On September 29, 2015, climate-related risks were officially put on the agenda of financial regulators and supervisors and also financial markets players. In his now famous Tragedy of Horizons speech 1 at Lloyds of London, the Governor of the Bank of England, Mark Carney, outlined the connection between climate change and its related impacts on economic systems, financial markets and their stability. The speech urged the financial industry – regulators, supervisors, financial institutions and service providers – to look beyond the immediate business and political cycles, and their current mandates, and assess the potential impacts that could derive from unmanaged risks related to global climate change. By linking climate risks to financial stability, this intervention marked a step change in how financial regulators, supervisors and central banks perceived the threat of global warming to financial stability. The impact of the speech across financial markets was monumental, and four years later much has changed. In December 2015, the G20 Financial Stability Board (FSB) created the Task Force on Climate-related Financial Disclosures (TCFD) with the objective of supporting the financial system (banks, investors, insurance companies and bond and stock issuing companies) to better understand the impact of climate change on financial markets and in the creation of guidelines for the identification, management and communication of climate-related risks. In June 2017, the TCFD published its recommendations 2 , establishing an important framework for the identification and management of climate Executive Summary risks in the operation of financial and non- financial institutions, including aspects of governance, strategy and business model, risk management processes as well. In December 2017, eight central banks and financial supervisors created the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) 3 . The Bank of Mexico was among the founding members and since then the Central Bank of Costa Rica, Superintendency of Colombia and the Mexican National Banking and Securities Commission have also joined. The network is expanding with 42 members and 8 observers as of July 2019, including the Bank of International Settlements, the International Monetary Fund, and multilateral banks as official observers. In Latin America and the Caribbean (LAC), regional supervisors and regulators have not yet explicitly included nor addressed climate-related risks in binding regulations and/or supervisory measures for the financial sector. This implies significant work ahead for the LAC financial sector to develop effective and complete frameworks to identify, assess, manage and disclose these risks within existing supervisory and regulatory frameworks in the region. At the same time, a lack of clarity prevails on both the taxonomy of such risks and the tools needed to manage them. In this context, the Inter-American Development Bank (IDB) launched a research program on the relationship between climate change and financial markets in the LAC region, beginning a dialogue with several regulators, central banks and supervisors, alongside an analytical effort that is presented here, consisting of two separate but related reports: 1. Regulating climate-related risks: a map of financial regulations and industry practices in Latin America and the Caribbean: The first paper reviews and maps current financial regulations, voluntary frameworks and guidelines for the financial sector in Latin America and the Caribbean that aims to identify, assess, measure, and manage climate-related risks in financial systems, 1 Bank of England, 2015. https://www.bankofengland.co.uk/speech/2015/breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability 2 TCFD, 2017. https://www.fsb-tcfd.org/publications/final-recommendations-report/ 3 https://www.banque-france.fr/en/financial-stability/international-role/network-greening-financial-system 4 Batten S., Sowerbutts R., Tanaka M. “Let’s talk about the weather: the impact of climate change on central banks.” Staff Working Paper No. 603. Bank of England. 2016 5 The Bank of England framework features as well a third pillar – Liability risks that however is here considered a derivative of physical and/or transition risk and for this reason excluded from the main discussion. providing a regional mapping and also four in-depth case studies on Brazil, Colombia, Mexico, and Peru, supported by interviews and discussion with regulators and supervisors in the countries. 2. “Financial system resilience to climate- related risks: International practices in using supervisory and regulatory instruments”: The second paper focuses on several measures that central banks and financial regulators in LAC could take to support financial system resilience to climate-related risks by analyzing international practices implemented in other regions, as well as considering their potential and challenges for adoption and replication in LAC. Research agendas relating to climate- related risk and the resilience of financial systems are incipient in LAC compared to some other regions. Nonetheless, there is an emerging consensus on the taxonomy of such risks (and their specific features when compared with environmental risks) and on the effects and relevance of such risks for financial systems, and on the role of financial regulators in addressing them. Taxonomy and definitions of Climate Risks In terms of taxonomy, these studies borrow the definitions of climate risks proposed by the Bank of England in 2016 4 which are centered on two main pillars 5 . First, climate physical risks that stem from weather- related events, such as floods, storms or higher/lower temperature and precipitation extreme events, causing direct impacts, such as damage to property, and indirect impacts, such as the disruption of global supply chains and/or resource scarcity. Second, climate transition risks caused by structural changes (political, technological or behavioral) in the economic system of countries moving towards low-carbon economic models, causing financial losses and devaluations of certain assets associated with higher carbon-emitting industries and activities. 3 Climate Risk and Financial Systems // 4 // Climate Risk and Financial Systems In addition, Environmental, Social and Governance (ESG) risks stem from environmental, social, and governance issues and liabilities potentially generated by a business or investment activity. They can represent impacts, losses and damages that assets and activities impose on the environmental system at the time of their execution and operation contrary to the losses and impacts caused by climate and/ or environmental (in a forward-looking perspective) systems on the assets and activities during their economic useful life. Despite these differences, the management of climate-related risks in LAC financial markets could build on the interaction with international initiatives such as the TCFD and NGFS, as well as existing practices for the management of ESG risks, including criteria and standards (the Equator Principles, Principles for Responsible Investment and other), industry-wide agreements and protocols (such as the Green Protocol in Colombia and the Sustainable Roundtable in Paraguay), and binding regulation (as in the case of Brazil). Therefore, this analysis looks at the emerging tools for the management of climate risks in international markets, then to the existing ESG-focused frameworks in LAC that could provide a solid basis to develop models for the inclusion of climate risks, and finally to emerging supervisory and regulatory practices in other regions that could be replicated, at least partially, in LAC. International frameworks on climate risks in financial systems As climate-related risk is a new concept for the financial industry and its regulators, an emerging consensus in the industry and amongst regulators on its assessment and management is only just beginning to take shape. At first, the debate focused on whether financial regulators and supervisors should intervene and address these risks, whether climate-related risks do indeed pose a systematic threat to the financial system, or whether such risks would not be better managed by fiscal and economic policymakers. Indeed, the mandates of the institutions providing guidance and supervision to financial systems (Financial Stability Board, International Monetary Fund, the Bank for International Settlements and the International Organization of Securities Commissions) do not currently include nor foresee any role in terms of management of climate-related or environmental risks. They do however include tasks such as promotion of confidence in the market, promotion of economic growth, preservation of financial stability, and management of systemic risk. Based on this situation, assessing whether climate risks pose a systemic threat to global financial markets’ stability meant assessing whether it was to be a key item in the agenda of financial regulators and supervisors. in such context, a first comprehensive solution comes from the TCFD recommendations released in July 2017. They proposed a voluntary, consistent management and disclosure framework, structured in four thematic areas: (i) Governance, structure and disclosure of an organization’s governance on climate-related risks and opportunities, (ii) Strategy, disclosure of potential impacts and opportunities related to climate risks from the organization’s businesses, strategy and financial planning perspectives, (iii) Risk Management, disclosure of the processes through which the organization identifies, assesses, and manages climate- related risks, and (iv) Metrics and Targets, disclosure of the metrics and targets used to assess and manage climate-related risks and opportunities. In terms of risk management framework (identification, quantification, modeling, strategy, and disclosure), the TCFD recommendations are largely consistent with most ESG standards, especially regarding identification and assessment of risks. Notably, the most significant difference is on the focus of the TCFD recommendations on modeling tools for the whole portfolio (for example stress testing) and for the forward- looking perspective in the identification of risks and in their management, with the recommended uses of scenario analysis and sensitivity tests (transition risks are an example). The TCFD recommendations do not imply a change in the mission of the companies that adopt the frameworks, nor do they suggest divestment of specific projects or exclusion of certain activities. Conversely, despite other voluntary frameworks such as the Equator Principles and the PRI, the proposed frameworks under TCFD do not include a verification and compliance system 5 Climate Risk and Financial Systems // For central banks and supervisors to fulfill their mandate in preserving financial stability: For policymakers to encourage broader transparency in financial markets: Integrating climate-related risks into financial monitoring and micro-supervision Integrating sustainability factors into own-portfolio management Bridging data gaps Building awareness and intellectual capacity and encouraging technical assistance and knowledge sharing Achieving robust and internationally consistent climate and environment-related disclosure, supporting the framework developed by the TCFD Supporting the development of a taxonomy of economic activities The Latin American and Caribbean Map for financial regulation Under the definition of climate-related risks of the BoE and TCFD, financial regulators in LAC countries have not yet explicitly included nor addressed climate-related risks in binding regulations and/or supervisory measures of the financial sector. However, several countries show regulatory and self- regulatory actions for environmental and social risk that can be considered a first step towards a more explicit regulation on climate-related risks. For regulatory and supervisory efforts, countries in the region can be categorized under three major groups, i) countries with regulation (for ESG risks) in place, ii) countries where supervisory measures have been implemented or initiated, and iii) countries where private sector initiatives (or self-regulatory) practices are being implemented or have led the efforts of the financial system. These categories are not mutually exclusive from one another, in fact in most cases private-public voluntary agreements have preceded regulation or supervisory actions. i. Three countries with regulation is in place: Brazil, with Resolution 4327 from the Central Bank enacted in 2014 Peru, with Resolution 1928-2015 from the Superintendent, enacted in 2015 Paraguay, with Resolution 8 from the Central Bank enacted in 2018 ii. There are seven countries where supervisory measures are being implemented: Brazil, Peru and Paraguay with actions emerging from their regulations. Chile and Mexico are performing a survey of the financial sector on ESG and climate-risk practices. In Colombia, a supervisory statement was of the climate related reporting, albeit they explicitly require disclosed information to be as verifiable as possible. While the TCFD was conceived as a private sector initiative for the market, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) was set up by supervisors with the aim of providing an international forum of discussion and knowledge exchange for regulators and supervisors on the issues of green finance and systemic risks from climate change. The network published its first progress report in October 2018 highlighting that physical and transition risks from climate change can have serious consequences for financial institutions and are a threat to the stability of the global financial system. The NGFS considers climate risks are material, system-wide and possibly destabilizing for the financial system and regards climate risks as falling within the supervisory and financial stability mandates of central banks and financial supervisors. It concludes that even if climate risks may be realized in the long term, their mitigation requires action in the short-term. In 2019, the NGFS published a series of recommendations aimed at both regulators and supervisors, and policymakers: 6 // Climate Risk and Financial Systems produced following the implementation of a survey; and Panama which has included environment and social risk within the list of 13 risk that banks need to prevision against. Finally, the Central Bank of Costa Rica, the Financial Superintendency of Colombia, the Mexican National Banking and Securities Commission and the Central Bank of Mexico are now members of the NGFS. iii. Ten countries with private-sector led initiatives: Argentina with the Sustainability Protocol for Public Banks from 2018, Brazil with the Protocolo verde (banks) dates back to 2009, Colombia with the Protocolo Verde from 2012 and the Protocolo Verde Ampliado from 2016 (bank and later finance sector), Costa Rica with the commitment to elaborate a Roadmap for Sustainable Insurance in 2018, Ecuador with the Sustainability Protocol from 2016 (banks), El Salvador with their Sustainability Protocol for Public Banks dated from 2018, Mexico with their Sustainability Protocol dated from 2016 (banks); Panama with the Sustainability Protocol from 2018 (banks), Paraguay with the Mesa de Finanzas Sostenibles from 2012 (Banks), Peru with the Programa de Inversión Responsible (PIR) and the Green Protocol. Regulation Supervisory Measures Private Sector Iniciatives Brazil Brazil is strongly involved in international initiatives on climate change and the financial industry, supporting research on solutions to scale up green finance, and to reduce financial vulnerability to climate risks. Brazilian financial regulation has long incorporated socio- environmental principles and is one of the more advanced in LAC in tackling these risks. Starting with the establishment of measures regarding the protection of the Amazon in 2008, several regulations have been established with the goal to address ESG issues in the financial system and to integrate them in the core risk management functions of financial institutions. In 2014, Resolution 4327 was released, requiring implementation of Social and Environmental Responsibility Policies (SERP) in regulated financial institutions and other organizations, such as cooperatives and federations of cooperatives, whose operations 7 Climate Risk and Financial Systems // 6 UNEP. “The Brazilian Financial System and the Green Economy” Center for Sustainability Studies at Getulio Vargas Foundation. 2014. 7 FEBRABAN represents 122 banks which accounts for 93% of shareholder’s equity and 97% of the total assets of the national banking system in Brazil retrieved from https://www.febraban.org.br . 8 Banco do Brasil, BNDES, Bradesco, Bradesco Seguros, Caixa, Mapfre Seguros, Itau and Santander. 9 Asociacion Bancaria de Colombia, retrieved from Official document: http://www.asobancaria.com/protocolo-verde/ are authorized by the BCB??. The regulation provides specific criteria for the risk assessment of high-risk activities and requires institutions to keep records of losses generated by socio-environmental damage, which is to be monitored and recorded for a minimum period of five years. In 1995, several state-owned banks signed The Green Protocol, 6 the first effort of integration of sustainability concerns in the banking industry. The Brazilian Federation of Banks (FEBRABAN 7 ) supports the UN Environment Finance Initiative and more than 50 institutions such as asset owners, investment managers, and service providers are signatories of the UN backed Principles of Responsible Investments (PRI). Another key initiative is the Brazilian Business Council for Sustainable Development (Conselho Empresarial Brasileiro para Desenvolvimento Sustentável, CEBDS). Officially launched in 2005, the group includes the largest financial institutions 8 (e.g. Santander and Itaú Unibanco), and with FEBRABAN has initiated a roadmap for the adoption of TCFD recommendations by the banks in Brazil. The roadmap identifies 10 landmarks to be accomplished in the next 5 years. Chile While there is not yet specific financial regulation in Chile on environmental and climate related risks, in 2019 the ministry of Finance has promoted a coordinated effort among the regulators and supervisors of the Chilean financial system including banking, asset management, pension and insurance to improve the understanding of climate-related risks and opportunities and support a platform of dialogue with the private sector. With the support of the IDB, the British Embassy and UNEP FI, the Ministry of Finance, the Central Bank, the Commission for the Financial Market (CMF) and the Superintendent of Pensions, launched in July 2019 a Public-Private Dialogue on Green Finance with the aim of agreeing by the end of 2019 a formal Green Agreement between Regulators and the Private Sector, a Joint-Declaration from the Regulators on the importance of climate issues for the financial system and a Road Map for Climate Finance 2020-2024 that will aim to support the integration of climate factors in the decision making process of financial institutions of the country. Colombia The Colombian financial regulatory framework does not yet include rules that explicitly address climate- related risks for financial institutions. However, with Decree 2555 of 2010, the government introduced regulation on environmental and social practices, risks and disclosure for financial companies in banking, insurance and capital markets sectors. The same title determines the frequency and the content of the reporting on ESG issues, to be released with annual frequency and using their communication instruments with the highest coverage and public access. The most relevant initiative for the domestic market is the Green Protocol. 9 It is a joint initiative of the Colombian government and the Colombian banking sector, focused Page of 116