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Delaying policy action on climate change will increase the negative economic impacts and the risks to the financial sector, according to new research from the Bank of Canada and the Office of the Superintendent of Financial Institutions (OSFI).

The warning comes in a report detailing the results of a scenario analysis carried out by the federal financial regulator and the central bank. The analysis examined transition risk posed by the shift to a low-carbon economy under four different scenarios that varied based on the timing and severity of emission reduction requirements.

The exercise revealed that delayed action, which results in larger emission reduction requirements, “increases the overall economic impacts and risks to financial stability.”

It concluded that the “mispricing of transition risks could expose financial institutions and investors to sudden and large losses. It could also delay investments needed to help mitigate the impact of climate change.”

The analysis did not consider physical risks, which it said is an area for future study. Physical risks and efforts to mitigate them “could also have significant implications for the global and Canadian economies and the financial system,” it said.

The research also revealed that the public and private sectors (including the financial sector) are at a relatively early stage in terms of their ability to assess climate-related risks.

“A common message we heard from a broad range of financial institutions was that there is a need to develop and standardize methodologies for climate risk assessment and to improve the availability of climate-related data,” the report said.

To that end, the six financial institutions that participated in the exercise — TD Bank, Royal Bank, Manulife, Sun Life Financial, Intact Insurance, and Co-Operators — committed to “enhancing their climate-related disclosure to align with the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosure (TCFD),” the report noted.

The Canadian Securities Administrators (CSA) have proposed new disclosure requirements for issuers that generally align with the TCFD recommendations, although the proposals would not require firms to undertake the sort of scenario analysis involved in the OSFI and BoC research.

The CSA has extended the comment period on its proposals by 30 days to Feb. 16, citing the effects of the omicron variant on possible commenters.

At the same time, federal policymakers indicated that they have plans to step up their work on climate risk. OSFI said Friday that it plans to issue draft guidance on climate risk management later this year.

“This work is a critical step toward building risk management capability and awareness among regulated entities and thereby promoting financial resilience through the transition,” said Ben Gully, assistant superintendent at OSFI, in a release.

The Bank of Canada also said it plans to “build its capacity to assess the implications of more frequent severe weather events and the transition to a low-carbon economy for potential output growth, the labour market and inflation.”

“This pilot illustrates how the public and private sectors need to work together to ensure our economy and financial system are adequately prepared to handle the transition to a low-carbon economy,” said Toni Gravelle, deputy governor at the Bank of Canada.