Climate Change Policy in Canada: Impacts on Sectors and Firms

1. Climate Change Policy in Canada: Impacts on Sectors and Firms U of T Environmental Finance Workshop May 11, 2007 Sandra Odendahl, Senior Director CIBC Environmental Risk Management Corporate Risk and Insurance Services, TRM

2. Outline • About CIBC • The Legislative Framework • Impacts on Banks • Impacts on Sectors, Clients and Portfolio • Opportunity Drivers • Summary and Conclusion U of T Environmental Finance

3. About CIBC • Assets ~ $304 billion; market capitalization $33.6 billion. • Approximately 37,000 employees worldwide. • 1,061 branches; more than 3,800 ABMs • Business areas: • CIBC Retail Markets (~76% of revenue) • retail markets (everyday banking, borrowing, mortgages and investing), wealth management and credit cards • CIBC World Markets (~24% of revenue) • wholesale banking arm of CIBC, providing a range of integrated credit and capital markets products, investment banking and merchant banking U of T Environmental Finance

4. About CIBCEnvironmental Risk Management Group • Oversight responsibility for Environmental Management at CIBC • Oversight of adherence to CIBC environmental policy and other environmental requirements and commitments • Corporate environmental footprint • Environmental credit risk management • Established in 1992 as part of TRM, Corporate Risk and Insurance Services • Originally driven by enactment of environmental legislation in Canada and the U.S. in the early 1990s that raised the possibility of significant credit and legal risk to banks associated with lending activities • Three full-time permanent staff: • Sandra Odendahl, Senior Director • Tony Basson, Senior Manager • Bill Christmas, Senior Manager U of T Environmental Finance

5. Risks Arising from Environmental Issues • Credit Risk • Ability of borrower to repay debt is impacted by problems associated with contaminated property and/or inadequate client environmental management systems, for example: • Revenue or net income affected by clean up costs, fines and penalties • Business operation curtailed due to regulatory orders • Value of collateral security much lower than appraised value, due to contamination, financial ratios are adversely impacted, and credit risk is higher • Legal Risk • Direct liability of bank for clean-up costs, possibly exceeding the amount of the loan or investment, following foreclosure or bankruptcy • Operational Risk • Risk of loss due to inadequate environmental management (fuel tanks, asbestos, etc) in bank’s own operations • Reputation Risk • Damage to bank reputation caused by association with environmentally damaging company or issue U of T Environmental Finance

6. Climate Change An Emerging Risk Issue Risks for a bank: • Credit Risk • Operational Risk • Reputation Risk Arising From: • Physical effects • Regulations to mitigate U of T Environmental Finance

7. Physical Effects of Climate Change In general: • Extreme temperatures • Change in precipitation • Increased storm frequency and intensity • Rising sea levels In Canada: • Shifting permafrost, • Hotter & drier summers, • Wetter winters, • Stormier coastline, • Rising sea levels U of T Environmental Finance

8. Climate ChangeThe Legislative Framework • Objective is to stabilize concentrations of GHGs at levels that will stabilize human-induced climate change • Targets at international, national, regional and/or provincial level • Most systems embrace emissions trading, which allows reduction targets to be met at lowest cost • Participants are issued allowances to cover targeted amount of emissions • To meet targets, participants can: • Reduce emissions internally • Buy the right to emit more GHGs (allowances) • Buy proof that GHGs have been reduced somewhere else (credits) International National Regional Provincial State Installation U of T Environmental Finance

9. Impacts of Climate Change on Banks U of T Environmental Finance

10. Impact on BanksPhysical Effects Risks • Human resources impacts • Effect of more respiratory problems = absenteeism? • Higher insurance costs for CIBC premises in some regions • Increased cooling requirements in summer • Business interruption due to major storms, power availability in Ontario, etc. • Credit risk due to impacts on clients’ sectors • (Especially agriculture, forestry, fisheries, tourism, food & beverage, etc) • Increased capital & operating costs to clients • Increased business interruption to clients • Increased cost for (or unavailability of) insurance Opportunities • New products and services • Lower building heating costs in northern areas U of T Environmental Finance

11. Impacts on BanksRegulatory Aspects Risks • Operational Risk • Increased cost for purchased energy if power producers pass on new regulatory costs • Credit risk • Clients face new regulations, new costs, climate change litigation and other • Reputation Risk • Stakeholders increasingly demanding action from banks and other firms to mitigate emissions, avoid lending to high CO2 emitters, and manage supply chain Opportunities • New products and services • Earn Offset Credits from energy conservation projects U of T Environmental Finance

12. Impact of Regulations on Industry Sectors • Companies will need to select one or a combination of strategies to meet carbon dioxide targets, including: • investment in internal abatement measures, • the purchase of credits on national or international carbon markets, and • investment in projects that will offset carbon dioxide emissions • Completed a study in 2006 to look at the impacts of GHG regulations on 3 levels: • Industries • Clients • Portfolio U of T Environmental Finance

13. 1. Impact of GHG Regulations on SectorsMethod • Modified Porter Model to identify key factors that determine how much a sector will be affected by new regulations: • Government policy • Policy can have uneven effects on different sectors • Energy Intensity • Input costs likely to rise • Emissions Intensity (emissions per unit output) • More emission intense industries may face higher absolute emission reductions • Ability to pass along costs • Can mitigate impacts of new regulation in that sector • Opportunities to abate • Are low cost abatement opportunities still be available to sector? U of T Environmental Finance

14. Impact of GHG Regulations on SectorsAs a function of 2 key variables Highest Risk Aluminum products Smelting/refining Steel Electricity Oil Sands Cement Chemicals Petroleum Emissions Intensity Refining Pulp & Paper Oil & Gas Mining Pipelines Lowest Risk Low High Ability to Pass on Costs U of T Environmental Finance

15. Impact of GHG Regulations on SectorsAs a function of 4 variables “CIBC WM Carbon Cap Vulnerability Index” U of T Environmental Finance

16. CIBC WM Carbon Cap Vulnerability Index U of T Environmental Finance

17. 2. Impact of GHG Regulations on CIBC ClientsMethod • Identified companies likely to face GHG regulation • Forecasted future emissions and compared to probable targets • Emissions – target = CO2 asset or liability • Calculated cost of compliance for companies in a liability position (i.e. unable to meet their regulated target) • Cost for abatement through new technology • Cost to buy CO2 allowances in the marketplace under different price scenarios • Cost to buy CO2 allowances from federal government at $15/tonne • Assessed ability of sectors and firms to pass on costs of compliance to customers • Determined annual cost of compliance on an absolute and percentage of net income basis U of T Environmental Finance

18. Impact of GHG Regulations on CIBC ClientsResults • Impacts of new regulations vary among clients within a sector • GHG regulations, as articulated in Canada’s “Project Green”, would have placed a fairly modest financial burden on most of CIBC’s large clients; however, a few clients faced potentially material impacts. • Clients in coal fired power generation and aluminum faced largest compliance costs. • Majority of Single Names faced some costs to meet GHG regulations, but 18% of firms likely to face no cost to comply with GHG regulations • For most Single Names, carbon compliance costs were a very small percentage of annual net income: representing under 1% of profit in 90% of cases • Analysis will be updated using details of new federal GHG regulations U of T Environmental Finance

19. 3. Impact of GHG Regulations on CIBC’s PortfolioMethod • Top-down approach: • Percentage of loans in portfolio that are to all clients in industrial sectors likely to be regulated, and that are to sub-investment grade clients (i.e. clients least likely to have financial means to meet new regulatory targets for greenhouse gases) • Bottom-up approach: • Use client info to determine sector average Loss in Event of Default (LIED) and Obligor Default Ratings (ODRs). Combine with loan exposure and apply a stress factor for impact of carbon regulations • Determine potential loss in each sector and then as a percent of portfolio U of T Environmental Finance

20. Impact of GHG Regulations on PortfolioResults • Portfolio impacts of proposed GHG regulations would have been very low, affecting clients representing less than 7% of CIBC’s net loans and acceptances. • Almost 90% of the clients that would be regulated were investment-grade • Climate change-related loan losses, under our worst-case scenario, were estimated to be <0.009% of total portfolio • Analysis must be updated when details of new regulations are released U of T Environmental Finance

21. Opportunities Opportunity Drivers • Emissions Trading • Abatement measures • Project Development • Adaptation U of T Environmental Finance

22. I. Emissions Trading Opportunities • Governments of Annex 1 Countries that have to meet Kyoto targets • For example, Italy, Denmark and Netherlands active in CDM through investment in World Bank carbon funds • Capped Corporations • Will have to meet targets under Kyoto or under National emission schemes like the EU ETS • Buying allowances from other firms and CERs or offsets from projects • Non-regulated companies • Investing in large GHG emission reduction projects and taking credits as output • Purchasing "green" credits (buy low, sell high; or retire the credits for good PR) • Creating offset credits by making permanent emission reductions; sell the credits • Carbon Funds • Pools of capital that invest in credit-producing projects • Financial Intermediaries: brokers, banks, hedge funds • JP Morgan Chase in 2005; Morgan Stanley in October 2006 • Individual traders and investors • Directly or indirectly through investment derivative products created specifically to take advantage of the growth of the CO2 market U of T Environmental Finance

23. II. Abatement Opportunities (1 of 3) U of T Environmental Finance

24. Abatement Opportunities (2 of 3) U of T Environmental Finance

25. Abatement Opportunities (3 of 3) U of T Environmental Finance

26. III. Project Development Opportunities U of T Environmental Finance

27. IV. Adaptation-Related Opportunities U of T Environmental Finance

28. Summary • Emitting CO2 and other GHGs will soon bear a price • already does in the EU and some regions of the world • Global and regional markets are being established to trade CO2 emissions • Business response to new legislation and new carbon markets is creating new risks, but also opportunities for many industry sectors, including financial services • Adaptation measures (mostly by government) are also sources of risk and opportunity • To understand risks and realize opportunities and respond, need to: • Understand international emission markets (Kyoto, Kyoto Part II?), regulations and GHG markets in regions where a company does business, and how regional and international markets fit together • Follow (or forecast) how governments, firms, and individuals are responding to new markets and rules • Once regulatory framework is established in Canada, may be possible to quantify opportunities (and risks) U of T Environmental Finance