Home Finance The Greening of Latin American and Caribbean Financial Markets: A Test Bed for Sustainable Finance

The Greening of Latin American and Caribbean Financial Markets: A Test Bed for Sustainable Finance

by internationalbanker

By Martin Chrisney, One Americas ESG, Deputy Lead, KPMG LLP, and Maria Eugenia Buosi, Partner, KPMG Brazil

 

 

 

 

In the past, the Latin America and the Caribbean (LAC) region was a stubborn source of global financial disruptions, such as the debt and currency crises of the 1980s and 1990s. At the same time, it has been a continuing source of financial innovation. The region was an early adopter of microfinance in the late 1980s, led the reentry of emerging economies into global debt and equity markets in the 2000s, and today has a thriving fintech (financial technology) community. These initiatives attest to the region’s outsized influence on financial markets. Today, LAC governments are implementing forward-looking policies that promote sustainable finance, while businesses are incorporating measures to manage risks and create sustainable operating models, suggesting the region is set to play a crucial role in greening global financial markets.

Initial conditions for sustainable finance

The region has unique factors that favor sustainable finance. Foremost are its energy infrastructure, natural endowments, demographics and increasingly globalized business communities. Opportunities arise from a wealth of hydropower and the widespread adoption of wind- and solar-energy generation. Already, 60 percent of its electricity comes from renewable sources. Abundant renewable-energy sources and the presence of rare-earth minerals put the region at the crossroads for developing the green hydrogen and battery technologies that are key to the expanded use of renewables called for in the recently concluded COP 28 (2023 United Nations Climate Change Conference). South America is also home to 40 percent of the planet’s biodiversity and more than a quarter of its forests—a large carbon sink that offsets global emissions. These assets are combined with a large, educated middle class, a population that is 82 percent urbanized and diverse ethnic cultures. Together, these features present significant opportunities to scale up sustainable finance and create positive environmental and social outcomes.

The region is also intimately linked to global markets through trade and foreign investments. These ties should accelerate the transition to sustainable finance. In commerce, roughly one-half of exports are destined for the United States (US) and European Union (EU) markets—the majority to the US. On the investment side, the EU is the largest source of foreign direct investment (FDI) and, combined with the US, accounts for more than 60 percent of annual inflows. Regional businesses are also linked to global markets through deep supply chains, while multilatinas (companies of Latin American origin)—such as CEMEX (Mexico) and LATAM Airlines (Chile)—are exposed to ESG (environmental, social and governance) regulations in other countries’ markets. Even smaller national firms are implanted in supply chains that require compliance and reporting standards to which buyers must adhere.

Because of the strong commercial ties, the financial sector is buffeted by regulations from the EU and the United States.

Similarly, the region’s banks, asset owners and managers are adopting ESG practices. Assets in sensitive sectors—such as mining, oil and gas, agriculture, forestry and fisheries—elevate portfolio exposures to transition and physical risks. The presence of major global banks brings ESG policies and practices from home-country headquarters, often a few steps ahead of local reporting and risk-management practices. The KPMG global survey “Big shifts, small steps: Sustainability reporting in Latin America 2022” shows that only 69 percent of Latin American firms (and 67% of financial service firms) had sustainability reports, compared to 96 percent of the top 250 firms globally. As a result, ESG is incorporated into the financial sector—both in qualitative and quantitative aspects—through stress-testing models, credit scores and financing decisions. Considering the region’s unique environmental and social issues, such initiatives should increase capital allocation towards more sustainable projects.

Four drivers of green finance in Latin America and the Caribbean

International regulatory pressures

Owing to strong commercial ties, the financial sector is buffeted by regulations emerging from the EU and the US. New EU regulations flow down to local markets, bringing taxes on the carbon content of some exports, social-reporting requirements on human rights and labor conditions, and deforestation disclosures that impact the region’s major commodity exports. (Between 2019 and 2021, some 53 percent of exports to the EU were commodity-based, led by coffee, soy and bananas.) (See Table 1.) In addition, forthcoming U.S. Securities and Exchange Commission (SEC) climate disclosure rules will impact publicly listed companies. Accordingly, the financial community is keenly aware of the changing regulatory environment and the need to incorporate ESG risks. (Disclosure standards, although not defined specifically for the Latin American region, have been following international guidelines and regulations, such as GRI [Global Reporting Initiative], SASB [Sustainability Accounting Standards Board] and, recently, the ISSB [International Sustainability Standards Board] standards, which have already started to be regulated in the region.)

Borrowers and investee companies also need to adapt and gather new data on their carbon footprints and sources of commodities, update governance rules, deploy monitoring tools and conduct ethical supply-chain reviews.

Table 1: ESG Regulatory Requirements Impacting Latin America and the Caribbean

Title Effective Date Short Description
EU: Sustainable Finance Disclosure Regulation (SFDR)

 

2021

 

Sets out how financial-market participants must disclose sustainability information.
EU: Regulation on Deforestation-Free Supply Chains 2024

 

Ensures that a set of  key  goods exported or placed on the EU market must be deforestation-free
EU: Corporate Sustainability Reporting Directive (CSRD)

 

2024

 

Requires large companies and listed companies to publish regular reports on the social and environmental risks they face and on how their activities impact people and the environment.
EU: Carbon Border Adjustment Mechanism (CBAM)

 

2024 Establishes prices for embedded carbon emissions generated by producing certain goods imported into the EU.
US: Securities and Exchange Commission (SEC) Climate-Related Disclosures Pending Requires SEC registrants to disclose climate-related risks (GHG [greenhouse gas] emissions, governance and management).

Proactive public sector

Many governments in Latin America and the Caribbean have stepped up their actions after signing of the Paris Agreement in 2015, the widespread adoption of net-zero pledges and the preparation of nationally determined contributions (NDCs). Seventeen central banks and supervisory agencies have joined the Network for Greening the Financial System (NGFS) as part of their sustainability agendas to improve risk management and mobilize capital. Public banks have added environmental- and social-risk standards to their portfolios and credit programs.

Legal frameworks have established ESG requirements for pension funds and other financial institutions. Since 2019, Chile has had ESG-focused pension-investment rules, and Mexico has had similar rules since 2021. The securities commissions of several countries have adopted reporting requirements for ESG-labeled funds or securities (Argentina, Brazil, Chile, Mexico, Peru) . These policies are part of a new paradigm that is creating the preconditions for green finance.

Taxes, carbon credits and sustainable bonds

However, systemic changes will require using incentives and creating new instruments that mobilize funds for sustainable projects. An early example is the emergence of carbon taxes in three countries at the national and/or subnational level (Mexico, Colombia and Chile) and the wide use of voluntary carbon credits—the region provides approximately 20 percent of the global supply. The credits market faces inherent challenges, but the region offers opportunities for nature-based offsets, and deforestation credits are featured in 7 of the 11 countries with voluntary credits markets.

In the debt market, sustainable bonds—in all their varieties of green, blue, social and sustainability-linked—have been issued equally by public and private issuers. Eighteen Latin American and Caribbean countries have already issued 239 themed bonds totaling US$44 billion. Among the main projects financed by themed bonds are renewable energy, clean transportation, environmental management and social impacts, which are featured more commonly than bonds issued in developed countries. (In 2019, Chile was the first country in the region to issue a green bond and has followed with other sustainable-bond issues. Ecuador issued the world’s first social bond for US$400 million in 2020, which funded low-income housing.) Innovations in the market include the emergence of debt-for-nature swaps in Belize in 2021 and Barbados in 2022; Ecuador’s recently issued US$656-million bond for the Galápagos Islands supported an IDB (Inter-American Development Bank) guarantee and political-risk insurance from the U.S. International Development Finance Corporation (DFC). In 2022, Uruguay issued the world’s first sustainability-linked bonds with performance indicators linked to GHG emissions and forestation, with a coupon step-down for overperformance and a step-up for not meeting agreed targets.

Taxonomies

Other catalysts for sustainable finance are regulations on climate disclosures and local adoption of green-finance taxonomies. The region is embracing climate disclosures under the Sustainability Accounting Standards Board (SASB) and Task Force on Climate-related Financial Disclosures (TCFD) (Brazil, Chile, Colombia). In 2022, Colombia became the first LAC country to publish a green taxonomy, followed by Mexico in 2023, and others are discussing introducing such frameworks. These taxonomies provide roadmaps to direct capital for eligible green investments and, with corporate and securities disclosure requirements, signal a strong commitment to sustainable finance and ESG adoption.

Conclusion

Moving forward, regulators should establish robust, transparent frameworks that will further enhance sustainable finance. Rules need to avoid the creation of multiple standards across regional markets and eliminate unnecessary regulatory hurdles. Businesses’ successes will hinge on their abilities to transition from mere reporting and disclosures to integrating sustainability into their business models. Firms should actively identify and capitalize on new market opportunities for environmental and social impacts and tap into the reservoirs of finance driven by sustainability targets. If history is a guide, local financial markets, bolstered by international capital, will continue to innovate and accelerate the transition towards greener finance.

Sustainable finance is clearly “easier said than done”. Yet recent developments suggest that countries in Latin America and the Caribbean are setting new standards for sustainable finance and creating the conditions to scale it up. The greening of financial markets will bring us a step closer to addressing the pressing sustainability and climate issues faced in the region and the world at large.

 

 

ABOUT THE AUTHORS
Martin Chrisney is Deputy Lead of the One Americas ESG Hub of KPMG LLP, supporting the corporate sector, banks, governments and the international community in Latin America and the Caribbean. He leverages his global expertise in strategy, operations and delivery to build multidisciplinary teams in finance and implement programmes with positive social and environmental impacts.

Maria Eugenia Buosi is an Economist with 19 years of experience in capital markets, sustainable finance and ESG integration. She joined KPMG Brazil as a Partner in 2022 and is responsible for the sustainable-finance agenda. She participated in the establishment of the Brazilian Network of the United Nations’ Principles for Responsible Investment (PRI) and worked as a Portfolio Manager for ESG funds at ABN AMRO Bank and Santander.

 

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