Strategy in November 2022, and many agencies in the country are building on this momentum, including the OSFI.
The OSFI has been working to incorporate a climate focus into their guidelines, culminating with the publication of Guideline B-15: Climate Risk Management in March of 2023. These guidelines outline how the OSFI expects financial institutions to manage their climate-related risks. In October of 2023, the OSFI followed up with the launch of the more detailed Standardized Climate Scenario Exercise, which builds on Guideline B-15 and prescribes a more detailed methodology for FRFIs to assess their exposure to the following climate risks:
|
Type of risk |
Impacts |
|
Transition: Business-related risks that arise from the societal and economic shifts toward a low-carbon economy. |
|
|
Physical: Risks from exposure to climatic events, such as wildfires, flooding, and extreme weather. |
|
For professionals involved in the buildings sector, there will be an emphasis on better understanding the transition and physical risk exposure of the commercial real estate market. In a post-pandemic world where the reimagination of office portfolios is key to many investors, these new guidelines will impact long-term investment strategies and the future of the real estate investment market.
Your property’s transition and physical risks may impact your mortgage.
Managing transition risks will become a driver for decarbonizing commercial buildings. The OSFI identified the following mechanisms (also known as transmission channels) of how the transition away from a carbon-intensive economy may impact the risks associated with real estate lending and investments:
- Properties powered or heated by carbon-intensive sources (e.g. fossil fuels or natural gas) may be impacted by the transition to net zero by way of
- decreased values relative to other properties that use lower-carbon technologies and
- carbon tax policies that will increase their operational costs.
- Borrowers in industries exposed to higher transition risks may face additional financial hardship given shifts in the labour market.
The OSFI notes that these transition risks may translate into financial losses for FRFIs’ real estate-secured lending and investment portfolios. As a result, commercial loans for carbon-intensive properties will likely be considered higher risk and thus carry higher financial costs for borrowers.
In addition to the transition risks, a property’s exposure to physical climate risks may also affect its ability or costs to secure lending. The OSFI will require FRFIs to assess the exposure to physical climate risks for all properties located in Canada based on their physical location. The assessment will consider various future scenarios based on different degrees of global warming. Many properties in various Canadian cities are likely to be impacted by climate change, potentially increasing the risk associated with their lending.
Acting now can unlock more opportunities.
It will take time for the new guidelines drafted by OSFI to impact FRFIs and affect commercial real estate borrowers, but waiting until these regulations impact your mortgage or construction financing is risky, as retrofits to reduce your property’s risk profile will require careful planning and new thinking. It is essential to integrate any decarbonization plans into the properties’ capital plan as soon as possible to avoid replacing fossil fuel equipment with new like-for-like equipment and “lock them in” for the next few decades.
At Arcadis, we have a strong history of helping real estate clients unlock the benefits of migration to a low-carbon economy and develop realistic transition plans to decarbonize their assets. We are experts in assessing physical climate risks and can provide you with a roadmap that addresses your portfolio’s physical and transition risks. The new guidelines from the OSFI are just another new policy development that will continue to push for the transition to a resilient, low-carbon economy.
