Brazil leads way for SRI bonds in LatAm
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Emerging Markets

Brazil leads way for SRI bonds in LatAm

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Green bonds have been limited in Latin America, but there is no shortage of progress behind the scenes as the region begins the unavoidable shift towards sustainability

As the green bond craze kicks on across the world, Latin America is somewhat left behind. Just three borrowers from the region have issued green bonds: Peruvian wind energy project Energía Eólica, Brazilian food company BRF and Mexican development bank Nafin.

Yet if COP21 in Paris in November was anything to go by, Latin American countries are well aware of the urgent need to transition to a low carbon economy, with several signing aggressive INDCs (intended nationally determined contributions). Moreover, they know this requires money.

“The need for infrastructure spending is there and so is the realisation that both domestic and international funding will be needed to finance the development and execution of good sustainable infrastructure projects,” says Tatiana Assali, who heads up networks and global outreach in South America at the UN-supported Principles for Responsible Investment (PRI).

“Governments cannot fund this transition alone. Private sector participation will be essential both in terms of financing and the creation of new ‘green’ instruments to bring diversity and scale to the market.”

One reason Latin American borrowers are not prolific issuers of green bonds is obvious: they are not prolific issuers of any bonds at all right now. Amid EM market turmoil and diminishing growth, regional issuance volumes are well below 2015 — itself a disappointing year. Sovereigns, typically not green bond issuers, have dominated supply.

“The green bond market in Latin America is currently developing at a slower pace because the type of issuer that usually issues green bonds is at the top end of the rating spectrum,” says Harry Koppel, director in SSAR origination at Barclays in London.

Koppel says that there are some development banks in the region that could potentially do a “proper carve-out transaction” but adds that the amount of structuring these would require means they may take time to materialise. No coincidence, then, that the best rated issuer in Latin America — the multilateral CAF — is starting work on the process [see box].

Furthermore, of the three green bonds to have emerged from the region so far, market participants say it was the one issued by a development bank that has provided the best model.

Gordon Kingsley, head of Latin America debt capital markets at Crédit Agricole, one of the three bookrunners on Nafin’s green bond, said it was a “really important trade” and that Nafin was “the perfect issuer” to get the green bond market going.

“It had the backing of the finance ministry and its portfolio is the greenest of the green, so we could get certification from the Climate Bonds Initiative,” he says.

A3/BBB+ rated Nafin sold $500m of five year green bonds in October 2015, attracting more than $2.5bn of orders and tightening initial price thoughts of low 200bp to a final spread over US Treasuries of 190bp.

According to Kingsley, the green aspect of the deal helped the borrower to “engage investors in a different way”, with many accounts saying “it was just what they had been looking for” in a green bond.

“Although it is hard to claim there was a pricing advantage from doing a green bond, the presence of green investors certainly helped demand stick as we tightened pricing,” says Kingsley.

No Mexican issuers have followed Nafin’s example, however, leaving Sean Kidney, CEO of the Climate Bonds Initiative, “slightly surprised”. He says that Mexico’s A3/BBB+/BBB+ credit rating means the country should have good prospects for green bonds.

Kidney is also seeing interest in Latin America’s other solidly investment grade economies: Peru, Chile and Colombia.

BRAZIL COULD BOOM AFTER BUST

In fact, some argue that the lack of triple-A names in Latin America should not be a hindrance for the development of the market. “I think green investors own a lot of triple-A names and are seeking diversification and higher yields,” says Kingsley. “We should begin to see demand for more single-A and triple-B credits, which will help Latin America.”

Kidney of the CBI says Latin America should not be focusing on SRI specialist funds that want triple-A paper but on “attracting mainstream investors who have or want SRI mandates”.

“Big investment and pension funds are telling asset managers that they want a bias towards green products,” he says. “There are also mainstream investors, including some central banks, pursuing SRI because they have a green policy.”

Indeed, the country generating most excitement among green bond enthusiasts in Latin America is one that has not just lost its investment grade rating but fallen emphatically from hero to zero in market standing: Brazil.

“There is a lot of interest in green bonds in Brazil at a government level and among potential issuers,” says Kidney. “There is initial interest from the renewable energy, biofuel, forestry and water infrastructure sectors, while [state-owned development bank] BNDES has also committed to doing a green bond once market conditions improve.”

Commodity producers in Brazil are also possible issuers as they “need to make sure that they are doing the right thing by the climate”. Kidney says that the industry is remarkably receptive to the idea. “They have understood that they have to get with the programme in terms of environmental protection,” says Kidney.

Market conditions — alongside broader economic and political volatility — are almost certainly why much of the green bond related work in Brazil is going unnoticed. Issuers have, in the words of CredAg’s Kingsley, “more pressing matters” to attend to.

“Some of the banks are good candidates but they don’t need funding of any kind, let alone green bonds,” he says.

Furthermore, with lucrative rates available on Brazilian domestic government paper, local investors can find high yielding opportunities in treasury bonds. All agree that this represents a major obstacle to starting a market that would be led by banks and corporates.

Overcome the market turmoil, however, and there will be plenty of optimism.

The Fundação Getulio Vargas Centre for Sustainability Studies (GVces) in São Paulo teamed up with Febraban, the Brazilian Federation of Banks, to produce a study on the opportunities and limits of the green bond market in Brazil in October.

Paula Peirão, project manager at GVces, believes there is potential for the market in the medium term. “The government and key financial institutions are very interested in the topic and once the market improves there should be dealflow,” she says.

The Febraban/GVces study first made general recommendations on the Brazilian debt markets that would help develop a green bond market. They highlighted the need for greater secondary market liquidity, fewer barriers to issuance and the need to reduce asymmetry in tax incentives for different classes of investments.

Indeed, the government’s attempts to encourage domestic infrastructure bonds in 2011 by offering fiscal incentives to investors did not take off.

“There is a need for structural improvements to the Brazilian capital markets in general and green bonds would benefit from reduced asymmetry in tax incentives for different classes of investment,” says Peirão.

But there are other more specific challenges.

“Firstly, there need to be uniform guidelines as to what is green so that it is easy for the second opinion to approve and so that investors think it is a credible market,” says Peirão, who points out that, in a time of crisis such as this in Brazil, credibility is particularly important.

Secondly, she highlights the need for the development of a local market for second opinion agencies. International agencies are understood to have been visiting the country and looking to create a market, but Peirão recommends they join with local players “in order to understand Brazil’s very specific way of working”.

She adds: “The more competitive the market for these agencies the lower the cost becomes for issuers.”

SEIZING ESG OPPORTUNITIES

Among the investor base, too, Brazil is leading the way.

PRI’s Assali says that Brazilian investors have shown the most advances in regulations and practices, “with many investors having quite progressive ESG (environmental, social and governance) methodologies”.

But across the region investors are advancing quickly in terms of how they incorporate ESG.

“Investors have historically given focus to corporate governance within their investments so typically have quite rigorous internal review processes already in place,” says Assali. Creating a more systematic approach to including environmental and social issues has followed “organically”, she says.

Investors have little choice but to start considering these issues. For Assali, taking ESG into account is “part of an investor’s fiduciary duty”.

“Investors have long term investment horizons, which means that analysing the potential environmental and social impacts is crucial to mitigating potential portfolio risks and securing sustainable returns,” she says. In other words: responsible and sustainable investing helps safeguard returns over the long term.

And when it comes to attracting foreign investment, sustainable projects could be a particularly useful selling point for Latin American countries.

“Latin America needs to seize this opportunity and focus its development plans on sustainable projects as a way to attract investors interested in securing sustainable long term returns,” says Assali.



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