Abrupt changes in climate policies from governments around the world could lead to fire sales of climate sensitive assets held by institutional investors, according to a the results of a pilot scenario analysis project from the Bank of Canada and the Office of the Superintendent of Financial Institutions.

“Climate transition risks are challenging to assess accurately given the long time horizons with high uncertainty about how policy, technology and socio-economic factors might evolve,” wrote the report’s authors in the paper’s introduction. “Scenario analysis provides a flexible what-if framework to explore how the risks may manifest in the future.”

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The report, which was based on contributions from six financial sector companies, considered various plausible scenarios to analyze possible financial risks posed to the Canadian economy by the transition to a low carbon economy. The scenarios, which aren’t intended to serve as forecasts, were meant to reflect possible futures for the Canadian economy.

In conducting the research for the publication, the project’s authors asked representatives of the Co-operators Group Ltd., Intact Financial Corp., Manulife Financial Corp., TD Bank Group, Royal Bank of Canada and Sun Life Assurance Co. of Canada to consider how different climate transition scenarios and other market risks could affect investment portfolios. The analysis focused on the 10 most emissions-intensive sectors in the economy.

In analyzing the data, the authors concluded that governmental climate policies could lead to assets being sold far below market value. These fire sales would be caused by exposure to climate-sensitive assets during tightening financial conditions.

“Enhancing the understanding and assessment of climate change impacts on system-wide market and credit risks will allow the bank and OSFI to improve how we assess system-wide vulnerabilities.”

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