THE WORLD BANK GROUP CHILE FINANCIAL SECTOR ASSESSMENT PROGRAM April 2022 TECHNICAL NOTE CLIMATE RISKS AND FINANCE Prepared By This Technical Note was prepared in the context Finance, Competitiveness, of a joint IMF-World Bank Financial Sector and Innovation Global Assessment Program (FSAP) mission in Chile Practice, WBG during April 2021 led by led by Charles Cohen, IMF and Miquel Dijkman, World Bank, and overseen by the Monetary and Capital Markets Department. IMF, and the Finance, Competitiveness, and Innovation Global Practice, World Bank Group. The note contains the technical analysis and detailed information underpinning the FSAP assessment’s findings and recommendations. Further information on the FSAP program can be found at www.worldbank.org/fsap. CHILE GLOSSARY AML Anti-Money Laundering ERA Environmental Risk Assessment ESG Environmental, Social, and Governance ESRM Environmental and Social Risk Management FI Financial Institution FSAP Financial Stability Assessment Program FSB TCFD Financial Stability Board - Task Force on Climate-related Financial Disclosures FBCC Framework Bill on Climate Change GDP Gross Domestic Product GEMC Growth and Emerging Markets Committee GFDRR Global Facility for Disaster Reduction and Recovery GHG Green House Gasses GOC Government of Chile IAIS International Association of Insurance Supervisors IFC International Finance Corporation IOSCO International Organization of Securities Commissions IPCC Intergovernmental Panel on Climate Change KYC Know-Your-Customer MDB Multilateral Development Banks MFI Microfinance Institution NDC Nationally determined contributions NGFS Central Banks and Regulators Network for Greening the Financial System NPL Non-performing loan PLC Publicly listed companies SEC Securities and Exchange Commission SBN Sustainable Banking Network SIF Sustainable Insurance Forum SFF Sustainable Finance Framework 2 CHILE CONTENTS Glossary ....................................................................................................................................................................................... 2 Executive Summary ................................................................................................................................................................. 4 Key recommendations ........................................................................................................................................................... 9 1 Introduction ...................................................................................................................................................................10 2 Context ............................................................................................................................................................................11 2.1 Definitions ...........................................................................................................................................................11 2.2 Vulnerabilities to climate change ...............................................................................................................12 2.3 Response by Government .............................................................................................................................16 3 Climate risks and the financial sector ..................................................................................................................18 3.1 Financial sector ..................................................................................................................................................18 3.2 Physical and transition risk............................................................................................................................19 3.3 Response sector ................................................................................................................................................22 3.4 Response supervisor........................................................................................................................................23 4 Climate Finance and the financial sector ...........................................................................................................31 4.1 The global and domestic green finance context ..................................................................................31 4.2 Mobilizing green finance ...............................................................................................................................33 4.2.1 Greening private capital............................................................................................................................42 4.3 Strengthening the climate information architecture ..........................................................................48 ANNEX I Overview of Chilean laws, programs and action plans related to climate change ....................57 ANNEX II ENERGY BALANCES ...........................................................................................................................................59 ANNEX III Map of Chile .......................................................................................................................................................61 ANNEX IV Physical risks in the banking sector ..........................................................................................................62 ANNEX V Transition risk in the banking sector ..........................................................................................................64 ANNEX VI Physical risks in insurance sector ...............................................................................................................65 ANNEX VII transition risk in insurance...........................................................................................................................66 3 CHILE EXECUTIVE SUMMARY1 This technical note explores the consequences of climate risks for the Chilean financial sector, and the role the financial sector can play in mobilizing resources to support the transition to a climate resilient and low carbon economy. Chile is sensitive to climate risks including drought, flooding, wildfire, heat waves, and coastal swells which are expected to also affect the financial sector. The GoC committed through its National Determined Contribution (NDC) to reduce its carbon emissions per GDP unit by 30-45 percent below their 2007 levels by 2030 and to reach carbon neutrality and be resilient to climate change by 2050. A Framework Law on Climate Change was approved by Congress and is currently under review by the Constitutional Court. Once enacted, the Law will make the NDC legally binding2. The Law also contains a section detailing the country’s climate finance strategy. It is expected that economic sectors that will be impacted by physical risk include agriculture, fishing, forestry, mining, tourism; transition risk will particularly affect energy intensive sectors. The financial sector will be affected as they have different geographical and sectorial exposures. Climate risk Chile’s financial sector authorities are strongly committed to identifying, assessing and mitigating climate risks and its impact on financial sector. The MOF, BCCh, CMF and SP have publicly committed to mainstreaming climate change through a Public Statement3 and their participation at the Green Agreement within the context of the Green Round Table. The BCCh4 has appointed a Board Member for climate-related topics, established an internal coordination body, developed a roadmap, and is planning to address the impact of climate change on the financial stability in the Financial Stability Report. The CMF5 has established board commitment, formulated a strategy, and set-up a climate change working group. It plans to integrate climate risk in its supervisory approach for banks, insurance companies, and investment funds. It has recently issued updated regulation on climate disclosure and created a specially-dedicated area for its supervision. The SP6 has begun requiring pension funds to consider Environmental, Social and Governance (ESG) factors to be included in a pension fund’s investment and risk management processes and is planning to review the first integrated annual report of pension funds in 2022. The financial sector authorities are studying the potential impacts of climate risk on the financial sector as they are very relevant. CMF is assessing the impact of six acute physical 1 This Technical Note has been prepared by Marc Schrijver and Cindy Paladines. 2 The Bill will provide a framework for climate adaptation and mitigation plans that are yet to be developed. This in includes the Long-term Climate Strategy (currently in public consultation), regional climate change action plans, sectoral adaptation plans and sectorial mitigation plans). 3 Joint Declaration on Climate Change 4 BCC Climate pledge (2021) 5 CMF Climate Strategy (2020) 6 SP Announcement of issuance of ESG regulation (2020) 4 CHILE events in select regions on the expected capital requirements of banks and is planning to develop a climate stress test to determine the impact of expected physical risk on banks’ loan portfolio. In parallel, the BCCh is studying the impact of IPCC scenarios on economic performance of certain sectors in select regions. Together with the IMF, BCCh is analyzing the impact of an adverse physical risk shock anchored at 2 percent of GDP. On transition risk, the CMF planned to determine the impact of transitional risk and partially physical risks (as firms work toward reaching the Paris agreement goals) on the investment portfolio of life insurers; and to develop a climate stress test to determine the impact of transitions risk on the loan portfolio of banks. BCCh together with IMF determined the impact of a carbon tax of USD 100 per ton carbon emission on the banking sector based on firm level data of scope 1 carbon emissions.7 There is scope for strengthening coordination, to avoid gaps and overlaps and enable the authorities in adopting a systemwide perspective on the impact of climate risk. Although the different studies are critical for understanding the different aspects of climate risk, there are potential gaps and overlaps8. Enhanced coordination among the key players, i.e. the MOF, BCCh, CMF, and SP could help to adopt a more systematic approach by mapping the available studies, models, data, and determining potential gaps, including those gaps identified by climate scientists. This is important to get a better understanding of climate risks not only for the individual sectors (banking, insurance, and investment), but also for the financial system as a whole and its cross linkages. Furthermore, it is important to consider scope 2 and 3 emissions9 as Chile imports 88 percent of its fossil fuel which is 64 percent of its total primary energy supply, as well as second round effects and unintended consequences. The MOF has indicated that it is analyzing the creation of a working group under the supervision of the Financial Stability Council to monitor the risks associated with climate change – as it is a commitment set out in the Green Agreement. Financial institutions could be required, as a next step, to integrate climate risk in corporate governance and risk management practices, as well as integrate it into their own supervisory practices. Although most financial institutions believe that climate change is a source of financial risk, there has been limited progress towards integrating these risks as part of business practices.10 More work is needed by the financial institutions in understanding and managing these risks. The recent issuance of regulatory disclosure guidance, NCG 461, is an important milestone, mandating sustainability-related disclosures by banks, insurance companies, issuers of public offering securities, general fund managers, and stock exchanges. In addition, CMF could (in the near term) require financial institutions to integrate climate risk in 7 FSAP Chile IMF Technical Note on financial stability analysis, stress testing, and interconnectedness (September 2021) 8 There are, for instance no granular data to determine physical risk per commune or determine transition risk as a result of scope 3 emissions, while CMF and BCCh are both studying the potential impact of physical risk and transition risk on the banking sector. As of yet, no work is planned on the investment sector. 9 The GHG Protocol Corporate Standard classifies a company’s GHG emissions into three ‘scopes’. Scope 1 emissions are direct emissions from owned or controlled sources. Scope 2 emissions are indirect emissions from the generation of purchased energy. Scope 3 emissions are all indirect emissions (not included in scope 2) that occur in the value chain of the reporting company, including both upstream and downstream emissions. 10 The outcomes of two surveys fielded by the Ministry of Finance to members of the Green Finance Roundtable largely confirmed this observation. A follow-up survey revealed that some institutions are only considering climate risk as a subject of corporate social responsibility, while others have come a long way in understanding these risks. Survey of the risks and opportunities associated with climate change for Chile’s financial sector (2019) 5 CHILE corporate governance and risk management practices, including developing specific guidance on scenario analysis/stress testing, as this will strongly contribute to understanding, managing, and pricing climate risk. It should integrate climate risk into their own supervisory practices in the near term. Climate finance Chile has adopted an ambitious package of measures to improve the flow of private capital that is allocated towards greener activities in support of Chile’s NDC and SDG commitments. Chile’s investment needs to meet their NDC and SDG commitments are greater than what can be financed through public resources alone and the mobilization of private finance is necessary to fill this gap. Financial policymakers and regulators can support these efforts in a number of ways. Sovereign capital market instruments, green taxes, and other fiscal policies can help reduce emissions and directly mobilize revenues. The financial sector can also play a fundamental role by mobilizing resources needed for investments to support climate mitigation and adaptation, especially in response to price signals. Financial sector regulators and policymakers can strengthen this pricing mechanism by implementing policies that ‘price in’ externalities and provide incentives to support Chile’s low-carbon transition. Chile achieved a historic feat in issuing the world’s first sovereign-level sustainability- linked bond in March 2022. Chile already hosts the region’s second largest green bond market and has recently introduced the world’s first sovereign sustainability-linked bond. The sovereign sustainability-linked framework was developed in February 2022. The framework preceded the March 2, 2022 issuance of the world’s first 20 year, US $2 bn sovereign sustainability-linked issuance. The issuance carried two targets linked to Chile’s Paris Agreement goals – the first, that the country emit no more than 95 metric tons of CO2 or equivalent by 2030; the second, that 60% of the country’s electricity production be derived from renewable sources by 2032. Should the sovereign fail to achieve either commitment, a financial penalty would be applied in the form of a step-up in the bond’s coupon rate. Beyond the landmark sovereign sustainability-linked bond, the country’s green capital markets are already among the largest in the region; the sovereign issuer can and should continue to further build this market. Chile’s green labelled bond market (US$ 9.5 billion) remains second only to Brazil (US$10.3 bn), more than doubling Mexico’s (US$4bn) (see Figure). The strength of Chile’s green bond market is driven by the sovereign issuer’s sizeable green bond program. Chile has issued nearly 1/6 of the global supply of sovereign labelled debt outstanding, providing a domestic benchmark for priority climate sectors.11 Externally, Chile’s sovereign bond portfolio has drawn attention to the seriousness of the government’s efforts to attract private capital towards climate action. However, 70 percent of the green debt issued by the sovereign to date has been allocated towards one large capital project (the construction of the Greater Santiago metro). A better 11 Staff analysis of publicly offered sovereign labelled securities listed on Bloomberg as of September 15, 2021. 6 CHILE investment tagging program and an investment program better aligned with the country’s mitigation and adaptation priorities might build more investor confidence in the sovereign green bond program. Public finance tools, including tax credits and other incentives, may spur further demand in green finance instruments such as bonds and loans as it did in the U.S. and other jurisdictions. Despite significant issuance by the sovereign, there have been less than a dozen non-government green and social bond issuances in the Chilean domestic market. Tax credit bonds, whereby investors receive tax credits from the government in lieu of interest payments, could help offset costs borne by issuers of green securities. Tax-exempt bonds, whereby investors are not obligated to pay income taxes on interest from green bonds they hold, have also been introduced in such contexts as Brazil. 12 Enhancing the eligibility of climate-focused funds for favorable tax treatment as part of savings products could also help attract more interest in this space. 13 Revenues from MoF’s green tax could be used to offset fiscal costs of incentive programs. Since 2017, Chile’s green tax has levied taxes on imported vehicles and on corporate carbon emissions. In some jurisdictions, carbon revenues are mirrored by or earmarked for increased public expenditure for low carbon technologies.14 In addition, the 2020 tax reform introduces the possibility of offsetting part or all of their emissions subject to the tax by investing in mitigation projects to reduce their emissions burden. The reform will pave the path for an offsetting regime to be implemented in 2023. The Framework Law on Climate Change also contemplates such a system, with regulated entities in turn being able to sell any surplus through an ETS or tradable performance standard. The CMF could consider assessing the impact of this market- based system on regulated entities, including by providing guidance on derivative products that could arise after the introduction of such a system. Financial institutions and corporates have begun to offer green products to the market, though work is needed to expand product offerings. Banco Estado’s green product portfolio includes preferential rate loans for electric vehicles, mortgages for eco-friendly homes, and a new green mutual fund offered to retail clients. Banco Santander also offers a similar portfolio of green products. In general, financial institutions and corporates with parent companies in Europe or North America, have reported a greater familiarity with assessing the climate risk landscape and offering products to address that demand in the local market. As more prominent investors, including domestic pension funds integrate climate risks in their risk matrix, market demand towards green products may emerge in turn. Further subsidy to on-lend preferential rates to consumers will support this process. With taxonomies recently developed in the EU and Colombia, Chile’s financial sector authorities could accelerate efforts to deploy an inter-operable green taxonomy to guide investors and product development. The EU adopted a taxonomy in June 2020, with further detail on the classification of adaptation and mitigation activities offered in 2021. The taxonomy and related 12 Evidence from experiences reducing the tax rate on other financial assets (e.g., withholding taxes on government securities) has induced demand for these securities, all else being equal. However, more research would need to be undertaken to determine the optimal use of these fiscal tools to induce demand in the Chilean context. 13 As referenced in the IMF’s recent Global Financial Stability Report: https://blogs.imf.org/2021/10/04/how-investment-funds-can- drive-the-green-transition/ 14 See World Bank analysis on use of carbon revenues: https://openknowledge.worldbank.org/bitstream/handle/10986/32247/UsingCarbonRevenues.pdf?sequence=7&isAllowed=y 7 CHILE Delegated Acts provide a common classification of economic activities that significantly contribute to environmental objectives, using science-based criteria. Colombia’s taxonomy is still in draft form and is largely based on the EU model.15 As an export-oriented country with an open financial sector, the impacts of EU’s sustainable finance legislation are already being felt in the Chilean financial sector, particularly among banks, funds, and insurers that are subsidiaries of European institutions. To improve global interoperability and minimize transaction costs, a taxonomy based on the EU approach, particularly for priority sectors including mining and agriculture, would be useful to support implementation of the Framework Law on Climate Change among financial sector participants. The Public-Private Roundtable on Green Finance developed a roadmap for taxonomy development in Chile. In March 2022, MOF formed a Preparatory Committee, including the Ministry of Environment, CMF, SP and BCCh, whose objective is to propose to the Minister of Finance the central elements that will lay the foundations for the development of the taxonomy. 16 CMF could take additional steps to improve the credibility of ESG data to bolster the assessment of the carbon footprint of investor portfolios, among other goals. The Public-Private Green Finance Roundtable in 2019 has served as a useful platform through which the broad concept of the importance of green finance could be debated and socialized. The CMF’s recently issued NCG 461 updates the environmental, social and governance (ESG) standards for banks, insurance companies, issuers of public offering securities, general fund managers, and stock exchanges, which is also a critical step to improve understanding by investors of the climate related risks across their portfolios.17 18 However, gaps remain to continue to improve ESG data transparency, standardization, availability, and use. Part of this work includes the need to take stock of the products and usage of ESG data providers and external reviewers in the Chilean marketplace. In addition, it will be important for securities regulators such as the CMF to bolster their capacity to understand and interpret non- financial climate and environmental related data, by building staff capacity and establishing closer links with the Ministry of Environment and the scientific community. Enhanced availability of credible climate-related data will also support the creation of low-carbon benchmarks for public markets, which will provide investors with better information on the carbon footprint of their investments and portfolios. In Colombia, the Superintendencia Financiera de Colombia (SFC) worked closely with the Ministry of Finance and Public Credit, as 15 well as the Department of Planning, the Department of Statistics, and the Ministry of the Environment and Sustainable Development, to develop the draft taxonomy for the financial sector. 16 See also recent Ministerial statements on the accelerating timeline for taxonomy development in Chile: https://www.hacienda.cl/subsecretaria/noticias/subsecretaria-de-hacienda-claudia-sanhueza-participo-en-seminario-organizado 17 The regulation is based on the Sustainability Accounting Standards Board indicators, which should allow for seamless updates in line with IFRS Foundation and other international guidance. The updated regulation can be found: https://www.cmfchile.cl/portal/prensa/615/w3-article-49804.html 18 See IOSCO Consultation Report for ESG Ratings and Data Products Providers: https://www.iosco.org/library/pubdocs/pdf/IOSCOPD681.pdf and ESMA guidelines on disclosure requirements for credit rating agencies: https://www.esma.europa.eu/sites/default/files/library/esma33-9- 320_final_report_guidelines_on_disclosure_requirements_applicable_to_credit_rating_agencies.pdf 8 CHILE KEY RECOMMENDATIONS Responsible Recommendations (References to Main Text) Time* Authorities Risks 1 MOF, BCCh, Adopt clear definitions of climate risks ST CMF, SP 2 Jointly design a systematic approach to determine the impact of climate risk on the MOF, BCCh, ST financial sector, including determining definitions, and mapping of data and models CMF, SP 3 Improve data collection and monitoring of climate risk metrics CMF, SP, BCCh NT 4 Require financial institutions to integrate climate risk in corporate governance and risk CMF NT management practices, including stress testing 5 Integrate climate risk into supervisory approach, including on-site and off-site. CMF, SP NT 6 Continue building internal capacity to support understanding, managing and pricing MOF, CMF, SP, ST climate risks. BCCh 7 Enhance (cross border) crisis management framework to prepare for natural disasters MOF, CMF, SP, NT BCCh Finance 8 Expand the sovereign green finance program, as appropriate given prevailing market MoF NT conditions and the sovereign’s debt management strategy. 9 Make progress in refining the public investment tagging system to support public MOF NT planning and investment for climate mitigation and adaptation 10 Explore use of fiscal and other incentives to induce greater supply and demand for CMF, MOF, SP NT green finance instruments by non-government issuers. 11 Strengthen the climate information architecture by prioritizing and accelerating the BCCh, CMF, NT implementation of the Chilean Taxonomy Roadmap to develop a green taxonomy MOF, SP 12 Monitor the implementation of the CMF’s new compulsory sustainability accounting CMF ST, NT standards as part of supervised entities’ annual reporting processes. Monitor the extent to which the SASB-based standards will align with the International Sustainability Standards Board guidance to be developed in 2022. 13 Map the market of ESG data providers and external reviewers, in line with IOSCO CMF ST, NT guidance, to enhance credibility of these products among market participants * Short Term (ST) = within one year; Near term (NT) = 1–3 years; Medium term (MT) = 3–5 years. 9 CHILE 1 INTRODUCTION 1. This technical note explores the consequences of climate risks for the Chilean financial sector, and the role the financial sector can play in mobilizing resources to finance Chile’s transition to a climate resilient and low carbon economy. Globally, there is increasing attention being paid to the impact of climate related and environment risks (CRER) on the financial sector. Regulators and central banks – through the Network for Greening the Financial System (NGFS) among other fora – are warning of the impact of CRER on the stability and soundness of financial sectors. These calls follow attention paid to this topic by the FSB Task Force on Climate-related Financial Disclosures (TCFD) and the G20 Sustainable Finance Working Group. There is also global recognition of the importance of financial sectors in mobilizing resources to meet the investment need coming from transitioning to a climate resilient and low carbon society as public resources and concessional finance are not sufficient. 2. Part one will assess how the financial authorities understand and address climate risks. The note will explore (i) to what extent Chile is vulnerable to climate related and environmental risk; (ii) how the financial sector so far responded to these vulnerabilities; and (iii) assess the response of the financial authorities. The assessment will make use of a simple methodology that is developed by the World Bank in absence of international standard to provide for a benchmark of international good practices. The note will touch upon the banking sector, insurance sector (liability side) and investment sector (including asset side of insurance companies, pension funds and investment funds). The assessors didn’t conduct a quantitative climate risk assessment as the focus of the assessment was to determine the progress of regulation and supervision. Nevertheless, the assessors did a qualitative climate risk assessment by identifying and assessing existing assessments done by the authorities, the World Bank, and the IMF. See chapter 3.2 Physical and transition risks for more details. 3. Part two will assess Chile’s efforts to stimulate climate finance. The note takes stock of public and private efforts to mobilize private capital to finance climate mitigation and adaptation efforts. Key areas explored include: (1) examining the role of the state to directly mobilize revenues from the market through sovereign capital market instruments, green taxes, and other fiscal tools; (2) private sector supply and demand for climate finance, (3) regulatory tools to strengthen the climate information architecture to reduce information asymmetry, support the further ‘pricing-in’ of externalities, and provide incentives to support Chile’s low-carbon transition. 10 CHILE 2 CONTEXT 2.1 Definitions 4. When developing an approach to climate-related and environmental risks, the financial authorities may find it helpful to adopt clear definitions. The NGFS describes climate related risks as financial risks caused by or related to climate change; and environmental risks are described as financial risks posed by the exposure of financial institutions to activities that may potentially cause or be affected by environmental degradation such as air pollution, water pollution and scarcity of fresh water, land contamination and desertification, biodiversity loss and the loss of ecosystem services. Climate related and environmental risks originate from two type of sources: physical risks and transition risks as described below. Although climate risks have both positive and negative effects, the focus in this note will be on the negative effects within the context of financial stability. See figure 1 for an overview of physical and transition risks and their transmission channels. • Physical risks originate from extreme weather events and gradual changes in climate, that can lead to economic costs and financial losses. Physical sources of risk can either be gradual in nature, such as rising temperatures and sea levels, and changes in precipitation; or abrupt, as in the case of extreme weather events. Economic impacts can either be insured, leading to underwriting losses for insurance companies, or uninsured, potentially leading to market, credit and operational losses for a range of financial institutions (including both banks and insurers). It is therefore important to determine: 1) sensitivity of sectors to climate hazards or long-term changes; and 2) geographical location. • Transition risks are related to economic adjustment costs during the transition towards a greener, carbon-neutral economy. These risks could be related to climate mitigation efforts, whereby abrupt policies to reduce CO2-emmisions and therewith limit climate change, could have a significant impact on the economy. On a broader note, policy pressure to tackle environmental pollution and improve livelihoods, can also lead to significant adjustment costs for companies and households. Disruptive technological change, for example in moving to cleaner sources of energy, as well as changing consumer and market behaviors towards ‘greener’ products and services, could also result in structural economic shifts. When happening abruptly, the transition towards a greener and carbon neutral economy can lead to rapid revaluations of underlying financial assets and hence to market and credit losses. It is therefore important to determine: 1) the policy sensitivity of the exposure, and 2) the tenor of the exposure.19 19 NGFS Guide for Supervisors – Integrating climate-related and environmental risks in prudential supervision 2020. 11 CHILE 5. The materialization of climate-related financial risks depends on the actions taken today. If the world is able to introduce effective measures to stop the rise in CO2-emissions in time, it might avoid the worst physical impacts of climate change. If action is taken too late, or not at all, there is a high likelihood that the impacts climate change will worsen significantly, leading to further economic and financial losses. At the same time, expedited mitigation measures will then be required to avoid further catastrophe. This could lead to a scenario of an abrupt and forced energy transition, which would have large structural implications for the economy and financial sector. Figure 1 Physical and transition risks and their transmission channels Source: IMF (2019). Climate Change and Financial Risk. 2.2 Vulnerabilities to climate change20 6. Chile is sensitive to climate-related and environmental risks. These arise from natural disasters and global warning (so-called physical risks), leading to economic costs and financial losses, and from the economic adjustment costs associated with the transition towards a greener, carbon- neutral economy (so-called transition risks), which can negatively impact the value of assets. It is important that the financial authorities develop a good understanding of these climate-related and environmental risks as will be discussed in chapter 3 Climate Risk and the Financial Sector. 20 This chapter draws from the work of different experts including Jose Angel Villalobos and Faruk Miguel Liriano. 12 CHILE 7. Physical risks arise from drought, flooding, and wildfire, among other. Although Chile is ranked 29th out of 181 countries on the ND-GAIN 2020 index21 as it is ranked 22nd in terms of vulnerability and 36th in terms of readiness, Chile is highly exposed and vulnerable to multiple hazards such as flooding, drought and wildfire.22 It is important to mention that earthquakes are a very important natural hazard but are typically not seen as a climate-related and environmental risk and therefore are not part of the scope of this technical note. Flooding. This threat registered the greatest economic losses in the period 1965-2019. Accumulated losses reached US$ 5.2 billion (CHP 4.1 trillion). In terms of frequency, 37 flood events occurred in 24 different years (out of a total of 54 years of records). It also recorded the highest number of people affected. The most severe flood in terms of economic loss was the flood of 2015 when US$ 2 billion (0.6% of GDP) was lost; and in terms of affected people the flood of 1965 when 806,000 people were impacted. In Atacama, Antofagasta and Coquimbo this event costed 52 people their live. Drought. This threat registered second in terms of economic losses and the highest number of people affected. It is directly impacting water resources such as rivers, lakes, reservoirs, snow covers and groundwater levels, and indirectly the ocean’s biodiversity (as lower quantities of nutrients such as nitrates and phosphates reach the sea). According to records, the 2019 drought affected 6 million people and generated economic losses of US$ 2 billion. Total drought losses in the period 1965-2019 accumulated US$ 4.4 billion (CHP 3.5 trillion) in only four events, implying an average of more than US$ 1 billion per occurrence. Since 2010, Chile is experiencing a mega drought for more than a decade. Recent studies find that the root cause can be linked to the Southern Blob of the hot ocean, located east of Australia and New Zealand, which is formed by rapid climate change. Wildfire. This is the third hydrometeorological threat in terms of economic losses, and the second in terms of people affected. The fires of 2017 affected 4.7 million people and the fires of 1999 caused economic losses of US$ 0.8 billion (CHP 0.6 trillion). The economic losses accumulated by Forest Fires amount to US$ 3.1 billion ((CHP 2.4 trillion). The area of forest destroyed by fire in central and southern Chile has increased 70% during the mega-drought, and the forest fire season now lasts for the entire year. Over 600,000 hectares were destroyed 21 ND-GAIN index ranks countries using a score which calculates a country’s vulnerability to climate change and other global challenges as well as their readiness to improve resilience. The more vulnerable a country is the lower their score, while the more ready a country is to improve its resilience the higher it will be. 22 WB Chile Climate Change Profile 2021 13 CHILE in the 2016 – 2017 season, which is more than 10 times the historic average. It also killed 11 people including 5 firefighters and destroyed 1,500 homes in the town of Santa Olga in the central Maule region, displacing thousands of people. 8. It is expected that several economic sectors will be impacted by physical risk, including agriculture, fishery, mining, and tourism. Agriculture, for instance, is impacted by drought and water scarcity (also complex water rights). Agriculture production is threatened by drought and toxic algal blooms (not climate change) that don’t live very long but kills everything; Infrastructure is threatened by waves, storms, landslide. It is noted that agriculture might also move from the north to the south as a result of climate change. Fishery such as anchovetas and sardines that are economically important for Chile are impacted, for instance, by decrease of nutrition as result of drought. Mining (such as copper) mostly located in the extremely dry northern Chile is also very sensitive to drought as most of the water supply needed for operation is exposed to climate risks. Chile produces nearly a quarter of the world’s copper supply. 72% of the copper production is coming from the north and 28% from the central region. In 2017, 76% of the water needed (30% surface water, 12% aquifer; 34% aquifer at risk) is exposed to climate risks, 24% is coming from seawater. This needs to increase because of water shortage; however, desalination might lead to swells along the coasts, which threatens ports. Some mines already had to close because of water shortages. There is also a reservoir of mining waste. Tourism is impacted by snow melting, national parks being threatened by wildfire, and water shortage; beaches threatened by coastal swelling. 9. The Climate risk Atlas (ARCLIM23) database was developed to determine the impact of physical risks on geographic location, though more work is needed as there are several data gaps. ARCLIM was developed by the Ministry of Environment, the Center for Climate and Resilience Research (CR2) and the UC Center for Global Change with the collaboration of 17 regional institutions. ARCLIM provides climate change projections based on scientific data. However, different scientists acknowledged that there are many data gaps and that more work is needed. It determined the impact of climate change for 12 economic sectors such as agriculture. It identified 52 risk chains and displays for each risk chain the climate threat (T), the exposure (E) and the level of sensitivity (S). Score of 4 is considered a high risk, score of -1 is considered an opportunity24. It is important to determine the impact of physical risk for the smallest geographical location (e.g. 16 administrative regions, 54 provinces and 346 communes. The threats are obtained 23 ARCLIM website 24 For example, it ARCLIM determined the impact of climate change on the almond production for the different municipalities. The level of risk is determined by (i) exposure (E), the area of crops by commune; (ii) the threat (T), the variation in almond crop yields as a result of climate change; and (iii) the sensitivity (S), irrigation-rainfed balance index and infrastructure index among other. 14 CHILE from the change experiences by climate variables between the recent past (1980 – 2010) and the medium future (2035 – 2065). The climate in both periods is obtained from climate simulations. In the recent past it has been verified that these simulations reproduce the observed climate. The future climate is not a prediction, but a projection based on a scenario of intense greenhouse gas emission (RCP8.5). 10. Transition risks arise from the transition to a low carbon society which will affect the energy, transport and manufacturing sectors. The total carbon emissions in Chile are 112.3 MtCO2e25 per year (2018) which is 0.2% of global carbon emissions26. The decomposition per sector is as follows: the energy sector emits 87 MtCO2e (77%), industrial processes emits 6.6 MtCO2e (6%), the agriculture sector emits 11.8 MtCO2e (10%) and waste sector emits 7.0 MtCO2e (6%)27. These emissions are offset by forests that absorb carbon. It is important to mention that wildfires negatively affect this absorption, and there is therefore a need for the Ministry of Agriculture to prevent wildfire. It is expected that transition risk will affect carbon intensive sectors such as energy, transport and manufacturing. Table 1 Inventory emissions and absorptions of GHG in gigagram (gg = kt) by sector # Sector 1990 2010 2016 2018 1 Energy 33,631 66,608 89,191 89,954 2 IPPU28 2,224 4,280 5,977 6,611 3 Agriculture 11,835 12,921 11,881 11,789 4 Waste 1,519 4,134 6,107 6,958 5 LULUCF29 -60,153 -76,966 -74,698 -63,992 Total (including forest) -10,943 10,976 35,458 48,321 Total (excluding forest) 49,210 87,942 110,156 112,313 Source: 4th Progress Report by Ministry of Environment (2020) 11. The RETC database is developed to register scope 1 carbon emissions and could consider to also register scope 2 and 3. The Ministry of Environment has an open data source to register carbon emissions (Registro de Emisiones & Transferencias de Contaminantes - RETC database30). Key indicators that can be found are: air emissions per region; carbon emissions generated by 25 The main greenhouse gas (GHG) emitted was CO2 (78%), followed by CH4 (13%), N2O (6%) and fluorinated gases (3%). 26 Global carbon emissions are 51 gigaton CO2e per year, Chile is the 44th emitter of the world with 81.3 megatonCO2e; and the 79th emitter per capita with 4,46 tonCO2e per capita (81.3 divided by 18.2). Source: Worldometer. INDC 2016 NDC update 2020; 3th Bienal update; 4th Bienal Update. 27 Data International Carbon Action Partnership (Augustus 2021) 28 IPPU is Industrial Processes and Product Use 29 LULUCF is Land Use Land Use Change Forestry. The offset by this sector was lowest in 2017 (11,710 kt CO2 eq) as a result of wild fires. 30 RETC website 15 CHILE category of transport, water emissions (groundwater, marine or inland water), emission by non- hazardous industrial waste (air, water, soil, waste). 2.3 Response by Government 12. GOC has been responding strongly to the challenges that climate change puts to society. Since ratifying the United Nations Framework Convention on Climate Change (UNFCCC) in 1994, and joining the Kyoto Protocol in 2002, Chile has been active participants of discussions and international efforts to tackle climate change. Chile was also one of 195 countries that signed the Paris Agreement in 2015 and issued that same year its Intended National Determined Contribution. In 2014 Chile introduced a carbon tax of USD 5 per ton of carbon emission (and implemented in 2017). In 2019, Chile organized the 25th Conference of the Parties (COP25) as part of UNFCCC. This created significant momentum and resulted in a range of initiatives (see annex I). The National Determined Contribution was updated in 2020 and followed by the drafting of the Framework Bill on Climate Change which has been sent to Congress in January 201931, and approved in March 2022, currently being under review by the Constitutional Court to be enacted. 13. Through the National Determined Contribution the GOC internationally committed itself to reducing its carbon footprint. The NDC 2015 was updated in 2020. The goal is to reduce its carbon emissions per GDP unit by 30-45% below their 2007 levels by 203032 and to reach carbon neutrality and be resilient to climate change by 205033. The updated NDC comprises of 5 pillars: (i) mitigation measures; (ii) adaptation measures; (iii) integrative measures (encompassing both adaptation and mitigation); (iv) means of implementation; and (v) social measures. 14. Enactment of the Framework Bill on Climate Change (FBCC) will make the Nationally Determined Contribution legally binding. The FBCC stipulates in article 4 that Chile will reach net zero emissions at least by 2050. The FBCC, further, will provide a framework for climate adaptation and mitigation plans. This includes the Long-term Climate Strategy, already published, regional climate change action plans, sectoral adaptation plans and sectorial mitigation plans. The plans are yet to be developed. 15. The Government has set a target to increase the share of renewable power in the energy mix from currently 23% to 70% by 2035 and 95% by 205034. The total primary energy supply 31 The National Climate Change Bill is approved by the Lower House in September 2021 and by the Senate on March 9, 2022. It is expected that the President will soon enact the Bill. 32 NDC 2015 33 NDC update 2020 34 Ministry of Energy (June 2020) Green Hydrogen Strategy / Estrategia Nacional Hidrogeno Verde. 16 CHILE (TPES) in 2015 in Chile is 36.11 Mtoe of which 36% (12.91 Mtoe) is produced in Chile and 64% (23,29 Mtoe), predominantly fossil fuels, is imported.35 The energy mix in Chile encompasses 42.3% oil, 20.2% biofuels and waste, 19.8% coal, 11,0% natural gas, and 5.7%, hydro. Wind and solar are relatively new sources of energy and are 0.5%, and 0.4% respectively of the total energy mix. Chile imports 88% (23.29 Mtoe) of its available fossil fuels e.g. oil, coal, gas (26.53 Mtoe) and only produces 12% (3.24 Mtoe) domestically. See annex for key statistical data on energy balances.36 According to the IEA (2018) Chile has some unique untapped potential for renewable resources which can help limit carbon emissions and reduce import dependency. For instance, the Atacama Desert in Chile has the world’s best solar resources. Chile also has the world’s longest national mountain ridge and shoreline, running in parallel, which provides a high potential for wind and hydropower, as well as geothermal and, in the future, ocean energy. This makes Chile a world class destination for in investment in renewable energy. 16. The FBCC also provides for a climate finance strategy. The Climate Finance Strategy has been developed under the leadership of the Ministry of Finance in 2019 and updated in March 2022, and intends to align actions to mobilize both public and private resources needed to transition towards a low emission and climate resilient economy. The mobilization of resources by the Chilean Government affects public expenditures (climate tagging), revenues (green tax37) and debt issuance (sovereign green debt). The latter is also important from a risk perspective for both the government (rising borrowing costs) and the financial sector (holder of sovereign debt)38. However, as public resources will not be sufficient to meet the investment need, mobilization of private resources are needed. This requires intervention to promote investors to value environmental return, but also consider incentives to increase financial return of green projects and decrease the financial return of brown projects through tax and subsidies. 35 IEA 2018 Second Review of Chile’s energy policies 36 1 Mtoe = 11.63 million MWh 37 The Carbon tax of USD 5 per ton carbon emission is not part of the Climate Change Bill but came already into force on January 1, 2017 through Law 20.780. 38 WB (June 2021) Fiscal Policies for a low-carbon economy by Willi Semmler and others; WB (2022) Sovereign Climate and nature reporting by Fiona Stewart and others. 17 CHILE 3 CLIMATE RISKS AND THE FINANCIAL SECTOR 3.1 Financial sector 17. Chile has a large and well-developed financial system. The market is well integrated into the global financial system, with the active participation of Chilean firms investing in foreign financial assets, either directly or via institutional investors, as well as foreigners participating in the Chilean market. As of end-2020, financial assets accounted for 300 percent of GDP (See the table for the details of the financial system). Total banking sector assets reached 161 percent of GDP (323 trillion pesos; USD 454 billion), insurance sector assets reach 27 percent of GDP (US$ 77 billion; CHP 60.4 trillion), pension sector assets are 74 percent of GDP (USD 210 billion; CHP 164.9 trillion) and non-bank financial institutions (NBFIs), which include collective investment vehicles and non- bank lenders (NBLs) such as credit unions and savings and loan associations, which are relatively small. The stock market is one of the largest and most liquid in the region. Total stock market trade stood at 201 percent of GDP (US$ 513 billion; CHP 403 trillion) in 2020. Table 2 Composition financial sector 2020 year-end Number (billion USD) (in percent) Banks 18 454.3 54% Domestic 8 192.5 42% Foreign banks 9 187.1 41% Subsidiaries 5 185.3 41% Branches 4 1.8 0% State-owned 1 74.7 16% Insurance companies 69 76.7 9% Life insurance companies 35 8.5 11% Non-life insurance companies 34 68.2 89% Pension fund administrators 8 209.5 25% Other fund administrators 68 105.0 12% Mutual funds 19 72.2 69% Investment Funds 49 32.8 31% Total 163 845.5 100% GDP (nominal) 281.9 Financial Sector as % of GDP 300% 18 CHILE 3.2 Physical and transition risk 18. The banking sector is expected to be sensitive to physical risks. As the financial authorities have yet to finish their research to determine the potential impact of climate change on the financial sector, the assessors made use of an exercises conducted by the World Bank in 2021 to better understand to what extent the banking sector is exposed to physical risks39. The exercise was the development of a hazard heatmap40. It was concluded that potential exposures of banks’ credit portfolio to floods and earthquakes are higher than other physical risks. As shown in Table 22.6 percent of banks’ nonfinancial corporate credit portfolios have exposure to floods. This type of natural disaster usually leads to business interruptions, damages to real state, and damages to other capital goods, which in turn directly affects the creditworthiness of businesses and household loans. Earthquake41 is the second most important event in terms of exposure, affecting 18.5 percent of banking credit. It is also observed that the exposures in 5 regions are very sensitive to multiple natural hazard (40 – 60 percent of the exposure). See annex IV on physical risks in the banking sector for more details. Table 3 Summary of percentage of credit exposure banking sector to natural hazard Wildfires Floods Landslides Earthquake Drought Very low - 0.6% - - 1.5% Chile Low - 0.6% 0.0% - - Medium - 20.6% 0.3% 0.2% 0.2% High 0.4% 0.8% 3.7% 18.3% 2.8% 0.4% 22.6% 3.9% 18.5% 4.5% 19. The insurance sector could be sensitive to physical risks. The insurance sector may be impacted through underwriting losses (increased pay out) which could negatively affect both life and non- life liabilities as a result of climate events. The total written premium of the insurance sector is US$ 11 billion (CHP 8.6 trillion) of which US$ 6.6 billion (CHP 5.2 trillion) is life insurance and USD 4.4 billion (CHP 3.4 trillion) non-life insurance. According to the Insurance association it is expected that 63 percent of written premium of life insurance and 15.5 percent of the written premium of 39 The assessors draw from WB (June 2021) Climate-related and environmental risks for the banking sector in Latin America and the Caribbean. A Preliminary assessment by Pietro Calice and Faruk Miguel, that has been tailored by Faruk Miguel for the purpose of this technical note. 40 The exercise comprised of several steps. Step 1 was to determine how sensitive the different regions are to different hazards e.g. wildfires, floods, landslides, earthquake, cyclone, drought (see ANNEX IV Table 1). Step 2 was to determine how sensitive sectors are to different hazards. WB determined that the following ISIC sectors are sensitive to Physical risks e.g. Wildfire, flood, landslide, earthquake, storm and droughts (see ANNEX IV Table 3). Step 3 was to determine the credit exposure in the different regions and sectors and create a heatmap (see ANNEX IV Table 4 and 5). Although earthquake risk are not within the scope of this technical note as indicated in paragraph 7, they are mentioned as they 41 were part of the regional study conducted by the World Bank. 19 CHILE non-life insurance is sensitive to climate events. Though it has yet to be determined what the level of sensitivity would be and whether this would lead to underwriting losses or rising premiums. It is expected that the claim on life insurance might increase as more people die as a result of climate events such as wildfire, droughts or flooding. It is expected that wildfire won’t have great impact on non-life insurance. Although 14.2 percent point of the written premium for non-life relates to fire insurance for real estate, it is expected that the policyholders will not call on these insurances as the real estate is mostly concentrated in the urban areas that are not close to wildfire (1.3 percent point of the written premium for non-life relates to agriculture and natural perils). The CMF planned to determine impact of physical risks on the insurance sector. 20. The investment sector could also be sensitive to physical risks. The investment sector is expected to be mostly impacted through market losses (equity, bonds, and commodities) in the agriculture, fishery, mining and tourism sector (see description of transmission channels in paragraph 8). This affects insurance companies, pension funds and collective investment schemes, investment funds and mutual investment funds with total assets of US$ 387 billion (CHP 304 trillion) that might invest in these sectors. The assessors have no data on the asset composition of the different sectors. It is recommended to assess the extent to which the investment portfolio is sensitive to physical risk. Though it has been observed that during the assessment there were no such activities planned by the CMF, SP or BCCh. 21. The banking, insurance and investment sectors are expected to be sensitive to transition risks through holdings in polluting and CO2-intensive industries. As policies targeting the reduction of GHG emissions of firms are expected to impair fossil fuel related exposures. The World Bank (2021) conducted an exercise that contributes to determine how sensitivity the loan portfolio of the banking sector is for transition risk.42 It appeared that 12 percent of the loan portfolio is sensitive to decarbonization trends (see figure 2 Transition risk of banks’ credit portfolio (2020))43. It is important to note that it has yet to be determined what the level of sensitivity44 would be and what the impact of scope 2 and 3 emissions is. There was no sector breakdown of the investment sector available that could give a sense to what extent insurance companies, pension funds, and investment funds are sensitive to transition risks. 42 The assessors draw from WB (June 2021) Climate-related and environmental risks for the banking sector in Latin America and the Caribbean. A Preliminary assessment by Pietro Calice and Faruk Miguel, that has been tailored by Faruk Miguel for the purpose of this technical note. 43 The exercise determined in 3 steps what part of the credit portfolio is sensitive to transition risk: Step 1: Determining the sector concentration of the credit portfolio (see ANNEX V table 1). Step 2: Determining transition sensitive industries (see ANNEX V table 2). Step 3: determine the credit exposure sensitive to transition risk (Figure 2 Transition risk of banks’ credit portfolio). 44 The original exercise in the WB (June 2021) paper assessed to what extent the interest coverage ratio is different for non- transition sensitive sectors and transition sensitive sectors. It went beyond the scope of this technical note to replicate this assessment for Chilean firms. 20 CHILE 22. The IMF provided some evidence that transition risks could be material for some banks, but not sizeable enough to compromise bank’s solvency or financial stability. This conclusion was based on a stress test45 that was developed together with the BCCh and that computed the impact of USD 100 per ton carbon tax on the solvency of 6 Chilean banks. It is important to note that the stress test was constraint by the available data and used assumptions. For instance, it only considered scope 1 emissions (see also paragraph 23). Nevertheless, it is expected that climate policy actions, such as the increase of carbon process, hit firms with high carbon footprints and impair credit quality of the banks that extend loans to these entities. The analysis attempts to quantify the impact on the probability of default of these firms. The magnitude of the increase suggests that a policy change on carbon pricing can have measurable impact on the credit quality of the corporate portfolios, and that transition risks could be an important contributor to future stress test results. The increase in the segment exposure-weighted corporate portfolio PDs ranges from 0.3 to 0.5 percent under a 3-year scenario, with the transportation, electricity and gas, forestry and mining industries being the largest contributors.46 Figure 2 Transition risk of banks’ credit portfolio (2020) % of total loans 3.83 3.85 2.34 1.99 Agriculture 0.08 Heavy Industry Transport Energy Generation 87.91 Fossil Fuels Non transition-sensitive 23. Scope 2 and 3 emissions are very relevant as Chile imports 88 percent of its fossil fuel. The climate risk assessment currently conducted by the WB and the IMF in cooperation with the financial authorities only considers scope 1 emissions. These are direct emissions from reporting 45 IMF (2021) Financial Sector Assessment Program Technical Note Financial Stability Analysis, stress testing and interconnectedness by Dimitrios Laliotis. The stress test followed three steps. Step 1 was to derive a bridge equation that estimates the relationship of default rates with three firm level balance sheet indicators reflecting viability, liquidity and solvency (e.g. interest coverage ratio, current ratio, leverage ratio) using only publicly listed firms; step 2 was to apply carbon scenario for a broader set of firms differentiated by industries and carbon intensity; step 3 was to determine the loan loss provision needed before and after the shock, as well, the impact on the solvency ratios. 46 For illustration purposes and bearing in mind all relevant caveats, if transition risk were taken into account under the adverse scenario this would have resulted in an additional depletion of capital ranging between 26 and 53 bps. 21 CHILE companies as registered in the RETC database. However, as Chile imports 88 percent of its fossil- fuel which is 64 percent of its total primary energy supply, it is critical to also consider scope 2 and 3 emissions indirect emissions coming from the consumption of purchased energy by the company (owned) or by small and medium enterprises in the value chain of the company (not- owned). It is important to identify which industries use these imported fossil fuels. 3.3 Response sector 24. Financial sector participants are increasingly aware of climate and environmental risks but have limited experience in properly managing those risks. Although most financial institutions believe that climate change is a source of financial risk, there has been limited progress towards integrating these risks as part of business practices. Following the Green Agreement in 201947, the Ministry of Finance fielded two surveys to members of the Green Finance Roundtable to understand practices in 201948 and 202149 respectively. This latter survey revealed that some institutions are only considering climate risk as a subject of corporate social responsibility, while others have come a long way in understanding these risks. Though more work is needed in understanding and managing these risks. It is important that financial authorities not lose the momentum created around COP25. 25. The banking sector could do more to systematically address the impact of CRER on its own loan and investment portfolio. The banking association committed itself via the green agreement to building capacity among its members, promote incorporating ESG principles in the corporate governance, strategy, and risk management, including promoting the use of environmental and social criteria in credit and investment analysis, as well as decrease its own carbon footprint. According to the last progress report (which was based on a survey conducted at the beginning of the year 2021) there has been 50 percent progress. As the responses are shown for each industry these averages do not show the dispersion of the responses. A sample of two frontrunning banks shows that, one bank, Itau Banco50, didn’t yet formally established a policy that determines how the bank assesses the impact of climate and environmental risk on its own financial risk. Though it indicated that it would evaluate every risk it identified. For example, the bank evaluates yearly the impact of water scarcity on its agriculture exposure. The other bank, Scotiabank51, indicated that has always assed the environmental impact of a project its finances 47 Acuerdo Verde by Ministerio de Hacienda (2019) 48 Public-private roundtable on green finance: Survey of the risks and opportunities associated with climate change for chile’s financial sector (2019) 49 Informe de progreso acuerdo verde by Ministerio de Hacienda (Mayo 2021) 50 Itau Banco uses the equator principles since 2013, established a socio-environmental risk policy since 2018, and publishes annually an ESG integrated annual report since 2018. See for example the ESG integrated annual report 2020. 51 Scotiabank also publishes yearly their ESG report. 22 CHILE (using the equator principles) and determines, since 3 years, the impact of climate and environmental risk on its own financial risk using three classifications (low, medium, high). So far, it only makes use of the information the company provides, that is being assessed by its credit risk managers. In the near future CRER expert will be hired and external information will be used. 26. The insurance sector could step up its effort to determine the impact of CRER for its liability risks, despite limited expected impact. The insurance association committed itself via the green agreement to promote incorporating ESG principles in the corporate governance, strategy, risk management, and disclosure. So far, according to the last progress report (which was based on a survey conducted at the beginning of the year 2021) there has been only 4 percent progress (though only 5 companies responded to the survey out of 59 members and 69 insurers in Chile).52 The insurance association, though, expects that the impact of CRER for liability risk is limited, as the non-life insurance policies are not sensitive to physical and transition risk. 27. The investment sector could also step up its effort to integrate CRER into its investment policies and decision making. The investment sector including insurers, investment funds, and pension funds committed themselves through the Green Agreement, where the (mutual) investment funds associations represented their members, there were six out of seven pension funds that signed the green agreement themselves (e.g. Capital, Cuprum, Habitat, Modelo, Planvital, and Provida). Based on early 2021 data, the investment funds reported 54 percent progress of the agreed target. The pension funds reported a 35 percent progress, and the mutual investment funds reported 11 percent progress. It is noted that more work is needed to evaluate climate risks and opportunities, as well as publicly report on it. 3.4 Response supervisor 28. Financial authorities are taking CRER risks seriously, and understand the threat posed by these risks on the safety and soundness of financial institutions and the stability of the system. The MOF, BCCh, CMF and SP publicly committed to integrate climate change as a variable for their in the Green Agreement. Table 5 provides a high-level assessment of the following aspects of the supervisory response: (i) governance and strategy; (ii) raising awareness and capacity building; (iii) risk identification, assessment, and mitigation; (iv) Supervisory guidance; (v) Supervisory approach, tools, and techniques; (vi) crisis management. Qualitative scores are attached to each of the six elements: advancing, emerging, not in place. This simple methodology is developed by the World Bank in absence of international standard to provide for a benchmark 52 Informe de progreso acuerdo verde by Ministerio de Hacienda (Mayo 2021) 23 CHILE of international good practices. Though the Standard Setters such as the Basel Committee on Banking Supervision started to explore the principles for the effective management and supervision of climate related financial risks.53 29. The financial authorities conducted a self-assessment to determine their progress against their commitment under the green agreements54. Based on early 2021 data, the MOF indicated that it completed 79% of their commitment including building capacity, establishing structures to develop policies, and supporting green financial instruments. It has yet to develop a working group to monitor potential risks to financial stability. CMF completed 75% including establishing a climate change strategy, partly identifying data collection, and building capacity. It is working on aligning green financial markets with international standard. BCCh completed 65% including publicly stating the relevance of climate change for the financial sector, permanent participating in national and international working groups, and working on evaluating and mitigating CRER. It indicated that it has more work to do to explore and evaluate CRER and its relevance for the stability of the financial sector. SP indicated that it completed 100% including incorporating ESG factors in guidance for corporate governance, investment processes, risk management and disclosure. Find below the WB assessment. 30. Governance and strategy are advancing. The BCCh, so far, has appointed a Board Member to lead climate related topics, established a coordination body connecting different internal divisions (Financial Policy, Monetary Policy, Market Operations, and Statistics), developed a roadmap, is conducting three research studies, and is planning to address the impact of climate change on the financial stability in their Financial Stability Report. The CMF established board commitment, formulated a strategy (though without clear timelines), set-up a climate change working group, is conducting three analytical studies to better understand the impact of climate change, and is planning to integrate it in their supervisory approach for banks, insurance companies, and investment funds. It issued Regulation 461 that modifies the content of the Annual Report, incorporating themes of sustainability and corporate governance, aligned with the international standards, recommendations and best practices. The SP didn’t analyze the impact of climate change for the pension sector but has begun requiring pension funds to consider Environmental, Social and Governance (ESG) factors to be included in a pension fund’s investment and risk management process. It is observed that the financial authorities are advancing well in the area of governance and strategy. 53 Basel Committee Consultative Document (November 2021) – Principles for the effective management and supervision of climate- related financial risks. 54 The Green Agreement (2019); Progress report on Green Agreement (2021) 24 CHILE 31. The financial authorities are in the process of raising awareness and building capacity. The BCCh, so far, raised awareness by including a box on the risks of climate change for the financial system in Chile in the Financial Stability Report in second half of 2019, organized a webinar on climate change in October 2021, and is working on a chapter on the risks of climate change in upcoming Financial Stability Report of the First Half of 2022. Further, it is participating in international fora, such as Bank for International Settlements and the Financial Stability Board. It also became member of the Green Roundtable55 in 2019 and the Network for Greening the Financial System (NGFS) on February 12, 2021. The CMF has raised awareness through several presentations by its authorities pointing out the importance of the risks arising from climate change, it has carried out several training sessions on disclosures of TCFD and SASB indicators, and generated capacities through courses by universities in the United Kingdom. The CMF has organized several internal activities on climate change and also became a member of the Green Roundtable and the NGFS in 2019 and published its Climate Change Strategy in 2020. It is also (observing) member of the BCBS and the IAIS, and collaborates closely with ASSAL in the working group for climate change and sustainability. The CMF plans to organize a high-level international technical meeting. seminar on the impact of climate change for the financial sector. It established several alliances with, for example, the Inter-American Development Bank, 2Degrees, the University of New York and UC-CLAPES. The SP is nationally a member of the Green Roundtable and is promoting its freely available webinars. Internationally it is member of IOPS and is working with the OECD Working Party on Private Pensions (WPPP) on issues related with climate change, as well as with the Inter-American Development Bank. It is observed that the financial authorities are advancing their effort to raise awareness and build capacity, though they should continue their effort as their understanding of the impact of climate change for the financial sector is growing. It could be worth considering to also attract climate change expert. 32. The financial authorities started to identify and assess climate risk. The BCCh is working on three research papers: (i) impact of climate change on twelve economic sectors; (ii) the impact of climate change on real estate; and (iii) the impact of climate change on mortality. Further, it developed together with the IMF a stress test (GDP shock for physical risk; carbon price shock for transition risk) and is planning to dedicate a chapter on climate change in the financial stability report (upcoming First Half 2022). The CMF also has three research papers in progress: (i) the impact of physical risk on bank capital (using historical approach); (ii) the impact of transition risk on the investment portfolio of insurance companies (using forward looking approach); and (iii) 55 The Green Roundtable is a Public-Private Roundtable on Green Finance, established and led by the MoF in 2019. 25 CHILE the impact of physical and transition risk on bank exposure (using forward looking approach). The SP has no plans yet to identify and assess CRER. It is observed that the financial authorities started to identify and assess CRER. Table 4 Overview of research to determine climate risk Natural disaster, Climate and Physical Risk Transition Risk environmental related risks Historical data Forward looking Historical data Forward looking Banking sector Step 1: Determine Chilean Climate Research: CR2 Center for Climate and sources of climate Resilience Research, Centro UC Cambio Global, Mesa de RETC database: change Agua, Mesa Oceanos registers carbon emissions per Step 2: Understand BCCh: Impact CC on 12 ARCLIM database: economic sector. transmission economic sectors (2022)57 impact of extreme channel physical risk scenario Finance and BCCh: Impact of climate change (intense greenhouse Sustainable on real estate (2021)58 emission) on 12 Development Working economic sectors Group of the Council of WB: impact natural disasters on Finance Ministers (GT- economic loss (2021) FDS) of the Pacific Alliance is assessing transition risk on 4 economic sectors.56 Step 3: Assess WB: determine natural hazard CMF: impact physical WB: determine CMF: impact physical financial exposure heatmap (financial exposure per risk on bank transition sensitivity of risk on bank exposure region/sector) (June 2021) exposure (stress test) economic sector (June (stress test) (planned (planned for 2022) 2021) for 2022) WB: determine impact of natural Step 4: Assess disasters on NPL (June 2021) BCCh/IMF: determine BCCh/IMF: determine potential loss impact of 2% GDP impact of carbon price CMF: impact physical events on shock as result of shock on bank capital bank capital (planned 2022) physical risk on bank (stress test) (2021) capital (stress test) (2021) Insurance sector Step 1: Determine Chilean Climate Research (CR2 Center for Climate and (liability) sources of climate Resilience Research, Centro UC Cambio Global, Mesa de change Agua, Mesa Oceanos. RETC database: registers carbon Step 2: Understand ARCLIM database: emissions per transmission impact of extreme economic sector. channel physical risk scenario (intense greenhouse Finance and emission) on 12 Sustainable economic sectors Development Working Step 3: Assess Group of the Council of financial exposure Finance Ministers (GT- FDS) of the Pacific Step 4: Assess Alliance is assessing potential loss transition risk on 4 economic sectors. Investment Step 1: Determine Chilean Climate Research (CR2 Center for Climate and sector sources of climate Resilience Research, Centro UC Cambio Global, Mesa de change Agua, Mesa Oceanos. RETC database: Step 2: Understand BCCh: Impact of climate change ARCLIM database: registers carbon transmission on economic sectors (2021) impact of extreme emissions per channel physical risk scenario economic sector. 56 This report is prepared by HPL.LLC in response to the request of the IDB (who finances) and the Pacific Alliance as a deliverable of the consulting services provided. The following 4 sectors were prioritized: (i) Agricultural; (ii) Electric; (iii) Mining; and (iv) Transport, and the following 3 transition risks, with indicators: (i) Policies and regulations (direct and indirect emission costs, emission reduction costs while maintaining power generation); (ii) Technology (energy matrix and energy efficiency); and (iii) Consumer preferences (income from change in demand). The final draft of the report is scheduled for April 29, 2022. 57 This project was divided in two documents: 1) The impact of climate change on economic output across industries in Chile (The impact of climate change on economic output across industries in Chile (plos.org))The impact of climate change on economic output in Chile: past and future (Working Papers N° 933: The impact of climate change on economic output in Chile: past and future - Banco Central de Chile (bcentral.cl). 58 This study by Carlos Madeira, Karla Hernández and Roberto Luna (2022), "Climate change's impact on real estate prices in Chile" is forthcoming and not yet published. 26 CHILE BCCh: impact of climate change (intense greenhouse on real estate (2021) emission) on 12 economic sectors WB: impact natural disasters on economic loss (2021) Step 3: Assess CMF: Determine impact financial exposure of transition risk on investment portfolio Step 4: Assess insurance companies potential loss (planned for 2022) 33. There is, however, scope for strengthening coordination, to avoid gaps and overlaps and enable the authorities in adopting a systemwide perspective on the impact of climate risk. Although the different studies are critical for understanding the different aspects of climate risk, there are potential gaps and overlaps. There is, for instance no granular data to determine physical risk per commune or determine transition risk as a result of scope 3 emissions, while CMF and BCCh are both studying the potential impact of physical risk and transition risk on the banking sector. As of yet, no work is planned on the investment sector. Enhanced coordination among the key players, i.e. the MOF, BCCh, CMF, and SP could help to adopt a more systematic approach by determining clear definitions, mapping the available studies, models, data, and identifying potential gaps, including those gaps identified by climate scientists. This is important to get a better understanding of climate risks not only for the individual sectors (banking, insurance, and investment), but also for the financial system as a whole and its cross linkages. See table for overview of the different research being conducted or planned to be conducted. 34. It is also important for the financial authorities to consider prudential second-round effects and unintended consequences, as well, market conducts risks. There is a risk that a potentially flawed framework leads to unintended consequences as a result of a misalignment of incentives. For instance, it might be possible that credit and investment decision will not be based on risk/reward criteria, but on green/brown criteria taxonomy targets. This could lead to too many investments in certain sector (creating green bubbles) and underinvestment in other sector. Although it is impossible to quantify certain risks at this point, it is important to consider these risks, also in the context of developing a framework. Further, it is recommended to do a market conduct risk assessment that involves the risk of green washing, among other. 35. The financial authorities recently issued the first supervisory guidance on climate risk, more could be done in the near term. Although most financial institutions believe that climate change is a source of financial risk, there has been limited progress towards integrating these risks as part 27 CHILE of business practices.59 More work is needed by the financial institutions in understanding and managing these risks. The issuance of ESG regulation by the SP on November 23, 2020 which entered into force on May 2, 202160 and the disclosure regulation NCG 461 by the CMF on November 12, 202161 are important milestones, mandating sustainability-related disclosures by banks62, insurance companies, issuers of public offering securities, general fund managers, and stock exchanges. In addition, CMF could (in the near term) require financial institutions to integrate climate risk in corporate governance63, business model, loan origination and risk management practices64, including scenario analysis/stress testing, as this will strongly contribute to understanding, managing, and pricing climate risk. The integration of climate change in capital requirements could be considered in the medium term.65 The BCCh didn’t issue any guidance mainly because it does not have supervisory attributions and according to its mandate is only to issue decision on key issues that can have a systemic impact. 36. The supervisory approach and tools are being considered by the financial authorities. The CMF is planning to integrate CRER into its supervisory approach after having conducted the climate risk assessment. There are no internal initiatives yet to reflect climate risk in capital requirements for banks, though insurance companies have technical reserve requirements related to earthquake and tsunami risks.66 The SP conducted a risk-based on-site inspection in 2020 to identify gaps for the implementation of the green agreement. It also planned to inspect the first integrated annual reports under the new ESG regulation (issued in 2021) in 2022. The BCCh is not involved in micro-prudential supervision but might develop macroprudential tools and a climate 59 The outcomes of two surveys fielded by the Ministry of Finance to members of the Green Finance Roundtable largely confirmed this observation. A follow-up survey revealed that some institutions are only considering climate risk as a subject of corporate social responsibility, while others have come a long way in understanding these risks. Survey of the risks and opportunities associated with climate change for Chile’s financial sector (2019) 60 SP requires pension funds to integrate risks arising from climate change and environmental, social and governance aspects into the investment and risk management policies and procedures. 61 CMF requires listed companies to disclose: 1) the impact that the company has on its environment or society; and 2) the impact of the environment and the society on the company. The first includes disclosing environmental indicators and social indicators. The second includes describing the impact of physical and transition risk on the company’s business, strategy and financial plann ing in the short and medium term. 62 This also strengthened pilar 3 of the Basel II framework that requires banks to publish information on the risk profile and risk management to improve market discipline. It could be considered to explicitly require ESG risks disclosure within pillar 3 of the Basel II framework. 63 Board needs to manage prudential risk, establish strategic guidelines, and determine information disclosure mechanism (article 3.1 – section ii of the GBL) (BCP p 89). CMF does not meet with board members (BCP p ) not assess quality of board oversight, not evaluate bank’s strategy and risk appetite (BCP p92). Board members don’t have not suitability requirements (only integrity requirements – article 49 GBA) (BCP p92) 64 64 Board of banks are required to manage prudential risks based on the three lines of defense e.g. line management, risk management and internal audit (which was introduced in September 2020). There is no regulatory requirement to establish integrated risk management function. 65 CMF follows Basel 1 where capital is only required for credit risk. Basel 2 (pillar 2 capital requirements are introduced on September 11, 2020, but it has not fully come into force yet; Basel 3 will be implemented starting December 2021. 66 The CMF has created a supervisory unit that will lead the setting of supervisory expectations for compliance with mandatory disclosures. 28 CHILE stress test in the future building further on the climate stress test that has been developed together with the IMF. It is recommended to integrate climate change risk into the supervisory approach e.g. developing a supervisory rating, conducting thematic on-site inspection, and make it part of off-site monitoring practice by developing risk metrics. Improvement of data collection is an important precondition. 37. The crisis management framework is emerging. The Financial Stability Council (FSC) has been created in 2011 which is chaired by the Ministry of Finance, and includes the CMF, the SP and the BCCh. The impact of climate change has not yet been discussed in the FSC.67 It could be beneficial to coordinate a systemic climate risk assessment through the FSC. It is further observed that the CMF and the BCCh established a Memorandum of Understanding that includes a crisis management section. There are no cross-border crisis cooperation and coordination arrangements. It is recommended to determine whether the crisis management framework is adequate to handle natural disasters, including international arrangements. Table 5. Assessment of supervisory response Element Score68 Examples of global good practices* Description of practices of Chilean financial authorities Governance and Advancing • Commitment and accountability of the authority’s • MOF: established and leads the Public-Private strategy board/governors Roundtable on Green Finance; Green Agreement • Developing a supervisory strategy/roadmap (2019); Green Finance Office (2020); Financial Strategy (endorsed by board/governors) against Climate Change. • Sponsorship from senior executive • BCCh: board commitment; set-up coordinating body; • Establishing internal governance structures and issued declaration; established roadmap; financial operating model69 stability report (2019H2). • Public reporting on governance approach and • CMF: board commitment; published strategy (2020); strategy established working group. • SP: started considering ESG matters since 2015; Finance Risk Department supervises ESG and reports to Deputy Chair of SP. Raising Emerging • Raising internal awareness and building staff • BCCh; financial stability report; member Public-Private awareness and member capacity Roundtable on Green Finance; ; member NGFS (2021) capacity • Knowledge building and cooperation (with national and active participant of its working groups; building policymakers, international authorities and external participates in BIS events; participates in FSB events; experts) Climate Change webinar. • Membership and participation in international • CMF: several inhouse activities organized by working networks group; member Public-Private Roundtable on Green 67 The MOF committed in the Green Agreement to the establishment of a working group under the auspices of the Financial to Stability Council, which monitors possible risks for the financial stability related to climate change. During the last meetings of the Financial Stability Council, the need to comply with this commitment has been raised. Work is currently under way to develop the objectives of this working group. 68 ‘Advancing’: means the initiatives deployed are on average aligned with, or ahead of, international good practices. Obviously, given the state of environmental and climate-related supervisory practices, this does not mean no improvements can be made; ‘Emerging’ means that initiatives have been deployed, but these are either not aligned with good practices, or implemented fu lly; ‘Not in place’ means that most of the activities mentioned in a category have not yet been taken up by the regu lator, or serious issues are curtailing efforts. 69 Depending on the nature of the institution, the operating model could be different: internal network, dedicated unit, hub-and- spokes model, see NGFS Guide for Supervisors (2020) for more details. 29 CHILE • Raising awareness among financial institutions Finance ; observing member BCBS; MoU IOSCO); • Conducting a survey to collect information from member IAIS; member NGFS (2019); organized financial institutions international high level technical seminar on April 26- • Reporting on (anonymized) survey outcomes and 27, 2022; capacity building and training sessions on sector assessment TCFD and SASB Standards; partnership Inter-American • Establishing a risk focused industry dialogue or Development Bank, 2Degrees, NYU and UC-CLAPES; platform Bolsa de Santiago has also engaged in capacity building for issuers • SP: member Public-Private Roundtable on Green Finance; member IOPS; OECD/WPPP; promote freely available webinars of green finance working group, IOPS, and Inter-American Development Bank. Risk Emerging • Conducting a (quantitative and/or qualitative) • BCCh: 3 research papers in progress: 1) impact climate identification, climate-related and environmental risk assessment change on 12 economic sectors; 2) impact climate assessment and • Ensuring adequate data availability and reporting by change on real estate; 3) impact climate change on financial institutions (e.g., regional and sectoral mortality; planned to dedicate chapter on climate mitigation breakdowns of exposures) change in financial stability report; developed stress • Analysis of exposures to climate-related and test together with IMF (GDP shock for physical risk; environmental physical and transition risks carbon price shock for transition risk) • Developing (macro and micro prudential) stress- • CMF: 3 research papers in progress: 1) impact physical testing capabilities and exercises events on bank capital (historical approach); 2) impact • Monitoring supervised institutions’ exposures70 of transition risk on investment portfolio insurers (forward looking); and 3) impact physical and transition risk on bank exposure (forward looking) • SP: no plans yet Supervisory Emerging • Develop and publish supervisory expectations / • BCCh: no activities yet (its mandate is only to issue guidance guidance incl. expectations on governance, strategy, decisions on key issues that can have a systemic risk management and disclosure (see below) impact). • Provide supervisors with a toolkit for supervisory • CMF: Issued disclosure regulation that includes climate engagement risk (2021). • Assessing and monitoring implementation of • SP: issued ESG regulation on November 23, 2020 and expectations entered into force on May 2, 2021. • Introducing new rule or updating listing rules to include climate/environmental disclosure requirements* Supervisory Emerging • Formally embedding climate-related and • BCCh: not applicable action and tools environmental risk in individual components of • CMF: planned to integrate climate and environmental supervisory frameworks and tools, including risk into the supervisory approach after climate risk supervisory review process assessment; there are no internal initiatives to reflect • Exploring risk mitigation by means of financial climate risk in capital requirements for banks; though resources (e.g. Pillar 2 capital add-ons for firms that insurers have technical reserve requirements related to do not meet supervisory expectations and/or that earthquake and tsunami risks. have concentrated exposures) • SP: Risk-based on-site inspection was conducted in • Integrating environment/climate-risk elements in fit 2020 to identify gaps for the implementation of the and proper tests green agreement; Inspection of the first integrated • Evaluating underwriting practices, reinsurance and annual reports under the new ESG Regulation in 2021 ensuring adequate (i.e., regionally tailored) by the Financial Division; Review of the first integrated catastrophe modelling report is planned for 2022. • Provide for measures to prevent, detect and sanction the misuse of funds used through sustainable or green-labelled instruments* Crisis Emerging • Having a framework in place that provides clarity on • Financial Stability Council (FSC) created in 2011 is management actions to be taken by supervisory authorities in the chaired by MOF, and includes CMF, SP and BCCh (as wake of a disaster advisor); the impact of climate change has not yet been • Ensuring the right operational arrangements are in discussed in the FSC. place for execution of the framework • BCCh and CMF established MOU that includes crisis management section; there are no cross-border crisis cooperation and coordination arrangements. 70 In Europe, supervisors are awaiting guidance from the ECB and the ESRB, which are jointly developing a pilot risk-monitoring framework for climate-related systemic risks in the financial sector, including the development of risk indicators. 30 CHILE 4 CLIMATE FINANCE AND THE FINANCIAL SECTOR 4.1 The global and domestic green finance context 38. Chile’s financial authorities have made strides to support the ability of financial entities to assess climate-related opportunities. Financial policymakers and regulators can support these efforts in a number of ways. Sovereign capital market instruments, green taxes, and other fiscal policies can help reduce emissions and directly mobilize revenues. The financial sector can also play a fundamental role by mobilizing resources needed for investments to support climate mitigation and adaptation, especially in response to price signals. Financial sector regulators and policymakers can strengthen this pricing mechanism by implementing policies that ‘price in’ externalities and provide incentives to support Chile’s low-carbon transition. 39. Global growth in sustainable finance across asset classes highlights the increasing importance that investors attribute to climate change. Sustainable finance is generally referred to as the process of integrating environmental, social, and governance (ESG) factors into the investment decision process. Growth in sustainable finance is driven by a desire of investors to have environmental and social impact, and better risk-adjusted financial performance. While sustainable investing began in equities, strong investor demand and policy support spurred the issuance of green and labelled sustainable bonds, growing the stock from $US 78 billion in 2015 to an estimated $2.2 trillion by end 2021.71 Sustainable finance can contribute to climate change mitigation by providing incentives for firms to adopt less carbon- intensive technologies and support the transition to new technologies. Channels through which investors can achieve this goal include engaging with company management, advocating for low- carbon strategies as investor activists, and lending to firms that are leading with respect to sustainability. Investors can also extend credit to sovereigns and companies that are integrating these practices in a responsible way. All these actions send price signals, directly and indirectly, that support the allocation of capital to entities and activities that can contribute to Chile’s low- carbon future. 40. Global investment requirements for addressing climate change are estimated in the trillions of US dollars – in Chile, investment needs to reach Chile’s mitigation goals are alone estimated to reach US $50 billion by 2050. In Chile, as elsewhere, investment needs to meet the country’s NDC and SDG commitments are high, and greater than what can be 71 HSBC ” Green Bond Outlook 2022”, December 2021. 31 CHILE financed through public resources alone. Mobilizing private capital is necessary to fill this gap, and it is also critical that future financial flows are directed towards activities that strengthen rather than undermine Chile’s climate and environmental priorities. Chile’s updated NDC includes as an indicator an emissions target of 95 million tonnes equivalent by 2030. Chile has recently issued its long-term climate strategy72 in service of Chile’s net zero ambitions. The strategy has already been deemed as one of the most sophisticated efforts globally, alongside the EU and Costa Rica.73 The strategy provides a path for the more than 400 measures Chile’s line ministries can take to 2050 to contribute to Chile’s long -term climate mitigation and adaptation ambitions. Many of these measures outline the role of private capital to fuel these changes. The authorities estimate that meeting these objectives will require an investment of US$50 billion, which will be offset by, “net benefits to the country of more than US$30 billion and potentially leading to a 4.4% increase in gross domestic product 74 (GDP) by 2050”. A landmark Climate Change Framework Law passed in March 2022, “establishes long-term climate targets, regulations to guide climate action as well as structures and arrangements in climate governance to advance towards a low-emissions and climate resilient economy”, further establishes Chile as among the most advanced countries in terms of policy planning for climate change. 75 41. Chile’s Financial Strategy on Climate Change complements these efforts, acknowledging the important role that private capital mobilization can play to further Chile’s long-term plans. Developed in 2019 and updated in March 2022, Chile’s Financial 76 Strategy on Climate Change outlines a three-pronged approach to enhancing climate finance in the country: the first, focused on the generation of information, data and analysis to mobilize capital flows under an institutional framework of policies and measures consistent with the country's climate objectives; the second, to promote the design and implementation of green financial and economic instruments and promote market development; and, finally, to, strengthen the understanding, capacities and action of the financial sector in terms of risks and opportunities arising from climate change, taking into account the evidence and international best practices. This in order to increase the competitiveness of the Chilean financial system, and capitalize on the opportunity to position Chile at the forefront of green finance at the regional 72 https://unfccc.int/sites/default/files/resource/CHL_LTS_2021.pdf 73 https://climateactiontracker.org/publications/global-update-september-2021/ 74 See publication: https://publications.iadb.org/publications/english/document/Options-to-Achieve-Carbon-Neutrality-in-Chile- An-Assessment-Under-Uncertainty.pdf. In addition, the new office of green finance in the Ministry of Finance affirmed this estimate in the press: https://www.latercera.com/pulso/noticia/hacienda-calcula-que-chile-necesita-inversion-de-us-50000-millones-en-30- anos-para-cumplir-compromisos-internacionales-en-cambio-climatico/XBJW442U2NE3LNGNRVBVDM2QSY/ 75 https://www4.unfccc.int/sites/ndcstaging/PublishedDocuments/Chile%20First/Chile%27s_NDC_2020_english.pdf 76 https://cambioclimatico.mma.gob.cl/wp-content/uploads/2020/12/Financial-Strategy-on-Climate-Change-Chile-EN.pdf 32 CHILE level. . In this way, the strategy rightfully acknowledges the need to understand existing patterns and flows, develop new instruments and pathways to strengthen the flow of finance that goes towards green activities, and build the capacity of domestic institutions to enhance their capacity to manage risks and take advantage of new climate-informed opportunities to help shape the path of Chile’s low carbon future. The CMF, for its part, has also developed a strategy to combat climate change that also focuses, in part, on the role of the regulator to promote green finance market development. 77 4.2 Mobilizing green finance Debt capital markets 42. Debt capital markets can play an important role in greening Chile’s economy and can help build the necessary foundations to ensure a stable transition. Labelled bonds are one way for issuers and investors to ensure bond proceeds are channeled to specific projects. Green bonds in particular account for more than half of the labelled bond market globally and are a type of bond instrument where proceeds are exclusively applied to finance or re- finance in part or in full new and/or existing eligible green projects. 78 Sovereign and corporate issuances and demand for labelled bonds are increasing sharply globally, reaching $US 2.2 trillion outstanding by end 202179. Analysts project that labelled bond supply will top $US 1.4 trillion in 2022 alone. In Europe, sales of labelled debt reached 44% of European marketwide bond deals in November 202180, a signal of the robustness of both supply and demand for these instruments globally. In addition to movements in the labelled bond market, ESG factors are increasingly playing a role as part of traditional credit analysis processes for conventional debt instruments, including for EM sovereign and corporate debt. 43. Although Chile’s debt capital market is small relative to regional peers, Chile hosts the LAC region’s second largest green bond market, driven by the sovereign issuer. Chile’s green bond market (US$ 9.5 billion) is second only to Brazil (US$10.3 bn) in the region, more than double that of Mexico (US$4bn) (see Figure). The strength of Chile’s green bond market is driven by the sovereign issuer’s sizeable green and labelled bond program. Indeed, Chile was the first sovereign issuer in the America’s to issue a green bond. As of January 2022, Chile had issued $25.655 billion USD in government labelled bond instruments, amounting to 11% 77 https://www.hacienda.cl/english/work-areas/international-finance/public-debt-office/green-bonds/other-reports/cmf-s-strategy- against-climate-change-spanish-only- 78 CBI data, WB staff calculations. 79 HSBC (citation to be added) 80 Bloomberg (citation to be added) 33 CHILE of total global government labelled debt ($226 bn)81. Within Chile, the sovereign’s green, social, and sustainable debt amounts to nearly a quarter (23%) of the sovereign’s overall outstanding government debt, another signal of the importance of this type of instrument to the sovereign’s debt management strategy. According to Chile’s debt manager, the country had issued $14.6 billion in social bonds, $7.6 billion in green bonds, and $1.5 billion in sustainable bonds as of October 2021. Euro-denominated issuances attracted a strong book of ESG-oriented foreign investors (80% of the investor base, according to analysis by the Ministry of Finance); USD-denominated issuances attracted an investor base of 50% ESG- oriented investors.82 Externally, Chile’s sovereign bond portfolio has drawn attention to the seriousness of the government’s efforts to attract private capital towards sustainable finance activities. Domestically, the sovereign’s labelled bond portfolio has helped establish a ‘green benchmark’ that can be helpful in guiding pricing of green debt in the broader economy. 44. However, the sovereign issuer has expressed difficulty in identifying new green activities to back the issuance of future green debt. Green bonds typically fund large- scale, capital intensive green infrastructure projects in energy efficiency, renewable power, and transport that result in positive climate mitigation or adaptation benefits. In Chile, nearly ¾ of Chile’s green debt (70 percent) had been allocated towards one large capital project, the construction of the Greater Santiago metro. By end 2021, the sovereign’s recent sustainable issuances had increased the proportion of other projects that had benefitted from allocations from the issuance, but the metro project is still estimated to account for more than half of the portfolio. The debt manager acknowledges that in 2022 the sovereign plans to issue sustainable (a mix of social and green debt) and social debt, as the country does not have the green projects to back future green debt issuances. 83 81 Staff analysis of government marketable labelled debt securities listed on Bloomberg as of January 3, 2022. 82 https://www.hacienda.cl/english/work-areas/international-finance/public-debt-office/green-bonds/other-reports/cmf-s-strategy- against-climate-change-spanish-only- 83 https://cleanenergynews.ihsmarkit.com/research-analysis/colombia-issues-first-latin-american-green-sovereign-bond-in-l.html 34 CHILE Total corporate bond issuances Total green bond issuances(amount issued, (amount issued, US$ Millions) US$ Billions) Source: Bloomberg, World Bank staff calculations, 2021 Source: Climate Bonds Initiative, 2021 45. Chile should create a better tagging system to identify eligible public expenditures to back future green debt issuances, as demand for green sovereign debt is likely to remain high. Chile has committed to greening 30% of public investment across the following portfolios: Ministry of Public Works, including projects from the Ministry of Health; Ministry of Vivienda and Urbanism; Ministry of Transport and Telecommunications; Ministry of Agriculture; Ministry of the Interior (Subsecretariat of regional development, SUBREDE)84. A parallel system to ensure these investments are tagged would be a critical step in supporting the sovereign’s ability to raise funding for this work from the capital markets. Recent analysis has found 1.8% of the public budget between 2016-2020 was linked to climate actions85. The Ministry of Finance, together with Dipres, have carried out parallel studies to assess public expenditure on climate change. Their analysis, which covered approximately 51% of the central government budget in 2019, found that approximately 0.71% of central government spending was allocated towards climate actions. 86 Various government entities have formed a productive working group focused on these issues87, and have formalized a work plan to develop an identification, measurement and reporting system to be able to measure and tag public investments for climate action more easily in the future. It should be noted that subtitle 31 of the National Budget mandates the Budget Directorate to now report on public spending on climate change. The Framework Law on Climate Change also 84 This target was formally introduced by Chile’s government as part of the government’s ‘Step by Step Plan, Chile Recovers’ COVID- 19 recovery plan, introduced on August 16, 2020. 85 https://www.df.cl/noticias/economia-y-politica/macro/mas-de-200-proyectos-de-inversion-publica-estuvieron-vinculados- al/2022-01-09/210913.html 86 http://www.dipres.cl/598/articles-225824_doc_pdf.pdf http://www.dipres.cl/598/articles-250349_doc_pdf1.pdf 87 https://www.ogp.gob.cl/noticias_ogp/1200/ 35 CHILE mandates the Directorate to prepare a climate investment report, in collaboration with the Ministry of the Environment. 46. In addition, public investments financed by Chile’s green debt should be better aligned with the country’s climate mitigation and adaptation finance needs. As discussed, most green debt (at least 56%) raised from the capital markets has been geared towards transport infrastructure, with more limited amounts going to other aspects of Chile’s mitigation needs. In addition, Chile’s sovereign green issuances have raised even more limited amounts to address the country’s significant adaptation finance needs. As the authorities advance with policy planning and the development of a green investment tagging system, making marginal improvements to resource planning for adaptation finance should be prioritized. 47. The sovereign issuer has taken another significant step by issuing the world’s first sustainability-linked bond, clearly committing the sovereign to important environmental outcomes. Sustainability-linked bonds (SLBs) are financial instruments with an embedded assessment of forward-looking performance against specific sustainability performance targets. The performance targets include ESG-related key performance indicators (KPIs) at the issuer level that the issuer agrees to achieve. If these targets are not met, additional payments to bondholders would be incurred, through a pre-defined mechanism (e.g. a step-up or step-down coupon, a redemption premium, an offset mechanism, etc). Unlike green or social bonds, the funds raised through a sustainability-linked bond or loan are not tagged to a specific use of proceeds but for general balance sheet purposes.88 In that sense, issuers are committing explicitly (including in the bond documentation) to future improvements in sustainability outcomes at an issuer-wide level within a predefined timeline. Chile’s sovereign issuer developed the world’s first sovereign sustainability-linked bond framework in February 2022, in alignment with ICMA’s principles and with the country’s own Paris Agreement commitments. In March 2022, the sovereign issued the world’s first sovereign sustainability-linked bond. Demand was high, and the bond was 3x oversubscribed.89 The success of the issuance will surely pave the path for future sovereign sustainability linked issuances in the region and globally. Although Sustainalytics noted in its Second Party Opinion that the first set of targets on Chile’s absolute GHG emissions was ‘ambitious’, the ‘highly ambitious’ nature of its second target, focused on achieving a 60% of the country’s electricity mix from renewable sources by 2032 was encouraging. The instrument also allowed the country to continue to innovate in the area of sustainability-oriented sovereign 88 For more detailed definitions, please refer to https://www.icmagroup.org/assets/documents/Regulatory/Green- Bonds/June-2020/Sustainability-Linked-Bond-Principles-June-2020-171120.pdf and https://cib.bnpparibas/the-ascent-of- sustainability-linked-bonds. 89 https://www.esgtoday.com/chile-issues-first-ever-sovereign-sustainability-linked-bond/ 36 CHILE issuances, especially until the country’s public investment green tagging systems are further developed. 48. Other sustainability-linked bond structures are also possible at the sovereign and corporate level, including a step-down coupon if targets are met, to reward good performance. The World Bank is contemplating such a structure, with the step-down structured as an incentive that could be used towards climate-friendly projects. The private sector would still face the same coupon payment. Under this structure, a third-party grantor would provide the grant, akin to pay-for-performance and impact bond schemes that have met with success elsewhere. 90 Sustainability-linked bond Green bond Use of proceeds General corporate purpose Green projects Issuer type Potentially any company that Companies able to generate can credibly commit to an large-scale green projects, ambitious sustainability target generally operating with already high green standards Performance Metrics-based KPIs at the issuer - Flows of proceeds indicator level and associated SPTs - Impact reporting relying on metrics-based KPIs Penalty for bad - Legally binding financial Reputational performance penalty - Reputational Pre-issuance Second-party opinions - Second-party opinions certification - Certifications (e.g. Climate Bonds Standard, European Green Bond Standard) Post-issuance Systematic external verification - Generalization of use of verification of KPIs vs. SPTs integrated in the proceeds reporting bond documentation - More variability regarding the availability and quality of impact reporting 49. Chile’s climate finance strategy also led to the development of a green tax which levies a tax on imported gas-fueled cars and industry. A green tax was established in 2014 under Law N° 20,780. The tax is levied on imported vehicles and on corporate carbon emissions. The 90 The following blog and accompanying paper outlines this approach in greater detail: https://blogs.worldbank.org/psd/striking- right-note-key-performance-indicators-sovereign-sustainability-linked-bonds 37 CHILE 2020 Tax reform introduced the possibility of offsetting part or all of the emissions subject to the tax by investing in mitigation projects. Implementation is set to begin in 2023.The recently passed Framework Law on Climate Change also contemplates such a system, with regulated entities in turn being able to sell any surplus through an ETS or tradable performance standard. Globally, as more companies are obligated to disclose their scope 1, 2, and 3 greenhouse gas emissions, there is an increasing recognition that it is both difficult and expensive to reduce emissions burdens quickly, especially through supply chains. Financial institutions and investment funds are also seeking carbon removal projects to better align public net zero commitments with disclosures. Unsurprisingly, new private sector players are responding to these signals by entering the carbon offset market, including new entrants that aim to broker, verify and/or finance new carbon removal or offsetting projects, including in emerging markets. Growth in this market is expected to continue. As such, more and more corporates, including those with subsidiaries in Chile, may turn to carbon offsets to reduce their emissions burdens. In other jurisdictions, including Singapore, a system for exchanging verified, science-based carbon credits is under development to support the capacity of corporates to reduce their carbon footprint and support price discovery in the carbon market. 91 The CMF could consider assessing the impact of this market-based system on regulated entities, including by providing guidance on derivative products that could arise after the introduction of such a system. The World Bank has provided support in this regard to the Chilean authorities and could integrate the CMF further in this portfolio of support. 50. The public sector could also play a larger role in spurring the entry of more green debt and equity products in the marketplace. In other contexts, public subsidies and tax incentives have helped to increase the issuance of green and sustainable debt instruments. setting an optimal green tax, and setting a tax on carbon, will be an important step forward to guide the financial sector and real economy. Tax credit bonds, whereby investors receive tax credits from the government in lieu of interest payments, could help offset costs borne by issuers of green securities. Tax-exempt bonds, whereby investors are not obligated to pay income taxes 91 DBS, the Singapore exchange, and other partners are developing a carbon credit exchange to provide a credible way for corporates to reduce their carbon footprint: https://www.sgx.com/media- centre/20210520-dbs-sgx-standard-chartered-and-temasek-take-climate-action-through- global?utm_medium=social&utm_source=twitter&utm_campaign=alwayson&utm_term=20052021&ut m_content=NR 38 CHILE on interest from green bonds they hold, have also been introduced in such contexts as Brazil.92 Enhancing the eligibility of climate-focused funds for favorable tax treatment as part of savings products could also help attract more interest in this space. 93 In Morocco and Egypt, the capital market authority has introduced reduced approval fees for corporates who issue green bonds or loans. In other jurisdictions, grant funds are provided by domestic development banks to offset fees associated with preparing a green or thematic bond, including defraying the cost of receiving a second party opinion on the framework or issuance. Enhancing the eligibility of climate-focused funds for favorable tax treatment as part of savings products could also help attract more interest in this space. 94 Banks and public development finance institutions 51. Some financial institutions are offering green products to the market, though work is needed to expand product offerings. Banco Santander, Itaú, and Scotia Bank offer green products to retail customers. Chile’s Banking Association also reports that climate-oriented product offerings often benefit from subsidies from government for preferential rate loans in agriculture or energy for clients that use climate-friendly methods. In general, financial institutions with parent companies in Europe or North America, have reported a greater familiarity with assessing the climate-risk landscape and offering products to address that demand in the local market. As more prominent investors, including domestic pension funds integrate climate risks in their risk matrix, market demand towards green products may emerge in turn. Further subsidy to on-lend preferential rates to consumers will support this process. 52. National Development Banks (NDBs) have a key role to play in overcoming the investment gap both in terms of building confidence through the alignment of public and private financial interests and also in building capacity in low carbon investment. Their dual role is focused on complementing and catalyzing the private sector through their insights into local opportunities and risks and also their relationship with the local private finance sector. In 2014, NDBs had contributed more than half of climate finance flows. For example, Nacional Financiera (Nafin) had an important role in Mexico’s 105% growth in clean energy in 2015 through one of 92 Evidence from experiences reducing the tax rate on other financial assets (e.g., withholding taxes on government securities) has induced demand for these securities, all else being equal. However, more research would need to be undertaken to determine the optimal use of these fiscal tools to induce demand in the Chilean context. 93 As referenced in the IMF’s recent Global Financial Stability Report: https://blogs.imf.org/2021/10/04/how-investment-funds-can- drive-the-green-transition/ 94 As referenced in the IMF’s recent Global Financial Stability Report: https://blogs.imf.org/2021/10/04/how-investment-funds-can- drive-the-green-transition/ 39 CHILE the largest onshore wind energy portfolios globally at an estimated USD 2.2bn for 1.6GW. Given that NDBs have been critical in promoting renewable energy investment and climate-proofing key sectors of the economy (including agriculture) there is a strong case to continue to expand the use of their balance sheet. 53. Commercial state-owned entities such as BancoEstado are playing a catalytic role, and can do more. In Chile, Banco del Estado de Chile (BancoEstado) maintains the most extensive array of products tailored to supporting green MSMEs and households. BancoEstado’s green product portfolio includes preferential rate loans for electric vehicles, mortgages for eco-friendly homes, and a new green mutual fund offered to retail clients. The subsidy offered to clients who wish to purchase a green retrofitted home is sizeable – in the recent past, customers could receive an ‘ecovivienda mortgage’ at rates of 4% as opposed to 8% for a mortgage for a conventional home. The program was begun with the support of KfW, the German development agency, but BancoEstado intends to continue to offer these popular products. 54. For its part, Chile’s Corporation for the Promotion of Production (CORFO) has also helped seed energy efficiency within Chile. CORFO’s Energy Efficiency Pre-investment Program supports small and medium enterprises (SMEs) in optimizing their energy consumption and reduce energy costs. CORFO provided financial support to support preparatory studies that identified energy saving investments for SMEs. The program offsets up to 70% of the total cost of these studies. The Non-conventional Renewable Energy (NCRE) program also supports investment planning studies and environmental impact assessments. Between 2005 and 2009, a total of 217 wind, biomass, biogas, geothermal, and small-scale hydroelectric projects benefited from this support. The National Energy Commission and the Ministry of Energy granted US$2 million to CORFO to continue the program. In 2008, Germany’s development bank, Kreditanstalt für Wiederaufbau (KfW), provided a €85 million loan to finance NCRE projects with credit facilities and concessional interest rates, which financed 19 projects. Since 2012, CORFO’s Renewables Energy Center has developed two new programs to subsidize pre-investment studies of NCRE projects. To date, a total of 30 projects (5 biogas, 1 biomass, 13 wind, 4 photovoltaic, and 7 mini- hydro) have been financed and 78 studies have received support for about US$726,000 (CLP$542 million).95 55. The Green Climate Fund (GCF) already has a program of support in Chile, and the country should continue to tap these resources. Despite their relatively small size compared to the total amounts invested in Chile, the international climate funds are strategically important for a number 95 The analysis of CORFO’s impact has been adapted from the IADB’s, “A Guidebook fo r National Development Banks on Climate Risks” case study on CORFO. 40 CHILE of reasons, including for attracting private investment through enabling NDBs and Multilateral Development Banks (MDBs) to develop risk-sharing instruments and fostering learning and develop the technical capacity to deliver climate-resilient investment. The GCF in particular has 6 projects amounting to US$ 194 million invested in Chile. 96 One project, a US$ 60 million equity investment in Espejo de Tarapacá, aims to increase renewable energy and hydropower capacity in Chile’s norther Tarapacá province. The project is expected to decarbonize up to 5% of the country’s energy mix, and support regional workers in adapting to a changing climate by providing stable water supplies from the project’s associated desalination plant. 97The GCF stepped in as an early anchor investor to attract further institutional investor, equity, and debt investors. 56. Chile’s two sovereign wealth funds can also be an important source of investment capital to seed Chile’s climate ambitions. The Economic and Social Stabilization Fund (ESSF) was established in 2007 to replace the Copper Stabilization Fund. The ESSF finances fiscal deficits and amortization of public debt. According to the Fiscal Responsibility Law, the ESSF receives annual contributions equal to the effective fiscal surplus, discounting the payment of public debt and advances from the prior year. As of the end of March 2022, the market value of the ESSF was US$ 8,148.98 The ESSF invests in four assets classes: sovereign bonds, money market, equities, and inflation- linked sovereign bonds. Approximately 91.1% of the fund’s assets are invested in sovereign bonds and the money market. For its part, the Pension Reserve Fund (PRF) was established in 2006 to support the financing of the government’s pension obligations. The PRF holds investments in six asset classes: sovereign bonds, corporate bonds, equities, inflation-linked sovereign bonds, high yield bonds, and U.S. mortgage-backed securities. Neither of these funds has an explicit investment mandate that incorporates ESG factors,, although it is important to note that the Ministry of Finance committed under the Green Agreement to modify the investment guidelines of the PRF and ESSF to incorporate a requirement for climate, environment, social and governance risk management. However, implementation of this commitment and more explicit consideration of these factors as part of the risk management function of the fund or through explicit investment policy considerations could strengthen the investment landscape for ESG- sensitive investments. 57. Indeed, recent analysis has highlighted how the integration of ESG factors by Chile’s sovereign wealth funds and AFPs has helped deliver better ESG outcomes while 96 https://www.greenclimate.fund/countries/chile 97 https://www.greenclimate.fund/news/gcf-investment-supports-green-energy-transition-chile 98 https://hacienda.cl/english/work-areas/international-finance/sovereign-wealth-funds/economic-and-social-stabilization- fund/financial-situation/market-value 41 CHILE maintaining financial performance. Recent analysis by the IADB99 constructing composite portfolios using ESG-adjusted equivalents for Chile’s sovereign wealth funds and a sample of pension funds found that in most cases the return of the ESG portfolio exceeded that of the fund’s average allocation. This Chile specific exercise has highlighted how ESG oriented investments can deliver better environmental, social, and governance performance without sacrificing financial returns. 4.2.1 Greening private capital Greening listed non-government debt and equity markets 58. Despite strong growth in sovereign green bond markets, Chile’s corporate green capital market has been less active. Relative to other issuers in the region, Chilean corporates have fallen behind in issuing green and other thematic labelled debt. There was a contraction in the Chilean corporate bond market overall in 2020, and no thematic debt instruments were issued that year. In April 2021, CMPC, a multinational paper pulp company, issued the Chilean market’s first sustainability-linked bond. The US$ 500m, 10-yr note was based on KPIs related to both greenhouse gas emissions (targeting a 23.5% reduction in CO2 emissions by 2021) as well as industrial water use (promising a 25% reduction by 2025). https://publications.iadb.org/publications/english/document/The-Business-Case-for-ESG-Investing-for-Pension-and-Sovereign- 99 Wealth-Funds.pdf 42 CHILE Market capitalization of listed domestic Thematic bond issuances by Chilean companies corporates (% of GDP) (2018-2020) 150 100 50 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Brazil Chile Colombia Mexico Peru Source: ‘Paving the Path’, 2021 Source: World Bank staff calculations, 2021 59. In Europe, the Green Bond Standard (GBS) is expected to apply strict requirements to securities that carry the green or sustainable label – this may not be the right approach for the Chilean context. The EU GBS is currently under discussion. However, the draft regulation contemplates the imposition of stricter requirements on issuers than the market- standard International Capital Market Association’s Green, Social and Sustainable Bond Principles. GBS draft regulation currently would require labelled bonds to be pre-vetted by an external reviewer that has been registered with regulatory authorities. Impact reports would also be required.100 ICMA has recently cautioned that new amendments to the regulation might make the label too costly for issuers. Furthermore, recent analysis by Commerzbank has suggested that significantly less than half of the euro denominated ESG bonds issued in 2021 would currently be even in contention for alignment with the draft EU Green Bond Standard. As with other countries in the region such as Peru, Chilean regulators have chosen not to issue formal regulation to dictate what constitutes a labelled bond in their jurisdiction, leaving it to investors and the BCS’s listing requirements101 to define what they 100 https://www.icmagroup.org/News/news-in-brief/analysis-of-the-amendments-to-the-eugb-regulation-proposed-by-the- rapporteur-of-the-eu-parliament/ 101 BCS’s listing requirements require issuers to adhere to the ICMA green, social, and sustainable bond principles https://www.bolsadesantiago.com/bonos_verdes_descripcion 43 CHILE will or will not accept in terms of characteristics of labelled bonds. As global jurisdictions, such as the EU, release stricter regulations, this may change investor appetite globally. However, for the time being, as this market continues to develop within Chile, it remains appropriate for BCS to adhere to ICMA standards. 60. Stock market capitalization in Chile is high relative to regional peers, and ESG-weighted indices are being introduced to highlight the relative ESG performance of listed corporates. Two ESG-weighted indices have been introduced to Chile’s domestic market: The 102 S&P IPSA ESG Tilted Index, and the Dow Jones Sustainability Chile Index. These indices select and weight constituent companies that form part of the S&P IPSA, Chile’s headline stock index, which includes the largest and most liquid stocks listed on the BCS. However, given market uncertainty about what constitutes good ESG performance, indices may not provide as much transparency about good environmental performance among Chilean corporates (see section on ESG ratings for a further elaboration of these issues). Among asset managers that were interviewed for this assessment, these indices complement their own more comprehensive analysis of ESG firm or issuer performance. 61. As institutional investors and asset managers step-up their screening of ESG factors, use of ESG-weighted indices and related products is likely to increase in relevance. More and more asset managers globally are recognizing the value of sustainable investing, with the number of asset managers in the APEC region signing up to the UN PRI almost tripling in five years.103 In Chile, the SP has introduced regulation to ensure that climate risks form a part of the matrix of risks that AFPs must review, mandating the inclusion of ESG factors as part of the risk management and investment processes as part of these critical investors. 62. While attention has been given to the role of greening public markets, private markets also have an important role to play to channel capital to green activities and investments. Private markets - including private equity and debt, infrastructure, and real estate – are already playing a significant role in financing Chile’s economic activities. According to Finstats, private bond market capitalization in Chile is 33.5% of GDP while public bond market capitalization is 14.4% of GDP as of 2015 (Finstats, financial structure database). Investment in clean energy in Chile has been estimated at US $8.5bn between 2009-2015. Commercial banks, along with private equity, have traditionally been the ‘first movers’ on 102 https://www.bnamericas.com/en/news/santiago-stock-exchange-sp-dji-launch-new-esg-index https://www.oecd.org/finance/financial-markets/Trends-in-ESG-Investing-and-Quality-Infrastructure-Investment-in-Asia- 103 Pacific.pdf 44 CHILE clean energy financing – notably through project finance. Around a third of all banks operating in Chile are financing renewable energy projects including wind, solar and small hydro, accounting for more than US$ 300 million by 2013. 63. In particular, sustainable investment funds are growing globally at a rapid pace. The global sustainable fund universe encompasses open-end funds and exchange-traded funds globally that, by prospectus, fact sheet, or other available resources, claim to have a sustainability objective and/or use binding environmental, social, and governance criteria to select investments. The sustainable funds group does not contain funds that employ only limited exclusionary screens such as controversial weapons, tobacco, and thermal coal, nor does it contain the growing number of funds that now formally integrate ESG considerations in a nondeterminative way for their investment selection. Money market funds, feeder funds, and funds of funds are excluded. Global assets in sustainable funds reached USD 3.9 trillion at the end of September 2021 as the number of funds in Europe increased by two thirds following the introduction of the EU Sustainable Finance Disclosure Regulation (SFDR). Since 2019, the assets of European ESG growth funds, which invest mainly in young and innovative companies, have grown over four times faster than those of non-ESG growth funds104 as an increasing number of international investors commit to align their portfolio with a net zero target105. This growth is expected to continue in Europe, as the EU Taxonomy and the SFDR takes effect. These policies will force asset managers in the EU to disclose their share of taxonomy-aligned assets under management, inevitably creating an incentive to raise that share to remain competitive. 64. In other emerging market contexts, blended equity and debt funds for MSMEs are aligning with the UN-backed principles for responsible investment (PRI) to ensure investments are sustainable. MSMEs that benefit from fund investments are required to measure their carbon footprints and develop appropriate action plans. Concessional/grant funds from local or global development banks also help curb any additional costs of these diagnostic efforts. In Colombia, a blended finance platform incubated within FDN, the domestic infrastructure-focused DFI, blends global concessional finance with domestic and international capital and offers an array of products to support sustainable infrastructure 104 https://www.ecb.europa.eu/pub/financial-stability/macroprudential bulletin/focus/2021/html/ecb.mpbu_focus202110_3.en.html 105 https://www.unepfi.org/news/industries/investment/net-zero-asset-owner-alliance-members-to-cut-portfolio-emissions-25-30- by-2025/ https://www.netzeroassetmanagers.org/net-zero-asset-managers-initiative-signatories%20disclose-interim-targets-with-over-a- third-of-assets-managed-in-line-with-net-zero 45 CHILE development: a first loss guarantee fund for renewable energy and clean technology; a guarantee fund for green municipal bonds; a bond fund purchasing green bonds issued by commercial banks; and a technical assistance facility to support climate-related project preparation. 65. Equity markets are also important as they tend to fund innovative sectors with intangible assets and typically have a longer-term investment horizon. Responsible stewardship practices encourage asset owners to actively monitor, encourage, and challenge companies by using their rights and direct/indirect influence to promote long-term, sustainable value generation. According to the 2020 Edelman Trust Barometer Special Report: Institutional Investors, 88% of LPs globally use ESG performance indicators in making investment decisions, and 87% said they invest in companies that have reduced their near- 106 term return on capital so they can reallocate that money to ESG initiatives. For general partners, this means that ESG is fast becoming a central factor in raising money. Some firms, e.g. EcoVadis, are commissioned by fund managers to undertake annual assessments of portfolio companies to demonstrate how ESG maturity has improved under its ownership. 66. Chile’s investment funds have begun to integrate ESG factors into investment decision- making, spurred on, in part, by capacity building measures of the Association of Chilean Investment Funds (ACAFI). Investment funds in Chile manage over US$14.4 billion in assets, or nearly 16% of GDP.107 More than 40% of the assets that they manage are from pension funds or insurance assets. Public funds heavily invest in the housing and alternatives, such as infrastructure. Chile’s new building construction standards should help push greenfield construction towards use of more sustainable materials and building practices. In addition, there is some evidence that broader ESG factors are beginning to influence allocation decision-making on the part of public and private investment funds, with the Association noting that its members have requested more information on best practice approaches to the analysis of ESG factors across different asset classes, rethinking selection, screening, and valuation practices. The domestic investor base 67. A key distinguishing feature of the Chilean financial system is the importance of non- bank financial intermediaries, in particular the pension funds which are the largest holders of domestic government securities (43 percent). While the holdings of other 106 https://www.bain.com/insights/esg-investing-global-private-equity-report-2021/ 107 https://www.acafi.cl/wp-content/uploads/2022/01/Presentacio%CC%81n-Industria-Acafi-040122.pdf 46 CHILE domestic non-bank financial intermediaries such as insurance companies and mutual funds are more limited, foreign investors have a large presence in the domestic government securities market (15 percent), which reflects the weight of the country in international local currency bond indices. Recent measures by the pension fund supervisor to ensure that pension fund managers are adequately assessing climate related risks may lead to more demand by pension fund managers for green or climate-risk ‘adjusted’ assets. The holdings of government securities by the banking sector have increased recently (30 percent of domestic government securities), partly compensating for the withdrawal of the pension funds. This shift was facilitated by the liquidity support provided by the central bank in response to the COVID-19 pandemic. As banks and pension funds are compelled to assess and manage climate related risks, and disclose the climate related risks affecting their portfolios, their demand for certified green assets, including green government debt, are likely to increase. 68. Against this backdrop, the SP’s recent introduction of new rules to compel pension fund managers (AFPs) to take climate risks into account is a positive step in the right direction. Chilean pension funds represent an important source of long-term finance for Chilean firms and economic activity. The SP introduced NCG N° 276 and Resolution N° 43 which compels AFPs to explicit consider climate and ESG risks as part of the risk matrix of Funds. ESG factors are also established as a new criteria in the best practice guidelines in the investment process for AFPs. This new regulatory context is108 positive news for issuers and corporates that are seeking new funding as they integrate best sustainable finance practices. The introduction of these guidelines will compel an important facet of Chile’s domestic investor base to seek out investments across different asset classes that are credibly committing to risk-adjusted investments with the same or better return expectations. At the same time, the move might compel portfolio managers to introduce new sustainable funds with explicitly sustainability-oriented investment outcomes. 69. In the face of Chile’s landmark disclosure rule, insurance companies and asset managers also report new attention to the need to integrate ESG factors in the credit analysis and investment process. Asset managers that manage insurance assets in Chile, as in other global contexts, report being at the forefront of climate risk analysis and management. These practices also extend to the investment process, as several asset managers cite Board directives that compel them to exclude investments in fossil-fuel related debt and equities. Beyond exclusion criteria, asset managers also report continued inclusion of ESG factors in their investment and credit 108 NCG N° 276 47 CHILE analysis processes. However, lack of standardized, regular data continues to be a challenge. There is hope that CMF’s new disclosure rule will help improve the availability of actionable ESG data. 70. 9 of the 21 mutual funds operating in Chile have ESG funds, according to the Mutual Fund Association of Chile. Mutual funds have begun investing in ESG assets, and there’s reason to believe that new regulatory efforts will compel more funds to seek out new green opportunities. Few investment funds currently report having dedicated ESG funds (with ACAFI noting that impact funds, that deliver below market returns to investors in exchange for outsized ESG-oriented non- financial returns, have grown to US$318 million by 2020). 109 4.3 Strengthening the climate information architecture 71. In late 2021, the Network for Greening the Financial System proposed a three-pronged approach to bridging data gaps to strengthen the conditions that would allow private capital to be channeled towards priority climate activities and investments.110 The approach was centered on: (i) rapid convergence towards a common and consistent set of global disclosure standards; (ii) efforts towards a minimally accepted global taxonomy; and (iii) development of well-defined and decision-useful metrics, certification labels, and methodological standards. Chile has made significant strides in all three areas, with further efforts needed to align domestic efforts with emerging global standards to ensure interoperability and standardization between jurisdictions. Disclosure 72. Improving the availability of climate-relevant data to ensure comparable, interoperable sustainability information can inform greener investment decisions. The news that the International Sustainability Standards Board (ISSB) has been formalized in November 2021 to develop global high-quality sustainability disclosure standards to meet investors’ information needs was for many a high point of COP26. The IFRS Foundation will complete the consolidation of the Climate Disclosure Standards Board and the Value Reporting Foundation (which houses the Integrated Reporting Framework and the Sustainability Accounting Standards Board (SASB) Standards) by June 2022. A climate prototype has also already been released. 111 109 https://www.acafi.cl/wp-content/uploads/2022/01/Presentacio%CC%81n-Industria-Acafi-040122.pdf 110 https://www.ngfs.net/en/progress-report-bridging-data-gaps 111 https://www.ifrs.org/content/dam/ifrs/groups/trwg/trwg-climate-related-disclosures-prototype.pdf 48 CHILE 73. In parallel, Chile has become the first country in the world to codify the use of SASB Standards into its Securities law - the next step for Chile will be to ensure disclosures are aligned with the ISSB’s work. The announcement by the CMF is part of a clear trend by Chilean policymakers in recognizing the vital importance of robust, industry-specific, sustainability disclosure. The availability of this data will support evidence informed decision making by investors, supporting the move towards investment allocations in line with sustainability priorities. The regulatory move helps to more rapidly introduce these practices in the Chilean context. Indeed, in a 2019 CMF assessment, only 176 Chilean issuers (out of nearly 14,000) were found to report their sustainability practices using the Global Reporting Initiative standard. 112 74. Chile’s adoption of a globally recognized sustainability standard should help report preparers in Chile be ahead of the curve as the ISSB works to develop a global sustainability standard. Financial institutions and non-financial corporates that already benefit from foreign investment saw these steps as a positive way to streamline and standardize information that they report annually. However, it remains to be seen the extent to which Chile’s disclosure regulations can be adapted to align with the ISSB’s future work. Investors must also be supported in helping to use this newfound trove of data in productive ways. 75. Appropriate review of what is disclosed, including green or sustainability oriented funds and instruments, will also be important to maintain the credibility of these standards. Emerging evidence of existing ‘greenwashing’ across global markets has been compounded by high profile instances of probes into mislabeled financial products (including by U.S. and German securities regulators against DWS in 2021113) and the probes launched in the summer of 2021 by U.S. and German regulators into Germany’s DWS for mis-labeling ‘green’ financial products underscore these concerns. CMF may wish to create an area specialized in the supervision of sustainable finance data in view of the need for adequate review of what is disclosed and to ensure CMF has the appropriate supervisory capacity to understand and interpret this non-financial data. Green taxonomy 76. Introducing a green or sustainable taxonomy can help to better define green and sustainable financial products. A taxonomy is a classification of sustainable (and 112 https://alessandri.legal/en/esg-and-climate-risk-to-be-part-of-the-investment-analysis-of-chilean-pension-funds/ https://www.ft.com/content/a3d6a8d1-0800-41c9-ab92-c0d9fce1f6e1?desktop=true&segmentId=7c8f09b9-9b61-4fbb-9430- 113 9208a9e233c8 49 CHILE unsustainable) economic activities. It could form the backbone of labeling for sustainable finance products, set prudential regulations and help support the building of benchmarks. Recently, the European Union and China introduced such taxonomies and useful insights can also be drawn from green bond taxonomies and FSB TCFD recommendations. 114 77. The International Platform on Sustainable Finance (IPSF) has synthesized global experiences into a Common Ground Taxonomy (CGT), which can be instructive for Chile. 115 The CGT is an analysis of the approaches taken under the EU and Chinese taxonomies, with the aim of developing a methodology for comparing and identifying commonalities and differences between some features of the two taxonomies. The CGT focuses on the following sectors as part of the initial effort: agriculture, forestry and fishing; Manufacturing; Electricity, gas, steam and air conditioning supply; Water supply; sewage, waste management and remediation activities; Construction; Transportation and Storage. 78. Given the influence of EU-domiciled investors in Chile, the EU taxonomy in particular can provide lessons-learned on how to use and introduce a taxonomy. Amongst other things, the expert group behind the EU taxonomy, highlights the importance of a taxonomy being flexible and adaptable over time, reflecting new insights on what is sustainable and what is not. It also highlights that a taxonomy should be detailed and granular enough to provide clarity. The EU also shows that such a taxonomy can be incorporated in regulations in order to formalize labeling for sustainable finance products and provide a basis for enforcement.116 In terms of scope the EU taxonomy has, to date, focused on the first two delegated acts on climate change mitigation and adaptation. Lack of alignment with the EU taxonomy could have implications on Chilean firms that benefit from European investment. As the EU’s taxonomy and sustainable finance disclosure regulation (SFDR) come into effect, fund managers will have incentives to ensure a greater share of investment portfolios are aligned with the taxonomy. Perhaps as a result of the influence of these regulations, Colombia became one of the first emerging market countries to publish a draft taxonomy based on the EU model in 2021. The box below describes Colombia’s taxonomy and its complementarities and differences with that of the EU. 114 EU Technical Expert Group on Sustainable Finance (2019). Taxonomy Technical Report. 115 https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/211104-ipsf-common- ground-taxonomy-instruction-report-2021_en.pdf 116 EU Commission (2018). Proposal for a regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment. 50 CHILE 79. Other jurisdictions, such as Mexico, are taking an expanded view of taxonomy development, by also reflecting on other dimensions of sustainability, including equity and gender. The review notes the importance of not limiting the taxonomy to green or sustainable economic activities, by also laying out a framework for unsustainable activities. This makes the taxonomy of better use to investors and regulators interested in identifying potentially riskier assets. It can also incentivize firms and issuers who fall in the unsustainable bucket to pursue green practices.117 80. Chile has rightly recognized the importance of a taxonomy for the financial sector by developing a roadmap for taxonomy development. The roadmap was prepared by the Climate Bonds Initiative at the request of the Ministry of Finance and the Public-Private Roundtable on Green Finance and in collaboration with the Inter-American Development Bank. 118 The roadmap rightly points to priority sectors including energy, transport, buildings and industry, while still emphasizing the importance of maintaining inter-operability with the taxonomy of other jurisdictions, including that of the EU. The roadmap provides a very helpful insights on the way forward for taxonomy development, particularly for complex sectors, including copper mining. For copper mining, the roadmap recommends that 94% of the energy consumption for surface mining and 82% of the energy consumption for underground mining should be provided by electricity and green hydrogen by 2050. Following the recommendations in this Roadmap, the Ministry of Finance announced in January 2022 the creation of a Preparatory Committee for the Classification System for Environmentally Sustainable Economic Activities. The Committee, convened and led by the Ministry of Finance, aims to coordinate the development of the Classification System for Environmentally Sustainable Economic Activities (“Green Taxonomy”). The Committee must define and agree on the structural elements necessary for the development of the Green Taxonomy. Among these structural elements are the environmental objectives, the classification system of economic activities to be used, the guiding principles of the taxonomy, among others. 117 NGFS (2019). A Call for Action: Climate Change as a Source of Financial Risk. 118 https://www.climatebonds.net/2021/05/taxonomy-roadmap-chile 51 CHILE The Colombian Green Taxonomy Broad partnership between relevant financial regulatory agencies. The Colombian green taxonomy was developed by the Superintendencia Financiera de Colombia (SFC) and the Ministry of Finance (Ministerio de Hacienda y Crédito Público or the MHCP), in coordination with the Department of Planning, the Department of Statistics, and the Ministry of Environment and Sustainable development, with technical assistance from the World Bank Group. The core principles of the taxonomy are to i) align with international standards (including the EU Taxonomy) where possible, ii) align economic activities with international standard industrial codes, iii) identify eligibility criteria and requirements for each asset and/or activity, and iv) reference, where necessary, practices or standards from environmental certification systems. Environmental objectives: climate change mitigation, climate change adaptation, protection of water resources, circular economy, pollution prevention, protection of ecosystems and biodiversity and land use management Architecture: The structure of the Colombian taxonomy is similar to that of the EU in that eligible activities must comply with technical screening criteria; do no significant harm to other objectives; and comply with social safeguards. Sectoral scope: Buildings, energy, ICT, industry, transport, water and waste, emissions control and capture, and land use (livestock, agriculture, and forestry). Tailored approach: While the first eight sectors relied heavily on the EU taxonomy, the land-use sectors were customized to suit Colombia’s natural and socio-economic context and address cross-sectoral solutions to key environmental issues. Historically, land development in Colombia has had highly concentrated ownership which combined with other structural issues (e.g., armed conflict, insecurity of land tenure, speculation through livestock occupation) has enabled deforestation and soil degradation. The taxonomy describes this socio-economic context together with the associated country-specific environmental challenges and targets (i.e., water and soil management, climate mitigation and adaptation, protecting biodiversity and ecosystem services) that the country has incorporated in its environmental policy and regulatory system. For each sector, the taxonomy’s eligibility criteria consist of the minimum legal requirements locally applicable, “do not harm” measures to protect natural resources, and a set of sustainable practices and technologies that have been tried and tested and deemed feasible in Colombia. As most of the farms are small and medium size, the taxonomy classifies land-use improvements across three levels —basic, intermediate, and advanced— based on complexity and cost. The level of improvement undertaken will depend on the farm reconversion or forest management plan that all farms in Colombia are required to incorporate. This type of tailored approach is consistent with other taxonomies under development, and once tested, has the promise to serve as a useful model for other emerging countries. Source: Superintendencia Financiera de Colombia 81. Other sectors that can contribute to Chile’s efforts to curb GHG emissions could also benefit from more explicit labels to guide investment decisions. For instance, to provide standards on what can be considered ‘green’ buildings, the authorities could also introduce energy efficiency labeling. Chile has in fact already contemplated such a system by 52 CHILE introducing an energy efficiency law in January 2021 that mandates the rating for all new or newly renovated buildings in Chile. Labels for green assets, for example for buildings and motor vehicles, can help banks and other investors better identify green investments and develop financial products related to them. 119 This new system may also provide an additional indicator of the quality of collateral (e.g., the vulnerability of assets to tightened energy efficiency standards and potentially increasing prices of utilities). Certifying ESG external reviewers and data providers 82. Market participants already use the services of external reviewers to validate the greenness of assets or activities with green frameworks and standards. For instance, third-party verification is often used pre and post-issuance of green and thematic bonds to ensure that bond proceeds have been managed appropriately, in accordance with the issuer’s framework. For asset managers and asset owners, external verification helps to provide an additional step of due diligence to ensure private capital is flowing in the manner as was stipulated. For European domiciled bond investors, external verification from a credentialed entity will likely be a critical step towards ensuring the green bonds meet with the proposed EU Green Bond Standard. 119 In other markets labeling systems have supported financial product development. In Europe for example, all commercial and residential buildings are labeled on a scale from A-G, A for the most efficient buildings, G for the least. In the Netherlands, this system of labeling is now generally tracked by banks and considered when issuing for example (green) mortgages and commercial real estate loans. Subsequently, a combination of government regulations and consumer preferences has led to notable impacts on pricing of energy efficient housing and commercial real estate. This again has further spurred banks in offering discounts for green buildings, as they perceive these assets of better quality. See DNB (2017) for an early exploration of this topic. 53 CHILE 83. Regulators can and should play a role in ensuring that there is appropriate oversight of external reviewers and verifiers. ESG data providers, including those entities that provide ratings to corporates based on their purported ESG performance, use a diversity of methodologies to evaluate firm ESG performance, especially with respect to environmental performance. While traditional credit analysis yields correlations among major rating agencies as 0.99, environmental performance ratings correlate substantially less (0.61) among the major providers.120 The wide variety of ESG rating methodologies reduces the incentive of firms and funds to invest in ways that might improve their ESG performance and therefore rating. There is also uncertainty in the market on the exact actions that would improve ESG ratings or even which ESG certification would be most credible in the market. As a result of this confusion, IOSCO has recently issued guidance to regulators on the issue of ESG data 121 ratings and data product providers. The report noted that, as the use of ESG ratings and data products has grown, the need for securities regulators to understand their role and influence has become more important. Of specific import is the need to better understand the methodologies underpinning the assessment of environmental performance among entities that receive ESG ratings, as well as the importance of avoiding conflicts of interest among ESG ratings and data providers. The OECD has also recently called for ESG ratings providers to emphasize the role of emissions reductions as part of ratings (instead of focusing solely on the role of disclosure).122 Chile should follow the same path of working to understand the ESG data providers that exist in the domestic marketplace, with the intention of providing appropriate oversight where necessary. 84. Chilean regulators should consider the adoption of minimum qualification entry requirements for private entities that provide green assessment, rating, or verification services. A parallel can be drawn here with credit rating agencies, as historically regulators in jurisdictions such as Japan, France, Hong Kong Special Administrative Region (SAR), and the US, have provided official recognition to rating agencies that meet certain criteria. Official recognition or verification schemes for private verifiers provides a level playing field for external reviewers, guarantees some set of minimum qualifications to ensure the quality of external review, and enhances comparability across private solutions. For example, the category of green bonds adheres to the “Climate Bonds Standard” (which contains scientific criteria consistent with the 1.5 degrees Celsius target declared in the 2015 Paris Agreement) must receive certification by an approved verifier (of which there are currently 55) across the Berg, F., Koelbel, J. F., and Rigobon, R. (2019). Aggregate confusion: The divergence of esg ratings. MIT Sloan School Working 120 Paper 5822-19 121 https://www.iosco.org/library/pubdocs/pdf/IOSCOPD690.pdf 122 https://www.responsible-investor.com/articles/oecd-report-calls-for-greater-focus-on-emissions-reductions-in-esg-ratings 54 CHILE world.123 To become an approved verifier, an entity must prove expertise in: debt issuance, technical aspects of low carbon projects, and the provision of assurance services. 85. Several countries are implementing regulatory frameworks to establish a minimum set of qualifications for green reviewers. In Russia, the national economic development institution (VEB.RF) plays a key role in selecting verifiers which allows them to ensure the underlying analytical methodologies are in line with government objectives. Similarly, Chinese authorities have introduced a framework for enabling private institutions to certify green bonds with the aim of preventing greenwashing and enhancing the credibility of green certification. The box below provides additional information on recent regulatory developments in two jurisdictions – China and the European Union– to supervise private verifiers. 123 For more details, see https://www.climatebonds.net/certification/approved-verifiers 55 CHILE Recent regulatory approaches for green verification entities China The People’s Bank of China (PBC) and China Securities Regulatory Commission (CSRC) introduced the Guidelines for the Conduct of Assessment and Certification of Green Bonds (Interim) in 2017, which define the qualifications for institutions carrying out assessments and certification of green bonds. Institutions must have: an established organizational structure, workflow, technical methods, fee rates, quality control; Qualifications for practice in the rating, certification, attestation, energy, climate, or environment field granted by competent authorities; Corresponding professionals in the accounting, auditing, finance, energy, climate, or environment field; ‘clean hands’, i.e. comitted no violation of laws and regulations and maintained a spotless record of integrity in the last three years or since its formation. In September 2021, the PBC and CSRC updated the Guidelines by calling for market-based assessment of green bond assessment and certification institutions. The process of verification of certifiers will be led by the 25 members of the Green Bonds Standard Committee, which are public entities with the National Association of Financial Market Institutional Investors in the lead position. European Union The Technical Expert Group on sustainable finance (TEG) set up by the European Commission published a report on 18 June 2019124 in which it recommends an accreditation regime for verifiers of the EU Green Bond Standard. The report analysed four different options for improved oversight and supervision of external review providers through accreditation: 1) A centralised regime for authorisation and supervision by the European Securities and Markets Authority (ESMA). This is also the recommended option in the report. 2) A decentralised regime, involving national competent bodies (national regulators, national ecolabelling authorities) in EU Member States on a harmonised basis, possibly coordinated by ESMA in cooperation with other EU institutions (e.g. European Environment Agency, European Banking Authority (EBA), European Central Bank). 3) Do nothing, i.e., status quo and/or de-facto harmonisation with ISO 14030. 4) Market-based regime with European Commission participation, in the form of an interim scheme convened by a market-based initiative in coordination with the future EU Platform on Sustainable Finance. 124 https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/190618- sustainable-finance-teg-report-green-bond-standard_en.pdf 56 CHILE ANNEX I OVERVIEW OF CHILEAN LAWS, PROGRAMS AND ACTION PLANS RELATED TO CLIMATE CHANGE National laws, programs and action plans National Climate The bill was submitted to the National Congress in January 2020. It was approved Change Bill in general terms and currently (August 2021) the details of the bill are under consideration with an “immediate discussion” status. Tax Modernization In February 2020 a tax modernization law was approved that considered specific Law (Law 20.780)125 adjustments to the green tax aiming at incentivizing emissions reductions, to be introducing a green implemented by 2023. Two main changes were incorporated: i) the criteria to tax determine facilities subject to tax, by amount of yearly emissions; ii) the incorporation of emission offsets in relation to the implementation of emission reduction projects. Net Billing (Law The Law was published in November 2018 and modified the previous law on net 21.118) 126 billing (Law 20.571 of 2014) incentivizing residential distributed generation. The law regulates the functioning of non-conventional renewable energy for self- consumption, allowing for residential users to inject energy into the system. Non-Conventional The Law was published in October 2013 and fostered the participation of non- Renewable Energies conventional renewable energy in the Chilean energy matrix. (Law 20.698)127 Regulation of The regulation, which is currently under public consultation, defines a process compensations for through which green taxpayers can offset their emissions by using compensation the Green Tax128 credits coming from local projects. Climate Finance Strategy Long-Term Climate The strategy will establish the guidelines for the national climate policy to be Strategy (in public aligned with the vision and long terms goals defined by the Climate Change Law, consultation) on how to reach carbon neutrality and enhanced resilience by 2050. Regional Climate These plans set the overall priorities and actions required at a subnational level to Change Action Plans address climate change goals, both in mitigation and adaptation. Sectorial adaptation The current and future adaptation plans are: national adaptation plan (to be plans updated soon), biodiversity (to be updated soon), agriculture and forestry (to be updated soon), fishing and aquaculture, health, infrastructure, energy, cities, and tourism. The water resources plan is going to be elaborated soon; coasts and mining plans are going to be elaborated by 2022. The National plan establishes the framework for climate change adaptation in Chile and articulates sectoral plans which define sectorial priorities and measures. Sectorial mitigation The current plans are for the energy and infrastructure sectors, which define plans sectorial priorities and measures. The Climate Change Law will establish mitigation plans for other several key sectors. 125 https://www.bcn.cl/leychile/navegar?idNorma=1142667 126 https://www.bcn.cl/leychile/navegar?idNorma=1125560 127 https://www.bcn.cl/leychile/navegar?idNorma=1055402 128 https://consultasciudadanas.mma.gob.cl/storage/consultation/iOLeVqU11xEpYAnM3aMhqFXiccJqeUuuZf6yjxDm.pdf 57 CHILE National Strategy of Presented in November 2020, this is a long-term policy that establishes the Chilean Green Hydrogen129 ambition to create a new industry, setting three main goals: to produce affordable green hydrogen by 2030; being among top 3 exporters by 2040; and to develop 5 GW of electrolysis capacity by 2025. National Published in 2017, established concrete goals for the use of electric vehicles, as by Electromobility 2040 all public urban transport to be electric and 40% of private vehicles to be Strategy130 electric. National Strategy of Published in 2017, it is a policy instrument that orients and integrates activities Climate Change and and measures aimed at mitigating and adapting to climate change, together with Vegetational facing desertification, land degradation and drought. Resources 2017- 2015131 Organic Waste The Strategy defines goals aiming a transition towards circular economy, Strategy 2040132 proposing a general goal of increasing the recovery and value of municipal organic waste from 1% to 66% by 2040. Circular Economy The document defines a vision by 2040 consisting of a regenerative circular Roadmap 2040133 economy that guides Chile toward sustainable, just, participative, and wellbeing- oriented development. International commitments NDC 2016 NDC 2020 update The updated NDC was elaborated during 2019 and 2020 and presented to the UNFCCC in April 2020. It establishes more ambitious goals for 2030, in line with carbon neutrality by 2050. 129 https://energia.gob.cl/sites/default/files/estrategia_nacional_de_hidrogeno_verde_-_chile.pdf 130 https://energia.gob.cl/sites/default/files/estrategia_electromovilidad-8dic-web.pdf 131 https://biblioteca.digital.gob.cl/handle/123456789/3372 132 https://economiacircular.mma.gob.cl/wp-content/uploads/2021/03/Estrategia-Nacional-de-Residuos-Organicos-Chile-2040.pdf https://economiacircular.mma.gob.cl/wp-content/uploads/2021/07/HOJA-DE-RUTA-PARA-UN-CHILE-CIRCULAR-AL-2040-ES- 133 VERSION-COMPLETA.pdf 58 CHILE ANNEX II ENERGY BALANCES 59 CHILE 60 CHILE ANNEX III MAP OF CHILE 61 CHILE ANNEX IV PHYSICAL RISKS IN THE BANKING SECTOR Table 1 Natural hazard map per region in Chile (2020)134 Hazard Region Drought Earthquake Floods Landslides Wildfires Aisen del Gral. Carlos Ibañez del Campo Antofagasta Araucania Arica y Painacota Atacama Biobio Coquimbo Libertador Gral. Bernardo O'Higgins Los Rios Los Lagos Magallanes y Antartica Chilena Maule Metropolitana Tarapaca Valparaiso Table 2 Loan portfolio banking sector per region (2020) Exposures per region (Dec 2020) Exposures to high/medium risk events (Jan 2020) # Provinces CLP millions USD % CLP millions % 1 Región de Arica y Parinacota 1,280,869 1,631,680,431 0.67% 64,173 5% 2 Región de Tarapacá 1,880,932 2,396,092,076 0.99% 261,765 14% 3 Región de Antofagasta 3,751,352 4,778,792,133 1.97% 446,831 12% 4 Región de Atacama 980,069 1,248,495,866 0.51% 148,018 15% 5 Región de Coquimbo 2,667,679 3,398,317,684 1.40% 667,235 25% 6 Región de Valparaíso 6,606,761 8,416,255,420 3.46% 2,315,079 35% 7 Región Metropolitana de Santiago 134,674,389 171,559,731,777 70.60% 48,267,206 36% 8 Región del Libertador Gral. Bernardo O’Higgins 2,725,468 3,471,933,463 1.43% 1,765,702 65% 9 Región del Maule 3,283,647 4,182,990,044 1.72% 1,784,109 54% 10 Región de Ñuble 2,387,339 3,041,195,890 1.25% - 0% 11 Región del Biobío 5,456,114 6,950,464,188 2.86% 2,481,554 45% 12 Región de La Araucanía 2,840,093 3,617,952,776 1.49% 1,405,461 49% 13 Región de Los Ríos 1,922,510 2,449,056,824 1.01% 405,588 21% 14 Región de Los Lagos 3,528,997 4,495,537,173 1.85% 1,407,542 40% 15 Región Aisén del Gral.Carlos Ibáñez del Campo 433,589 552,342,237 0.23% 52,387 12% 16 Región de Magallanes y de la Antártica Chilena 1,246,612 1,588,041,281 0.65% 168,323 14% No avaiable 15,088,973 19,221,621,518 7.91% Total loan portfolio 190,755,393 243,000,500,780 100.00% 61,640,974 32% Total assets 356,390,000 454,000,000,000 134 The red shades reflect four levels of hazard materiality ratings: very low (yellow), low (orange), medium (dark orange), and high (red). This classification follows the ThinkHazard! methodology. For instance, the hazard level of drought is classified as medium if there is up to 20 percent chance droughts will occur in the coming 10 years. For additional reference, see https://thinkhazard.org/en/report/51-chile. 62 CHILE Table 3 Economic sectors sensitive to natural hazards Natural Disaster Most affected sectors Wildfire A02 Forestry, logging and related service activities Flood A01 Agriculture, hunting, and related service activities F Construction K Real estate, renting and business activities H Hotels and restaurants Landslide I Transport, storage and communication Earthquake F Construction K Real estate, renting and business activities Storm A01 Agriculture, hunting, and related service activities B Fishing F Construction K Real estate, renting and business activities H Hotels and restaurants C11 Extraction of crude petroleum and natural gas Storm A Agriculture, hunting and forestry Table 4 Geographical exposures in banking sector sensitive to natural hazards (amount) Hazard Region Total Drought Earthquake Floods Landslides Wildfires Aisen del Gral. Carlos Ibañez del Campo 14,836 41,916 55,672 9,391 1,080 122,894 Antofagasta 7,377 355,732 362,456 83,068 653 809,287 Araucania 299,587 521,714 782,688 62,445 38,614 1,705,048 Arica y Painacota 33,805 28,207 59,851 14,496 2,161 138,520 Atacama 35,487 79,978 114,364 31,453 1,101 262,382 Biobio 469,654 876,820 1,232,006 258,260 114,468 2,951,208 Coquimbo 228,872 367,424 590,188 64,831 6,108 1,257,423 Libertador Gral. Bernardo O'Higgins 565,455 275,058 819,677 84,677 20,836 1,765,702 Los Rios 158,871 111,927 246,312 22,862 24,486 564,459 Los Lagos 332,249 440,889 758,719 193,516 14,419 1,739,791 Magallanes y Antartica Chilena 75,324 98,465 171,200 67,269 2,589 414,848 Maule 621,102 521,384 1,104,650 120,240 37,836 2,405,211 Metropolitana 2,775,459 19,418,959 21,937,986 3,878,371 256,431 48,267,206 Tarapaca 2,789 221,460 223,415 36,684 833 485,181 Valparaiso 295,731 731,581 1,009,033 260,455 18,279 2,315,079 All Regions 5,916,597 24,091,513 29,468,218 5,188,018 539,892 65,204,239 <-- Non-financial credit portfolio 130,408,479 <--Total credit porfolio 356,390,000 <-- Total assets Table 5 Geographical exposures in banking sector sensitive to natural hazards (percentage) Hazard Region Drought Earthquake Floods Landslides Wildfires Aisen del Gral. Carlos Ibañez del Campo 0.0% 0.0% 0.0% 0.0% 0.0% Antofagasta 0.0% 0.3% 0.3% 0.1% 0.0% Araucania 0.2% 0.4% 0.6% 0.0% 0.0% Arica y Painacota 0.0% 0.0% 0.0% 0.0% 0.0% Atacama 0.0% 0.1% 0.1% 0.0% 0.0% Biobio 0.4% 0.7% 0.9% 0.2% 0.1% Coquimbo 0.2% 0.3% 0.5% 0.0% 0.0% Libertador Gral. Bernardo O'Higgins 0.4% 0.2% 0.6% 0.1% 0.0% Los Rios 0.1% 0.1% 0.2% 0.0% 0.0% Los Lagos 0.3% 0.3% 0.6% 0.1% 0.0% Magallanes y Antartica Chilena 0.1% 0.1% 0.1% 0.1% 0.0% Maule 0.5% 0.4% 0.8% 0.1% 0.0% Metropolitana 2.1% 14.9% 16.8% 3.0% 0.2% Tarapaca 0.0% 0.2% 0.2% 0.0% 0.0% Valparaiso 0.2% 0.6% 0.8% 0.2% 0.0% All Regions 4.5% 18.5% 22.6% 4.0% 0.4% Color codes Very low Low Medium High 63 CHILE ANNEX V TRANSITION RISK IN THE BANKING SECTOR Table loan portfolio banking sector per sector Sector USD % A - Agriculture, livestock, forestry and fishing 7,765 3.20% B - Mining and quarrying 2,377 0.98% C - Manufacturing industry 10,569 4.35% D - Supply of electricity, gas, steam and air conditioning 4,577 1.88% E - Water supply, sewage disposal, waste management and decontamination 1,109 0.46% F - Construction 8,286 3.41% G - Wholesale and retail trade, repair of motor vehicles and motorcycles 15,879 6.53% H - Transportation and storage 4,577 1.88% I - Accommodation and food service activities 1,431 0.59% J - Information and communications 2,332 0.96% K - Financial and insurance activities 17,948 7.39% L - Real estate activities 16,369 6.74% M - Professional, scientific and technical activities 1,833 0.75% N - Administrative and support service activities 3,122 1.28% O - Public administration and defense, compulsory affiliation social security plans 296 0.12% P - Teaching 1,779 0.73% Q - Human health care and social assistance activities 1,468 0.60% R - Artistic, entertainment and recreational activities 169 0.07% S - Other service activities 394 0.16% ZZ - No available 140,720 57.91% Grand Total 243,000 100.00% Table Economic sectors sensitive to transition risk 64 CHILE ANNEX VI PHYSICAL RISKS IN INSURANCE SECTOR Table Insurance sector written premium 2020 Insurance Type sub-type written premium Share Pension life annuities 1,605,922,334 24% Compulsory disability and survivorship insurance 1,357,564,812 21% Health 887,213,519 13% Unit Linked insurance plan 835,049,882 13% Credit Life insurance 621,868,894 9% Life Life 495,244,339 8% Voluntary pension savings 461,937,793 7% Personal Accident 208,523,913 3% Non-pension life annuities 43,208,657 1% Compulsory personal accident insurance 6,136,608 0% other 59,949,838 1% Subtotal 6,582,620,589 100% Fire, earthquake and other perils Fire 504,725,399 11% Fire, earthquake and other perils Fire business interruption 74,996,412 2% Fire, earthquake and other perils Fire special perils 47,003,484 1% Fire, earthquake and other perils Earthquake and tsunami 929,479,347 21% Fire, earthquake and other perils Earthquake business interruption 81,228,850 2% Fire, earthquake and other perils Natural perils 43,428,003 1% Fire, earthquake and other perils Terrorism 109,143,773 2% Motor 1,148,585,347 26% Liability 217,909,905 5% Unemployment 196,195,609 4% Non-life Credit and surety 181,910,769 4% Transport 158,076,786 4% Engineering 153,157,531 3% Theft 138,812,734 3% Personal accident 85,339,462 2% Compulsory accident insurance 73,676,562 2% Hull 60,976,357 1% Agriculture 12,119,155 0% Health 7,572,087 0% Other 209,859,299 5% Subtotal 4,434,196,871 100% Total 11,016,817,460 Source: insurance association 65 CHILE ANNEX VII TRANSITION RISK IN INSURANCE Transition Sensitive industry Mapped sectors Fossil fuels C11 Extraction of crude petroleum and natural gas Energy generation E Electricity, gas and water supply Heavy industry C Mining and quarrying (excl C11) D20 Manufacturing of wood and products of wood and cork D21 Manufacture of paper and paper products D23 Manufacture of coke, refines petroleum products and nuclear fuel D24 Manufacture of chemicals and chemicals products D25 Manufacture of rubber and plastic products D26 Manufacture of other non-metallic mineral products D27 Manufacture of basic metals D28 Manufacture of fabricated metal products, except machinery and equipment D29 Manufacture of machinery and equipment D31 Manufacture of electrical machinery and apparatus D34 Manufacture of motor vehicles, trailers and semi-trailers D35 Manufacture of other transport equipment D36 Manufacture of furniture Transport I Transport, storage and communication Agriculture A Agriculture, hunting and forestry Table insurance sector – breakdown investment portfolio Industry Total Equity Bonds Alternative 10101010 Oil & Gas Drilling & Services 1,848,696 12,152 1,836,544 - 55101010 Electric Utilities 7,178,145 118,850 6,465,720 593,574 151010 Chemicals 4,550,888 82,623 4,355,721 112,544 20301010 Air Freight & Logistics 3,984,120 19,472 3,496,017 468,631 302020 Food Products 1,595,332 39,031 1,556,301 - 25101010 Auto Parts & Equipment 2,785,161 47,275 2,733,523 4,363 21,942,342 319,403 20,443,826 1,179,113 100% 1.5% 93.2% 5.4% 66