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Local markets hold future as LatAm green gets up to speed

After a sluggish start, Latin American green bond activity is picking up. But for green financing to really gain influence, it needs to continue its progress in domestic markets. Olly West reports.

In 2015, Nacional Financiera (Nafin) realised that it had a portfolio of renewable energy projects, of which several were denominated in dollars, that needed financing. But the Mexican development bank had not issued internationally since 1999, and wanted its return to be memorable. 

A green bond was deemed the solution, and Nafin set about its task seriously, obtaining certification from the Climate Bonds Initiative (CBI), and a second opinion from Sustainalytics. The state owned issuer was rewarded with more than $2.5bn of orders for a $500m five year deal.

“The green bond was not only a way to mark Nafin’s return to international bond markets, but also promoted this type of instrument in Mexico and Latin America,” says Pedro Guerra, deputy general director of treasury and markets at Nafin.

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Before Nafin, only Peruvian wind farm Energía Eólica in November 2014 and Brazilian food company BRF in June 2015, had sold green bonds from Latin America. 

DCM bankers had said development banks were needed to really get the market going, and Nafin’s deal certainly seemed to do the trick: Banco Nacional de Costa Rica (BNCR) issued a dollar denominated green bond in April, while multilaterals CAF and Cabei have both tapped the Uridashi market in 2016 — Cabei with a green bond and CAF with a “water bond”.

Furthermore, Brazilian pulp producer Suzano sold a green bond in June, and Mexico’s new airport lined up a green issue in September. Kurt Vogt, managing director in sustainable financing at HSBC, therefore argues that the “encouraging aspect” of progress in LatAm green bonds is the “great variety of issuers”.

Development banks are natural green bond candidates because they often have a climate friendly portfolio of projects to finance.

Sometimes the impetus comes from the bookrunners. According to Bernardo, Alfaro, deputy general manager of risk and finance at BNCR, the Costa Rican issuer’s structuring banks suggested the green bond when they realised that the majority of projects that the bank was planning to finance would count as eligible projects under the Green Bond Principles (GBPs).

Mexico leading the way

In a region the size of Latin America seven bonds hardly make a dent. But market participants say there is no lack of potential.

“There is a huge need for social and infrastructure investment in Latin America, which means there is a opportunity for investment with a green angle,” says HSBC’s Vogt.

If progress is slow, it is perhaps because — China and India apart — the green bond market in emerging markets is moving relatively slowly, according to Sean Kidney, chief executive of the CBI.

But on Kidney’s frequent trips across Latin America he has found interest, and he believes that that, although issuance will not be “massive”, the market should “grow significantly in the next 12 months”.

CBI is supporting two banks in Peru with potential green bonds, and there is plenty of work going on behind the scenes elsewhere, with September seeing the inaugural meetings of Brazil’s Council for Sustainable Market Development and a Mexican green bond committee co-chaired by Grupo Sura and Banorte.

Kidney believes that there would have been more green bond issuance from Brazil were it not for the country’s economic troubles, but Mexico appears to be the hub of activity.

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Indeed, Mexico City’s new airport, which plans to be carbon neutral, was financed by a green bond in September.

Guerra of Nafin says that the development bank’s green bond highlighted the Mexican government’s “commitment to environmental projects”, and others agree that the country is a leader in the region.

With its 2012 Climate Change Act, Mexico became only the second country in the world to enact a law committing to reducing greenhouse gas emissions, pledging to cut them by 30% by 2020 and 50% by 2050. Late in 2015, Mexico passed an energy transition law that should see 35% of power generated by clean energies.

These provide “a legal and political base for green projects in Mexico”, says Alba Aguilar, director of new markets at Mexico2, a carbon trading platform that produced a recent report on the state of the green bond Mexican market with CBI.

Nafin flags local opportunity

What, therefore, is holding back the market? For Kidney, it’s a question of project generation. “LatAm governments need to work on outlining the pipeline for green projects and look for fiscally efficient measures to incentivise private investment.”

This is perhaps one reason why Mexico is looking more promising. Aguilar at Mexico2 sees a “huge opportunity” to grow. “There should be stable flow of transport and renewable energy projects that will need financing,” she says.

Kidney does not think investor demand is the problem, and indeed all LatAm green bonds issued so far have attracted substantial orders. 

It is hard to know to what extent this is down to the green aspect. Guerra says that specialist green investors bought 40% of Nafin’s dollar green bond, while Alfaro says that 18% of the buyers allocated BNCR’s deal could be called green.

Yet green bonds have been an SSA-focussed product, and Manuel Lewin, head of responsible investment at Zurich Insurance, points out certain limiting factors in Latin America.

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“Many global green investors either have restrictions that mean it is not easy to place LatAm deals in their portfolios, or have limited appetite for EM risk,” he says.

This is why Nafin’s second green bond (a Mp2bn seven year deal sold in domestic markets in August 2016) could be so crucial. Lewin says that, for Zurich, it makes much more sense to look at LatAm from a local currency perspective.

Interestingly, although Zurich “liked the green framework” of Nafin’s dollar bond, the investment house struggled to find a home for a Mexican issuer in its US dollar portfolios. However, Zurich participated in the peso green bond by using its local balance sheet.

“Until now LatAm issuers have been thinking about green bonds as a dollar or euro product, but I hope that Nafin’s peso deal can be a sign of things to come,” says Lewin. “The future of green bonds in Latin America lies in domestic markets.”

Nafin’s peso deal earned broad praise for setting the standard; just like its dollar deal, it had CBI certification and a Sustainalytics report.

“Part of Nafin’s mandate is to develop domestic capital markets,” says Guerra. “With our peso-denominated green bond, we aim to start the local green bond market in Mexico and encourage issuers to follow.”

Of interest to Aguilar, who says Nafin’s peso deal was a “very positive sign”, was that the bonds were tagged as green on the stock exchange so that investors can identify them within portfolios. Similar issuances will begin to generate interest among the buyside, from where Aguilar says the leadership has to come.

“Green finance is a topic that has only recently become part of the discussion in Mexico, so we are working on educating the market,” she says. “Logically those investors with international networks are the first ones to have brought the concept of responsible investing here.”

Lewin admits that large international firms have a role in increasing local awareness, and says they have the resources, responsibility and interest to do so. But “interest has to begin with local institutions”, he adds.

The recently-formed green bond committee in Mexico thus unites representatives of various parts of the financial sector, including pension funds, insurance companies and bankers’ associations.

“It is very important when you are developing a new market that there is a consensus and no one’s voice is left out,” says Aguilar. 

Vogt echoes the importance of developing domestic green bond markets, and highlights a further reason it needs to lead the growth.

“One obstacle facing the green bond market in Latin America is finding issuers with enough green capex to justify the green use of proceeds,” says Vogt. “There are companies investing in the transition to a low carbon economy, but whose investments are not big enough to raise a liquid bond.”

With international deals usually needing to be $300m or more to have the liquidity investors seek, domestic markets, where deal sizes can be smaller, present an opportunity.

“As the bond size floor is lower, there is greater potential for green bond transactions in the local markets,” says Vogt. “Furthermore, many potential green bond issuers, like cities, want to issue in their own currency; they can do this in the local market.”   

  Green to go asset-backed with IIC   

Although the Inter-American Development Bank (IADB) has not issued a green bond, the Inter-American Investment Corporation (IIC), its private sector arm, aims to develop the market. Its most notable work is the creation of a platform to issue green securities backed by energy efficiency projects.

“Energy efficiency presents a huge opportunity but lacks financing,” says Maria Tapia, lead investment officer at the IIC. “Although commercial banks understand renewables, it is harder for them to finance energy efficiency. And these projects are typically too small to tap capital markets.”

After receiving approval for the project in 2014, the IIC is putting together an SPV to purchase a portfolio of receivables from energy efficiency projects. Once the vehicle has enough it will issue a green bond, backed by these cashflows, in the Mexican market. It is still accumulating the projects, so the first green bond is likely to be in 2017.

“The idea is we pre-finance the pool of projects and then, to make sure that there’s going to be good acceptance from institutional investors, we’ll co-guarantee the bonds with the green climate fund,” says Tapia. “We also don’t want to issue the bonds while there is still construction risk, so we will wait until the whole portfolio is generating cashflows before issuing.”

Two projects have already been approved in Mexico, and the IIC is hoping for approval for a third one involving solar projects. There is a similar vehicle, still in the approval process, planned for Colombia.