The first quantitative assessments of Latin American financial institutions’ potential exposure to transition risks
Latin America is one of the most vulnerable regions to climate change, with exposure to both physical risks (floods, droughts, etc.) and transition risks associated with the shift to a low-carbon economy. However, efforts to understand and respond to transition risks, in particular, are still in their early stages.
To help address this issue, over the past two years, 2° Investing Initiative has been expanding its work in emerging markets with an initial focus on Latin America. We have partnered with four industry associations and two supervisors in the region, including the Colombian Insurers Association (FASECOLDA), Colombian Financial Superintendence (SFC), and Mexican Pension Funds Association (AMAFORE).
Among the first outputs of this program, 2DII is proud to announce the publication of two new reports on the use of climate scenario analysis by financial institutions in Latin America. Together, the reports provide critical evidence to policy makers, supervisory authorities, investors, and banks on the need to quantify, manage, and disclose climate-related risks.
The first report focuses on the five largest financial markets in the region (Argentina, Brazil, Chile, Colombia, & Mexico). Using the PACTA climate scenario analysis methodology and proxy metrics, the report highlights the extent to which both banks and investors could be potentially exposed to transition risks.
- Banks financing local auto and fossil fuel producers are potentially exposed to transition risks, as most companies in their lending portfolios are still over-producing high carbon-intensive products and under-producing low carbon alternatives
- Latin American capital markets are significantly exposed to transition-relevant sectors, with 3.6x higher share of investments in high-carbon technologies vs. low-carbon technologies
- Banks and investors must assess their exposure to these risks and devise strategies for mitigating them, such as engaging with investee companies
Written in partnership with FASECOLDA, the second report uses the PACTA methodology to analyze the Colombian insurance sector’s listed equity and corporate bond portfolios (total AuM: US$14.9 billion). In 2021, 2DII will continue its partnership with FASECOLDA, to monitor progress and to apply a stress-testing tool that will help model the losses associated with transition risks.
- Colombian insurers are significantly exposed to transition-relevant sectors, which cover up to 46% of the AuM of the listed equity and corporate bond portfolios
- Overall, the scenario analysis results are relatively positive: for example, results for the oil & gas, hydropower, and gas-based power of the corporate bond portfolio are compatible with a 2°C scenario
- However, the insurers’ portfolios still face potential exposure to risks arising from a disruptive transition that will need to be mitigated, due to their investments in oil, coal-based power, and certain auto companies
In the coming months, 2DII will continue to expand its partnerships with regional industry associations, supervisory authorities, and NGOs, aiming to accelerate the uptake of climate scenario analysis and other practices in emerging markets.
Interested in learning more? Please contact Laura Ramirez, Program Manager for Emerging Markets, at lauraramirez at theiafinance.wpengine.com.
Funding information: This project is part of the International Climate Initiative (IKI). The Federal Ministry for the Environment, Nature Conservation and Nuclear Safety (BMU) supports this initiative on the basis of a decision adopted by the German Bundestag. It has also received support from the Inter-American Development Bank.