This article was produced by IFR and originally published on www.IFRe.com
More Latin American sovereigns are expected to issue sustainability-linked bonds (SLBs) and some could follow Uruguay’s innovative two-way pricing structure that included a step-down coupon to incentivise environmental improvement, as well as a step-up to penalise underperformance.
- Uruguay’s successful SLB is encouraging other LatAm countries to follow.
- Connecting financial structures to countries’ NDCs could accelerate emission targets.
- LatAm countries are innovating in other sustainable finance products, including blue bonds.
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The success of Uruguay’s US$1.5bn SLB has set a precedent for other countries to issue similar deals as investors get to grips with the idea that environmental outperformance can mean lower credit risk.
“Uruguay’s leadership is going to inspire other sovereigns in Latin America to come to market with sustainability-linked bonds and some could take a similar approach with both a coupon step-up and step-down,” said Romina Reversi, head of sustainable investment banking for the Americas at Credit Agricole.
Connecting a financing structure to countries’ Nationally Determined Contributions – which detail efforts by each nation to reduce national emissions to meet the goals of the Paris Agreement on climate change – could help to accelerate progress as the world is seriously lagging emissions targets.
Uruguay’s US$3.96bn order book saw demand from 188 global accounts, including 40 new lenders, which gave a final spread of 170bp. This represented an encouraging 20bp ‘greenium’ over Uruguay’s sovereign curve in the secondary market.
Uruguay said the deal saw additional demand from ESG investors and helped to increase the visibility of the country’s climate strategy. The deal is also expected to provide better access to other international climate financing instruments for the transition to a lower-carbon economy.
“Beyond the financial mechanism itself, it was also rewarding to see that many investors valued the country’s resolve of turning its Nationally Determined Contribution goals into financially binding commitments, which is a big leap for an emerging market country,” said Herman Kamil, head of sovereign debt management at Uruguay’s ministry of economy and finance.
Which countries may offer SLBs next?
Chile could be one of the next Latin American sovereigns to issue an SLB with two-way pricing as it continues its trailblazing approach to sustainable finance that has already seen the country issue in green, social and sustainable use-of-proceeds formats, and the first ever sovereign SLB in March.
Mexico, on the other hand, is unlikely to follow. It sees SLBs as more appropriate for the country’s corporate issuers and is expected to focus on creating sustainable benchmarks for more Mexican issuers.
Latin America is also seeing innovation in other sovereign use-of-proceeds formats, such as blue bonds. In September, Barbados became the third country to raise capital to protect the oceans after the Seychelles and Belize.
Why are KPIs critical?
For two-way pricing to succeed in a sovereign context and beyond, the choice of KPIs is critical, particularly the ambition of the step-down, as investors are unwilling to fund easy targets.
“If a sovereign or corporate comes to market to try to do a step-up and step-down structure and the step-down is not considered highly ambitious, the structure faces potential market pushback,” Reversi said.
Uruguay’s two KPIs – to reduce greenhouse gas emissions and to maintain the size of its native forest area – had two sustainability performance targets each and will only step down if the country outperforms its NDC commitments.
Kamil said that the second KPI to maintain the size of its forests “resonated strongly with accounts, as the conservation of natural capital and protection of biodiversity are increasingly important to halt climate change”.