How this applies to the Canadian financial system
To understand the direct and system-wide impacts of climate transition risk in Canada, Bank staff conducted a study, assembling a large and novel dataset. This dataset contains information about:
- the direct exposure of Canadian financial entities to sectors that are likely to be impacted by the climate transition
- interconnections within and among types of entities in the financial system
Collaboration with provincial and federal regulators as well as financial market participants enabled the collection of these insightful data.
The study authors then applied a framework to these Canadian financial system data and mapped out the direct impacts of climate transition risk, finding the impacts to be generally modest. This partly reflects the limited exposure of Canadian financial entities to sectors of the economy that may be negatively impacted by the transition. Despite this limited exposure, the interconnections revealed in this study play a role in spreading the impacts of the climate transition risk to the overall financial system. In particular, common exposures, fire sales and cross-holding positions were found to be important transmission channels.
This study significantly improves the Bank’s understanding of climate transition risk for the Canadian financial system. The data collected enable the better assessment of the links between financial entities and sectors of the economy that are likely to be impacted by the transition. The data also provide valuable insights into how different entities may respond to climate transition risk. For instance, some entities, such as investment funds, would likely spread and amplify climate transition shocks through the financial system while others, like pension funds, may help contain them.
This study also presented the opportunity for Bank staff to engage in discussions about climate transition risk with various Canadian financial system entities, notably pension funds. This collaboration shed light on long-term investors’ perspectives and how they assess and manage climate transition risks and opportunities.
This study also uncovered the many analytical challenges in assessing the effects of climate transition risk on the financial system. One such challenge is the lack of readily available data about direct exposures or interconnections within the financial system. This work highlights the need to establish standardized and systematic measurement and disclosure of exposures to climate transition risks. Another key challenge in evaluating climate transition risk is developing a simple yet comprehensive analytical framework to map out risks of transitioning to a low-carbon economy. This study is an important step toward this goal.