May 2022 Research Paper on Climate-related Financial Disclosures

Commissioner of the Environment and Sustainable DevelopmentResearch Paper on Climate-related Financial Disclosures

Research paper

Summary

Climate-related financial disclosures by entities such as companies, pension funds, and government organizations are necessary stepping stones in the path to a low-carbon economy. For these disclosures to be effective, they need to be part of a widely applicable framework that allows them to be compared and provides transparent and relevant information to investors and other stakeholders.

Several frameworks have been developed over the last few years and continue to evolve. New frameworks building on previous ones are also anticipated. Given the number of different frameworks now available to reporting entities, the Government of Canada has recognized the need for a common framework for disclosures. In December 2021, it committed to working collaboratively with the provinces and territories to move toward mandatory climate-related financial disclosures. It also committed to requiring federally regulated institutions, pension funds, and government agencies to issue climate-related financial disclosures.

Although an increasing number of entities follow voluntary global frameworks for disclosures, such as the one recommended by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) , Canada has recognized that mandatory disclosure will accelerate the pace of adoption of a common disclosure framework, the quality and comparability of disclosures, and ultimately the transparency of such disclosures.

Various initiatives are underway in Canada to improve the disclosures of climate-related financial information. However, Canada lags behind countries at the forefront of regulating these disclosures. Given the interconnectivity of financial markets and economies and the importance of effectively addressing the climate crisis, Canada cannot afford to be a laggard in this area. Despite the decentralized nature of the regulatory frameworks for financial disclosures more generally—with the provinces and territories responsible for securities regulations within their own jurisdictions—Canada must address the lack of transparency, the inconsistencies, and the quality of climate-related financial disclosures. Doing so will support the country’s vision for a transition to a low-carbon economy and the achievement of Canada’s greenhouse gas emission (GHG) reduction targets.

Climate-related financial disclosures are one of the tools available to improve transparency into the impact of climate change on businesses and other entities. They are useful to investors and managers in their decision-making process. Other tools, such as taxonomies that classify economic activities according to their environmental sustainability, can be used in addition to climate-related financial disclosures to improve transparency. From a larger perspective, other mechanisms, such as carbon pricing, can also be implemented to ensure that the costs borne by society and the environment are factored into financial decisions.

Climate-related financial disclosures and associated tools to fight climate change also need to be broadened to cover other dimensions of the current environmental crises, such as biodiversity conservation.

Introduction

Background

Canada is committed to addressing the climate crisis through a variety of means including reducing its greenhouse gas emissions by 40 to 45% below 2005 levels by 2030. It is also committed to reaching net-zero GHG emissions by 2050.

In June 2021, the Canadian Net-Zero Emissions Accountability Act came into force. The act establishes a legally binding process to set 5-year national emissions-reduction targets for 2030, 2035, 2040, and 2045 and delivers on the Government of Canada’s commitment to legislate Canada’s target of net-zero GHG emissions by 2050. For each national emissions target, the act also requires the Minister of Environment and Climate Change to report the following to Parliament:

The act also calls on the Commissioner of the Environment and Sustainable Development to examine and report on the government’s implementation of climate-change mitigation measures. The act further requires the Minister of Finance to prepare an annual report on key measures that the federal public administration has taken to manage its financial risks and opportunities related to climate change.

In December 2021, the Prime Minister of Canada issued mandate letters to federal ministers following the election. In the letters to the Deputy Prime Minister and Minister of Finance and the Minister of Environment and Climate Change, the Prime Minister included the shared objective to “work with provinces and territories to move toward mandatory climate-related financial disclosures based on the Task Force on Climate-related Financial Disclosures framework.” The mandate letters also direct the Ministers to “require federally regulated institutions, including financial institutions, pension funds and government agencies, to issue climate-related financial disclosures and net-zero plans.” These commitments reflect the increasing priority that the fight against climate change is taking in Canada.

For Canada to achieve its climate change targets, it has committed to transitioning its GHG emissions-intensive economy to a low-carbon economy. This transition requires significant public investments to decarbonize certain industries and develop others. For example, the Government of Canada issued its first green bonds for a total amount of $5 billion dollars in March 2022. Green bonds are a specific type of bond in which the proceeds are used exclusively to fund projects with environmental and climate benefits. Through such bonds, funds can be raised for climate change adaptation and mitigation infrastructure projects. Green bonds provide investors with an opportunity to support the transition to environmentally sound, low-carbon economies.

However, public funding will not be sufficient on its own to fund the significant investments required for a transition to a low-carbon economy. Private capital will be needed to finance the necessary changes. For capital flows to enable the transition and for investors to make informed decisions, there is a need for easily accessible climate-related financial disclosures. They provide information to investors and other stakeholders about the impact of climate change on an entity, the entity’s strategy in dealing with the risks and opportunities presented by climate change, and metrics to measure the entity’s performance and risks related to climate change.

As stated in Canada’s climate plan, A Healthy Environment and a Healthy Economy, “Understanding the risks and opportunities posed by climate change and the emerging low-carbon economy are now an essential part of good financial decision-making. That is why a growing number of companies and countries are factoring climate considerations into their planning.” In addition, companies that place themselves ahead of the curve in identifying risks and taking advantage of opportunities created by climate change will be in a better position to reap the financial benefits of the transition to a low-carbon economy.

As explored further in this research paper, climate-related financial disclosures are just one of the necessary stepping stones to transition the Canadian economy to a low-carbon economy. Climate-related financial disclosures provide transparency about the impact of climate on entities. They complement other tools, such as green taxonomies used to classify economic activities against environmental criteria to assess how “green” they are.

Climate-related financial disclosures will be more relevant if accompanied by other measures such as carbon pricing. Environmental harm caused by the increase in GHG emissions are not fully internalized by companies, even though they adversely affect all of society. Costs are considered to be fully internalized when they are reflected in the price of products or services. One way to ensure companies internalize the cost of damage to the environment is to put a price on carbon. By putting a price on carbon emissions, the costs of goods and services will better reflect the true societal and environmental costs related to climate change.

As cost internalization initiatives such as carbon pricing become more prevalent, climate-related financial disclosures will become increasingly relevant for investors. Carbon pricing will have a direct financial impact on entities that emit GHGs. The higher the carbon price is set, the greater the financial impact will be, making climate-related financial disclosures all the more important.

Focus of this research paper

This research paper provides an overview of the role of climate-related financial disclosures and frameworks for climate-related financial disclosures.

Specifically, it examines the following:

This research paper is not an audit and is not intended to provide assurance on the results of a program or a federal government initiative or to make recommendations.

We reviewed public government documentation and literature on climate-related financial disclosures, including reporting frameworks, domestic and foreign legislation, and industry reports. We also reviewed a wide range of academic literature on climate change regulation and discussed climate-related financial disclosures and other regulatory tools, such as taxonomies, with different interested parties. We did not review financial prudential regulation in Canada, other environmental topics such as biodiversity, or any other environmental, social, and governance-related (ESG)Definition 1 topics.

Why are climate-related financial disclosures necessary?

Climate-related financial disclosures provide information on the risks and opportunities that climate change has for a project, company, or investment funds but can also provide information on the impact of an entity on climate. These disclosures describe, and quantify how these risks and opportunities are identified, assessed, measured and managed. Climate-related financial disclosures enable investors to make informed decisions and direct their investments toward industries and market players that are aligned with the transition to a low-carbon economy. According to the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD), disclosures should

Financing the transition to a low-carbon economy

Financing as a catalyst to the transition

One of the essential functions of financial markets is to price risks to support informed and efficient capital-allocation decisions. While it is widely recognized that continued GHG emissions will have increasingly significant negative environmental, social, and economic consequences, it can be challenging for stakeholders to identify, assess, and measure risks associated with their specific activities. Accurate, reliable, comparable and timely disclosure of climate-related risks is becoming increasingly important.

A 2015 study from the Economist Intelligence Unit estimated that the risk of climate change to the total global stock of manageable assets ranges between United StatesUS$4.2 trillion and US$43 trillion between now and 2100. The study highlights that “much of the impact on future assets will come through weaker growth and lower asset returns across the board.” This implies that investors might not be able to completely avoid the risks related to climate change by divesting from certain asset classes, as a wide range of asset classes will lose value as a result of lower growth in the whole economy. But investors with larger exposure to activities that are not aligned with the transition to a low-carbon economy will be at risk of lower returns compared with their peers who shifted their investments to be aligned with the transition to a low-carbon economy.

However, there are also opportunities for investors. The Institute for Sustainable Finance at Queen’s University estimated in 2020 that the Canadian economy would require around $128 billion in investment per year to finance its transition to a low-carbon economy between 2020 and 2030. Such investment would increase the chance of limiting global temperature increases to 2 degrees Celsius (°C), the threshold that the United Nations Intergovernmental Panel on Climate Change has identified as necessary for “avoiding catastrophic climate change.”

Growing demand for climate-related financial disclosures from investors

Market-led demand for climate-related financial disclosures

As part of the investor-led initiative Climate Action 100+, more than 600 investors with over US$68 trillion in assets under management are engaging with the world’s largest corporate greenhouse gas emitters to encourage them to strengthen their climate-related financial disclosures. This illustrates the growing demand from a range of stakeholders, including investors and creditors, for the publication of consistent, comparable, reliable, and clear climate-related financial disclosures. There has also been a growing recognition of the negative impact that weak corporate governance can have on shareholder value, resulting in increased demand for transparency from organizations on their risks and risk management practices.

Investors demand climate-related financial disclosures with specific qualities such as relevance and comparability—in contrast to boilerplate disclosures that do not provide information specifically relevant to the company and are not useful to investment decisions.

Another pitfall that investors want to avoid is greenwashing, sometimes called sustainability-washing, whereby a company or a project inaccurately or misleadingly claims to represent a green investment. Greenwashing undermines the confidence of investors and other stakeholders in companies and the markets, and risks misdirecting investment flows earmarked for green investments. Given that there are few constraints around the presentation of climate-related financial disclosures in Canada and no standardization, how companies and investment funds market their products can make it difficult for investors and financial advisors to assess to what extent a project, company, or investment is aligned with its internal ESG criteria and standards. Climate-related financial disclosures are an important part of the suite of ESG criteria. Comparable and reliable climate-related financial disclosures significantly reduce the risk of greenwashing, increase investors’ confidence, and enable financing to flow to projects and companies aligned with the transition to a low-carbon economy.

Case study: Canadian pension plans

Pension plans support climate actions…

In November 2020, the CEOs of eight leading Canadian pension plans, collectively representing CanadianCAN$1.6 trillion in assets under management, signed a letter publicly affirming their commitment to create more sustainable and inclusive growth by taking into account ESG factors, including climate change, in their investment decisions. To deliver on this commitment, these pension plans now require companies to enhance transparency by measuring and disclosing materialDefinition 2 and industry-relevant information using a recognized framework. Pension plans then use this information to strengthen their ESG disclosure and allocate capital to investments best placed to drive long-term sustainable returns.

…but not at the expense of financial return

Despite the push from some investors and other stakeholders for pension plans to invest in companies that publish climate-related financial disclosures and reduce their carbon footprint and environmental impact, pension plan managers owe a fiduciary duty to members to administer plans so that they achieve their expected rate of return (within their duty to act with care, prudence, and diligence). Generally, federal and provincial laws state that returns must be in accordance with investment policies and procedures. Therefore, when faced with an investment decision, pension plan managers will often select the investment option that is most likely to help them achieve the expected rate of return with an acceptable level of risk. They often limit consideration of climate change implications, such as a path to net-zero emissions, to dealing only with reputational and liability risks that could affect their return.

However, given the impact of climate change on the economy and financial markets (for example, increased claims under insurance, physical risk to assets, weaker growth, and lower asset returns), some stakeholders we spoke with argue that accounting for climate-related risks is part of the pension plan managers’ fiduciary duty, falling under their obligation to act prudently and manage risks when investing plan assets.

Divest or engage to drive climate actions?

Our research indicates that Canadian pension plans have taken different approaches to reducing their portfolio’s carbon footprint. Some pension plans have divested or plan to divest from some of their assets with the highest greenhouse gas emissions to quickly reduce their portfolio’s carbon footprint and have stopped financing companies and industries with high GHG emissions. This strategy has been criticized by some stakeholders, however, as global emissions are not necessarily reduced from the divestment. Rather, while the carbon footprint of a portfolio is reduced, companies will continue operations, financed by other investors less concerned about climate-related considerations. On the other hand, some stakeholders we spoke with argued that divestment signals to other investors that carbon-intensive assets are less desirable, something that potentially could lower the value of these assets.

The strategy followed by many pension plans, including in Canada, is one of active engagement, where they remain invested in these assets and use their influence as shareholders to drive change and reduce the carbon footprint of these companies. In practice, this means pension plans use their voting rights to support ESG-favourable proposals at shareholder meetings. Some pension plans also put forward their own proposals at shareholder meetings to support climate-related financial disclosures and other ESG considerations. However, the conditions to put forward a shareholder proposal in some jurisdictions make it difficult for minority shareholders to get their proposals on the agenda. Pension plans also have the option of voting against specific board members if they believe that the board’s ESG policy is not aligned with that of investors. This more direct and last-resort approach usually opens up a dialogue between the board and pension plan managers.

According to some pension plans, a strategy of active engagement is not appropriate for all types of assets with a heavy carbon footprint. Some industries, by their nature, will have little to no role in a low carbon-economy, in which case divestment is appropriate to avoid the risk of stranded assets (that is, assets that suffer from a sudden and unanticipated loss in their value). Other industries with high GHG emissions, such as cement manufacturing, will nevertheless be needed in a low-carbon economy and require heavy investment to enable them to decarbonize their production processes.

The influence of pension plans is greater in private companies where they are frequently a large shareholder and, as such, can nominate one or more directors to the board. In these cases, pension plans can drive significant changes directly from the board. In other cases, pension plans go as far as purchasing assets with a large carbon footprint, thereby temporarily increasing the carbon footprint of their portfolio, and then increase the economic value of these assets by making investments targeted at reducing their carbon footprints. For example, a pension plan could purchase a coal power plant and retrofit it to use natural gas, resulting in a lower carbon footprint for the global economy and increasing the useful life, and economic value, of this asset. However, these changes usually take years to materialize and could pose a challenge for a pension plan trying to quickly reduce its carbon footprint.

Pension plans, like the companies in which they invest, publish climate-related financial disclosures. However, the information presented can sometimes be fragmented and incomplete, with details lacking on the amount invested in carbon-intensive sectors. Disclosures, for example about GHG reduction targets, are also not necessarily comparable across pension plans. This makes it difficult for pension plan beneficiaries to know the impact of their savings on climate.

Several Canadian pension plans have embraced climate-related risks in their investment strategy. However, tensions remain between their fiduciary duty and pressures to play an active role in shaping a low-carbon economy. Strategies to reconcile both also vary among pension plans, with some divesting from specific industries while others prefer active engagement.

The push for mandatory climate-related financial disclosures reporting

Mandatory disclosures driving change

In 2021, the Government of Canada indicated, via mandate letters to senior federal ministers, its intention to move toward mandatory climate-related financial disclosures. Some jurisdictions have already taken important steps to make reporting on a comprehensive set of climate-related financial disclosures mandatory. For example, in 2015, France passed the Law on Energy Transition for Green Growth. This legislation—unique at the time—requires institutional investors registered in France to provide detailed reporting on both their exposure to climate-related risks and their efforts to mitigate climate change. This law pioneered the first mandatory disclosure by institutional investors (such as insurance companies and pension plans) of both their climate-related risks and their contribution to national climate change mitigation goals. French legislators aimed to make institutional investors aware of the emissions induced by their investments and the resulting financial risks. They also wished to incentivize public authorities, non-governmental organizations, and citizens to align their investments with the required transition to a low-carbon economy.

Six years after the law was passed, La Banque de France published a study that found strong evidence of a sharp relative decrease in holdings of fossil energy securities in the portfolios of investors subject to the law, as compared with holdings by investors not subject to the law. The effect of the mandatory climate-related financial disclosure was strongly significant, both statistically and economically. Results showed an average reduction of 39% in holdings of fossil energy securities in the portfolios of investors. Considering the volume of outstanding investments into fossil energy by French institutional investors at the end of 2015 as a reference point, this suggests French investors redirected EuroEUR 28 billion in funding out of this industry. These results underline the power of mandatory climate change–related financial disclosures to redirect financing flows and enable the transition to a low-carbon economy.

Mandatory climate-related financial disclosures decrease the risk of insufficient, incomplete, and non-comparable information that could mislead investors about the true impact of a company or its products on the climate and the environment. Mandatory reporting also

Climate-related financial disclosures as a stepping stone

Climate-related financial disclosures necessary but not sufficient

Although climate-related financial disclosures are seen by many as a necessary step toward the transition to a low-carbon economy, other complementary elements are needed to support the transition to a low-carbon economy. Examples include taxonomies, measures to divert financial flows away from fossil fuel assets, and setting a price on carbon emissions.

Green taxonomies classify economic activities according to their environmental sustainability. They allow investors to assess and classify companies’ activities, financial instruments, and investments against environmental criteria. In that context, they provide investors with an indicative proportion of the companies’ sustainable activities or funds’ sustainable share. In essence, a taxonomy informs the investor how “green” an investment is. A taxonomy can significantly reduce the risk of greenwashing by enhancing comparability across companies and investment funds, making it easier for sustainably-minded investors to allocate their investment in the pursuit of transitioning to a low-carbon economy.

Another tool available to prudential regulators is to introduce measures that would help divert financial flows away from fossil fuel assets. For example, financial regulators could require lending institutions to increase their capital requirements for investments in fossil fuel assets. To do so, regulators could increase the risk weight for activities that are contributing to large GHG emissions and are subject to transitional risk. This would force financial institutions to fund these activities with a larger share of equity and increase the implicit cost of funding carbon-intensive activities, effectively reflecting more closely the true costs of fossil fuel assets. However, some stakeholders interviewed for this research paper said it might be too early to consider implementing capital requirements based on climate risks, given the lack of sufficient data.

Companies, central banks, and financial regulators and supervisory bodies can also use climate scenarios to investigate a range of potential pathways for climate-related risks over the long term. Climate scenarios illustrate how climate change could potentially affect companies and financial institutions—and how they could respond to these risks. They differ from mainstream stress tests that are near-term assessments of how a company, a financial institution or the financial system would react to a shock with limited time to adapt. Climate scenarios can be used by individual companies to inform their risk management strategy but also by regulatory and supervisory bodies to help shape their regulatory policies. For climate scenarios to be pertinent prudential tools, prudential regulators might prefer the use of a set of standardized climate scenarios with common assumptions and variables. This standardization would allow the aggregation of results and the assessment of risk at a systematic level. It also allows investors to more easily compare companies that publish the results of their scenarios. Standardization of climate scenarios does not prevent companies and financial institutions from publishing additional scenarios they have run, which could be specific to the risks they face.

Approaches to reporting climate-related financial disclosures

Task Force on Climate-Related Financial Disclosures

A comparable global framework

In 2015, the group of 20G20 finance ministers and central bank governors asked the international Financial Stability Board to review how the financial sector could account for climate-related issues. As part of its review, the Financial Stability Board identified the need for better information to support informed investment, lending, and insurance underwriting decisions and improve understanding and analysis of climate-related risks. It also established the Task Force on Climate-Related Financial Disclosures (TCFD) to help identify the information needed by investors, lenders, and insurance underwriters to appropriately assess and price climate-related risks and opportunities.

In 2017, the TCFD released widely adoptable recommendations for organizations across sectors and jurisdictions to make climate-related financial disclosures in 4 main areas (which are subdivided into 11 more specific categories). Large investment funds, pension plans, and asset managers have an important role to play in influencing and guiding the organizations in which they invest to provide better climate-related financial disclosures. The 4 main recommendations are as follows:

The recommendations were designed to have the following characteristics to make them relevant and adoptable by a wide range of stakeholders:

The recommendations quickly emerged as a widely recognized framework around the world and are now supported by over 3,000 organizations across 89 countries. Jurisdictions such as the European Union, the United Kingdom and New Zealand are in the process of implementing legislation aligned with the recommendations.

IFRS International Sustainability Standards Board

The International Financial Reporting Standards (IFRS) Foundations a not-for-profit, public interest organization established to develop a single set of high-quality, understandable, enforceable, and globally accepted accounting standards known as the IFRS Standards. The foundation launched a consultation in September 2020 to collect views on the need for global sustainability standards and to consider its potential role in developing such standards. In its consultation paper, the IFRS Board stated that “a ‘bottom up’ cooperation among regional initiatives or existing standard-setters alone would not be sufficient to realise the goal of establishing even a basic set of standards. According to the IFRS, to develop such standards, a global initiative would be needed, and it would be vital for that global initiative to cooperate with regional initiatives to achieve global consistency and comparability.”

The responses to the consultation confirmed the urgent need for global sustainability standards and the role the IFRS Foundation could take in developing such standards.

In November 2021, the IFRS Foundation created the International Sustainability Standards Board (ISSB), a new standard-setting board focused on climate change disclosures. The IFRS Foundation also announced it would consolidate the Climate Disclosure Standards Board (an initiative of Carbon Disclosure Project) and the Value Reporting Foundation (which houses the Integrated Reporting Framework and the Sustainability Accounting Standards Board) by June 2022. The consolidation of these reporting standards will improve the comparability of climate-related financial disclosures across companies. Furthermore, the Technical Readiness Working Group, formed by the IFRS Foundation trustees to do preparatory work for the ISSB, also published a prototype for climate and general disclosures requirements.

The Government of Canada had published a letter in July 2021 expressing its support for the proposed ISSB. Canada also supported the proposal to have the new board first focus on climate change “given the pressing need for investors to properly price climate-related financial risks and new investment opportunities, and for such work to leverage the Task Force on Climate-related Financial Disclosures (TCFD) recommendations.” The ISSB will have an office in Montréal.

How is climate-related financial disclosure addressed in Canada?

Federal and provincial/territorial regulation responsibilities

Fragmented regulatory oversight

Canada does not have a national securities regulator, despite recent efforts to create such a body. At present, the 10 provinces and 3 territories in Canada are each responsible for securities regulations within their own jurisdictions. The securities regulators from each province and territory have teamed up to form the Canadian Securities Administrators, an umbrella organization aimed at achieving collaboration and consensus on provincial policy decisions without having regulatory power of its own to impose regulations on provinces.

In 2021, the Canadian Securities Administrators initiated a consultation on climate-related financial disclosures. The consultation proposed the introduction of mandatory climate-related financial disclosures in Canada, based on the Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations, with two main modifications. The proposed regulation would not require issuers (that is, entities issuing equity shares and bonds)  to publish climate scenario analyses, as some stakeholders raised concerns that the comparability of scenarios between issuers would be difficult, that the development of scenario analyses would be too costly, and that the methodology for climate scenarios is not yet mature enough. The proposed regulation would also depart from the TCFD recommendations on GHG emissions disclosures by adopting a “comply or explain” approach for scope 1, 2 and 3 emissions (as defined by the GHG Protocol),Definition 3 where issuers would have to disclose their emissions or explain why they chose not to. Alternatively, the disclosures of scope 1 emissions could be made mandatory.

The Canadian Securities Administrators proposed a phased-in transition of one year for issuers listed on the major stock exchanges such as the Toronto Stock Exchange (known as non-venture issuers) and three years for other public companies (known as venture issuers). For example, if the regulation would be implemented in 2022, it would apply to non-venture issuers with a reporting period starting on or after January 1, 2023 which would result in the first disclosures due to be published in March 2024 for non-venture issuers and March 2026 for venture issuers.

The responses to the consultation showed a support for the Canadian securities regulation to be aligned with the TCFD recommendations. Of the respondents that addressed scope 1 and 2 emissions, a majority of them supported the mandatory disclosure of scope 1 (79%) and scope 2 (68%) emissions. Ony 27% of respondents were in support of disclosures of mandatory scope 3 emissions, while 23% were in favour of the “comply or explain” approach proposed by the Canadian Securities Administrators.

Independent Review Committee on Standard Setting in Canada

In March 2021, Chartered Professional Accountants (CPA) Canada and the Accounting Standards Oversight Council, which oversee the accounting standard boards for the private and public sectors, launched the Independent Review Committee on Standard Setting in Canada—20 years after the last review of accounting and assurance standard setting in Canada. This committee launched a consultation on sustainability reporting standards in December 2021, partly in response to the IFRS Foundation’s recent creation of the International Sustainability Standards Board (ISSB). Among other things, its consultation paper proposes the creation of a board to set Canadian sustainability standards. The responsibility of this new board will be to adapt and adopt international sustainability standards to Canadian accounting rules.

Large Employer Emergency Financing Facility

Even though securities regulatory oversight sits with the provinces and territories, the Government of Canada introduced mandatory climate-related financial disclosures for large companies that sought financial support during the COVID-19 pandemic under the Large Employer Emergency Financing Facility (LEEFF), a program providing short-term liquidity to large Canadian employers affected by the pandemic. The terms and conditions of the program are commercial in nature and include a covenant on climate-related financial disclosures: “Borrowers will be required to produce an annual climate-related financial disclosure report highlighting how their corporate governance, strategies, policies and practices will help manage climate-related risks and opportunities and contribute to achieving Canada’s commitments under the Paris Agreement and goal of net zero by 2050. The report should follow the recommendations of the Financial Stability Board’s Taskforce on Climate-related Financial Disclosure, which provides clear direction on the required disclosure. The climate-related disclosure report is part of the ongoing compliance with LEEFF loan terms but not a pre-condition to be considered for LEEFF loans.” However, given that only 7 companies used this financing facility, it had limited impact on the adoption of TCFD-aligned climate-related financial disclosures.

Voluntary reporting by issuers

Existing voluntary disclosures

Current provincial and territorial securities legislation in Canada requires disclosure of certain climate-related information in an issuer’s regulatory filings, if such information is considered to be material. In its current state, climate-related financial disclosures are not comparable, as no single framework is used across companies and industries, or even within industries. Moreover, the generic disclosures and use of boilerplate disclosures reduce the usefulness of such disclosures to the investor community.

The Canadian Securities Administrators, as the umbrella association of the provincial regulators, summarized the main climate-related financial disclosures required by the provinces and territories in its Staff Notice 51-333 “Environmental Reporting Guidance” published in 2010. These requirements include, but are not limited to, the following:

In 2017, the Canadian Securities Administrators announced a project to review the disclosure of risks and financial impacts to issuers associated with climate change, as well as the governance processes related to them. The project had the following objectives:

In 2018, the Canadian Securities Administrators presented the project’s results in its Staff Notice 51-354 “Report on Climate change-related Disclosure Project.” The report concluded that, although issuers were following current regulation on climate-related financial disclosures, the level of details in disclosures and comparability between issuers differed significantly. In response to its findings, the Canadian Securities Administrators intended to focus on the following:

In 2019, the Canadian Securities Administrators published Staff Notice 51-358 “Reporting of Climate Change-related Risks,” which is intended to help companies identify and improve their disclosure of material risks posed by climate change. The notice clarifies existing legal requirements by reinforcing and expanding on the guidance in its Staff Notice 51-333 “Environmental Reporting Guidance.”

Low voluntary disclosures level

In 2021, CPA Canada published its complete report on its 2019 study of climate-related financial disclosures by Canadian public companies, a follow-up to its initial study in 2015. The 2021 study reviewed the climate-related financial disclosures made by 40 Canadian companies listed on the Toronto Stock Exchange in their regulatory reports and assessed the alignments of these disclosures with the recommendations of the TCFD.

CPA Canada found that almost all of the companies reviewed (98%) provided some sort of TCFD-aligned disclosures , and that more than a third provided disclosures in all 4 categories (governance, strategy, risk management, and metrics and targets). However, only one of the companies reviewed disclosed in all 4 main categories and all 11 subcategories. These results demonstrate that the depth and extent of disclosures are not yet aligned between companies and not on par with best practices. Even so, the extent of climate-related financial disclosures has improved since the 2015 study. Mandatory disclosures would address the lack of consistent and transparent disclosures.

Although the use of the TCFD framework has improved consistency in climate-related financial disclosures, the lack of commonly accepted definitions of terms relevant to climate-related financial disclosures among companies and sectors hinders the assessment of climate-related financial disclosures against the TCFD recommendations and makes comparisons challenging. CPA Canada also noted that although companies often indicated they had thoroughly assessed climate-related risks, all of them concluded that climate change did not represent a material risk to them. Given the wide array of channels through which climate change affects companies (including physical risks, regulatory changes, supply chain disruption, and litigation risks) and the general acknowledgment by market commentators that climate change presents a risk to a wide range of economic actors, it appears that some companies might not yet fully grasp the risks and opportunities that climate change represents.

Sustainable Finance Action Council

Enhancement of climate-related financial disclosures on the way

On May 12, 2021, the Minister of Finance and the Minister of Environment and Climate Change launched the Sustainable Finance Action Council. The council’s principal mandate is to make recommendations on critical market infrastructure needed to attract and scale sustainable finance in Canada, including the following:

These areas respond to the recommendations of the Expert Panel on Sustainable Finance, a panel of 4 experts created by the federal government to consult with Canada’s financial market participants on issues related to sustainable finance, including climate-related financial disclosures. The council’s early emphasis will be on enhancing climate-related financial disclosures, aligned with the recommendations, in Canada’s private and public sectors. Transparent climate-related financial disclosures could help accelerate movement of private capital in support of the Government of Canada’s climate goals such as the achievement of Canada’s enhanced 2030 target and a transition to a net-zero emissions economy by 2050.

Mandatory use of TCFD framework by Crown corporations

Federal Crown corporations are entities with a mix of commercial and public-policy objectives wholly owned by the Canadian government. Their purpose is to fulfill a desired policy objective (for example, delivering mail or providing passenger transport to remote locations) and provide an outcome of national interest that would not be met appropriately by the private sector. Federal Crown corporations operate directly in vital sectors such as transport, telecommunications, utilities, and power generation. They also play an economic role and provide funding in sectors such as finance, business development, and agriculture. Because of their policy objectives, size, ownership, and position in vital sectors of the economy, their influence on the Canadian economy is significant.

In its Budget 2021, the Government of Canada announced that federal Canadian Crown corporations will be required to report in line with the TCFD standards, or according to more rigorous, acceptable standards, in order to demonstrate climate leadership to the private sector. Entities with over CAN$1 billion in assets were required to comply with this new requirement by 2022 at the latest. Entities with less than CAN$1 billion in assets have until 2024 to comply or provide justification as to why climate risks do not have material impact on their operations.

As part of our research, we examined the 2019–20 annual reports and publicly available information of 14 of the largest federal Crown corporations. The quality and completeness of climate-related financial disclosures varied greatly among Crown corporations. Some reported according to TCFD guidelines or another global framework, while others appeared not to be following a globally recognized framework. Some Crown corporations were lacking a consistent set of climate-related financial disclosures but had a strategic plan in place to publish climate-related financial disclosures. Not all strategic plans had a clear timeline for their implementation. More problematic is that some entities did not appear to publish any climate-related financial disclosures or have any plans to do so. Mandatory climate-related financial disclosures should help bridge the inconsistencies in reporting among Crown corporations.

Given that Crown corporations share the same shareholder (that is, the Government of Canada), they should report in a consistent manner. Given the limited and uneven progress that Crown corporations have made on voluntary climate-related financial disclosures to date, questions remain as to how prepared they are to report on their climate-related financial risks now that the new requirements are in effect.

How do other jurisdictions regulate climate-related financial disclosures?

New Zealand TCFD-based legislation

The New Zealand Productivity Commission’s Low Emissions Economy report in 2018 stated that the stock prices of emission-intensive companies were overvalued because the lack of climate-related financial disclosures prevented investors from correctly assessing the value of these companies. In response, the Ministry for Environment and the Ministry for Business, Innovation and Employment of New Zealand issued a discussion document in 2019 that proposed “the introduction of a mandatory disclosure regime based on recommendations made by the Task Force on Climate-related Financial Disclosures.” In 2021, New Zealand passed a climate-related financial disclosure bill that broadens non-financial reporting by requiring and supporting the making of climate-related financial disclosures and related matters, one of the first of its kind. The specific purposes of the law are the following:

The legislation requires about 200 large entities in New Zealand to make climate-related financial disclosures in 2023 at the earliest. The new rules apply to the following entities:

Managers of registered investment schemes will be required to make disclosures on a fund-by-fund basis. This will enhance investors’ understanding of the impact of climate change on the future performance of their investment.

Corporations incorporated overseas will be required to make disclosures if their New Zealand business is over the thresholds outlined above. This should improve the provision of information to their New Zealand stakeholders. The above thresholds will be increased from time to time to reflect the movements in the consumer price index.

Reporting will be against one or more standards that are being developed in line with the recommendations of the TCFD. The External Reporting Board, an independent Crown entity, will prepare, consult on, and issue the new reporting standards for businesses required to disclose. Elements of the disclosures relating to GHG emissions will be required to have independent assurance. This assurance requirement will enter into force after three years, whereas the disclosure requirement will enter into force in one year, effectively leaving two years for relevant stakeholders before they need to get their disclosures audited. The Financial Markets Authority, the government agency that regulates New Zealand’s financial markets, will be responsible for independent monitoring, reporting, and enforcement of the regime.

The law also introduced significant penalties for non-compliance. Directors of a climate reporting entity who knowingly fail to comply with applicable climate standards could be liable for imprisonment for a term of up to 5 years and/or a fine not exceeding NZ$500,000 for such an offence. In turn, the climate reporting entity could itself face a fine of up to NZ$2.5 million for the same offence. Certain contraventions would also give rise to civil liability including a penalty not exceeding NZ$1 million in the case of an individual or NZ$5 million in any other case.

Strong political support has made it possible for New Zealand to pass legislation that mandates climate-related financial disclosures. These disclosure requirements will be adapted to New Zealand while being aligned with the recommendations of the TCFD. The new legislation will apply to about 73% of listed entities and about 200 organizations with over NZ$1 billion in assets, which represents about 90% of assets under management in New Zealand.

European Union taxonomy

As part of its commitment to becoming a global leader in sustainable finance, in 2018, the European Commission adopted its Action Plan on Sustainable Finance, which has three main objectives:

Since then, the European Commission has also developed its European Green Deal, a set of proposals to make the European Union’s climate, energy, transport, and taxation policies fit for net-zero carbon emissions by 2050.

A central aspect of both the Action Plan on Sustainable Finance and the European Green Deal was to develop a taxonomy to classify economic activities according to their environmental and social sustainability and their effectiveness in fighting climate change. Doing so would provide a legal basis for using this classification system across different areas (for example, standards, labels, green-supporting factors for prudential requirements, and sustainability benchmarks).

This green taxonomy is a transparency tool that introduces mandatory disclosure obligations on some companies and investors, requiring them to publish their share of taxonomy-aligned activities. The disclosure of a proportion of taxonomy-aligned activities is expected to improve the comparison of companies and investment portfolios, which will help guide market participants in their investment decisions.

Companies and asset managers have to report the percentage of their turnover, capital expenditures, and operational expenditures aligned with the European UnionEU taxonomy. Asset managers have to report the percentage of their portfolio invested in activities aligned with the EU taxonomy.

The Taxonomy Regulation establishes a unified and consistent system of indicators to classify and compare which economic activities and investments are deemed “environmentally sustainable.” These must contribute substantially to one or more of the following objectives while (i) not significantly harming any other objectives, (ii) meeting minimum social safeguards, and (iii) complying with the technical screening criteria:

Technical screening criteria for assessing specific types of economic activity (such as forestry, energy, and manufacturing) are being developed. The criteria for climate change mitigation and adaptation (also known as Level 1) were published 21 April 2021 and came into force on 1 January 2022. The remaining criteria, which have been delayed due to the length and level of technical details, are expected to be published in 2022 with an implementation date of 1 January 2023.

The Taxonomy Regulation, with its supporting criteria, is a work in progress. Notably, it does not provide a comprehensive list of “green” activities, much less a separation of “good” and “bad” economic activities and investments. Rather, it provides a common set of principles to be observed by investors, financial institutions, companies, and issuers in line with their own ESG commitments and the mobilization of capital toward more sustainable financing. To do so, the technical screening criteria make reference to greener alternative practices in order to meet the outlined criteria and objectives. Industries such as aviation and maritime shipping are not yet included for lack of technological and economical alternatives—but this will be reviewed as technology evolves.

The European taxonomy excludes certain “brown” industries, mainly fossil fuels, which effectively excludes transition activities such as the decarbonization of these sectors.

In Canada, the CSA Group, formerly known as the Canadian Standards Association, an international organization that develops and tests standards and certifications in a number of fields, has formed a technical committee to create what is called a “transition finance taxonomy” to define what projects should qualify for financing to transition to more sustainable ways of operating. This taxonomy would be more adapted to natural resource–based economies, such as Canada’s. The committee includes representatives from Canada’s financial sector (including the major banks, pension fund managers, wealth and asset managers, insurance companies, rating agencies), Canada’s natural resource sectors, government, and related industry stakeholders.

The overarching aim of this transition taxonomy is to drive investments in entities and activities that will decarbonize the sectors that are currently carbon-intensive and form a large part of the Canadian economy. Enabling these sectors to transition to a low-carbon model instead of excluding them from the taxonomy would reduce sudden instability in the economy and the associated social impacts. This taxonomy is expected to be published sometime in 2022.

Contrary to the EU green taxonomy, which is legislation developed by a supranational governing body and mandatory for relevant stakeholders, the CSA Group transition taxonomy is being developed by market participants and will be adopted by stakeholders on a voluntary basis. Companies, pension plans, and investment funds operating in Canada will have the choice to apply the taxonomy guidelines and publish the relevant information. For the participants who announce that they apply the disclosures guidelines of the CSA Group transition taxonomy, the consequences for not fully adhering to the rules are not yet clear.

United States Securities Exchange Commission

In February 2021, the US Securities and Exchange Commission announced it would increase its focus on climate-related risks by assessing how well public companies comply with disclosure obligations under federal securities laws. Following this announcement, the Securities and Exchange Commission created a task force in March 2021, to identify any material gaps or misstatements in issuers’ disclosures of climate risks under existing rules. The task force will also evaluate and pursue tips, referrals, and whistleblower complaints on ESG-related issues.

The February announcement also included a commitment to engage with public companies to update the 2010 guidance on climate-related financial disclosures. In March 2021, the Securities and Exchange Commission initiated a 3-month consultation on updating its climate change disclosures, addressing several questions such as the use of the TCFD recommendations, the case for “comply or explain” disclosures, the place for investors and industry participants in designing such disclosures, and the enforcement of such disclosures. The consultation received over 550 responses, with 3 out of 4 respondents supporting the introduction of mandatory climate-related financial disclosures.

In March 2022, the Securities and Exchange Commission proposed new rules for consultation that would require certain companies to publish climate-related disclosures. These disclosures would include:

For companies that already conduct scenario analysis, have developed transition plans, or publicly set climate-related targets or goals, the proposed rules would require certain disclosures that will enable investors to understand those aspects of the companies’ climate risk management.

The proposed new rules would also require companies to disclose their scope 1 and 2 emissions. Scope 3 emissions would need to be disclosed if they are material or if the company has set a GHG emissions target or goal that includes scope 3 emissions. The proposed rules would provide a waiver if liability for scope 3 emissions disclosure and an exemption from the scope 3 emissions disclosure requirement for smaller companies.

The implementation of these new rules and the required assurance level would be phased in between 2023 and 2027. The proposed rules are under consultation until May 2022.

The Securities and Exchange Commission’s mandate to protect investors is driving its approach to climate-related financial disclosures, with this topic being identified as an area of concerns by investors. This is an area where a company usually holds significantly more information than its investors have access to. To fulfill its duty to protect investors, the Securities and Exchange Commission has renewed its efforts to enforce the existing climate-related financial disclosure requirements in its regulatory framework. This enforcement sent a strong signal to financial markets and prepared them for the consultation and potential future additional requirements to be implemented in this area.

Given the strong interconnectivity between the American and Canadian economies, any US regulation could have a significant impact on Canadian businesses. Therefore, any climate-related financial disclosures that Canada wishes to implement might have to take into account standards implemented by other economies linked to the Canadian economy.

About the Research Paper

A research paper is not an audit and is not intended to provide assurance on management performance or recommendations to management. In assurance engagements, we express a conclusion in a report designed to enhance the degree of confidence of the intended users about the outcome of the assessment of a subject matter against criteria. In contrast, a research brief communicates the nature of the work carried out with respect to a subject matter and the factual results or observations from this work.

Purpose

The Commissioner of the Environment and Sustainable Development within the Office of the Auditor General of Canada is required to monitor the progress of federal organizations toward sustainable development. As part of our work in selecting future topics for auditing and reporting, our staff develops knowledge of various subjects. This research paper is intended to share insights that our office has compiled from public sources and interviews with stakeholders about climate-related financial disclosures.

Scope and approach

This research paper examined the role of climate-related disclosures in financial markets and the frameworks used to report climate-related disclosures. We also looked at Canada’s progress  toward making climate-related disclosures against examples of international legislation and initiatives.

We reviewed government documentation and literature on climate-related disclosures, including reporting frameworks, foreign legislation, and related industry reports. We also reviewed a wide range of literature on climate change regulation and discussed this topic with relevant stakeholders.

We did not examine macro-prudential regulation in Canada, other environmental topics, such as biodiversity, or any other ESG-related topics.

Period covered by the research paper

The research paper covered the period from 1 January 2015 to 4 April 2022.

Research team

Principal: Philippe Le Goff
Director: Mathieu Lequain
Senior Audit Professional: Brian Caire

Selected references

Bank of Canada and Office of the Superintendent of Financial Institutions. Using Scenario Analysis to Assess Climate Transition Risk: Final Report of the Bank of Canada and Office of the Superintendent of Financial InstitutionsBoC–OSFI Climate Scenario Analysis Pilot. 2022.

Banque de France. Showing off cleaner hands: mandatory climate-related disclosure by financial institutions and the financing of fossil energy. Working Paper Series no. 800. 1 January 2021.

The Economist Intelligence Unit. The cost of inaction: Recognising the value at risk from climate change.

Environment and Climate Change Canada. A Healthy Environment and a Healthy Economy.

Environment and Climate Change Canada. Pan-Canadian Framework on Clean Growth and Climate Change. 2016.

International Financial Reporting StandardsIFRS Foundation. “IFRS Foundation announces International Sustainability Standards Board, consolidation with Climate Disclosure Standards BoardCDSB and Value Reporting FoundationVRF, and publication of prototype disclosure requirements,” new release, 3 November 2021.

International Energy Agency. Energy and Climate Change: World Energy Outlook Special Briefing for 21st Conference of the PartiesCOP21. 2015.

Ontario Securities Commission. National Instrument 58-101: Disclosure of Corporate Governance Practices. 2016.

Organisation for Economic Cooperation and Development. Managing Environmental and Energy Transitions for Regions and Cities. 18 November 2020.

Task Force on Climate-related Financial Disclosures. Final Report: Recommendations. June 2017.

Definitions: