Sustainability funding, off to a slow start in Latin America, is building momentum. More issuers are teeing up green bonds as governments, corporations and investors ask pointed questions on the use or proceeds and the potential environmental impact of projects
Editor’s note: We set out to cover green finance and COVID-19 caused an upheaval. The digital edition reflects what went to printing press just prior to the extraordinary measures western governments have put in place to fight this pathogen. While green finance remains a relevant topic, we ask that you keep in mind the comments given by experts in preparation for this edition were given as a reasonable reflection of the world prior to the novel coronavirus derailing, temporarily, the flow of everyday life.
Chile’s set off a stampede of interest in green funding in Latin America by selling more than $6 billion worth of bonds earmarked for environmentally-friendly spending within the past year. Then, the country went a step further by mandating that the enormous AFP pension fund system consider climate risk in its analysis.
Throughout the region, bankers and lawyers are positioning themselves to advise in the green space. While adoption of green loans can have a profoundly positive impact on the environmental practices of corporate and sovereign issuers, advisors also tout their potential to tap a broader investor base, which could lead to better pricing.
Corporate and sovereign issuers are cultivating this new market. The Climate Bonds Initiative says 2019 was a record year for green bonds in Latin America, with nearly $4.7 billion issued. That brings issuance to date to just under $14 billion. Brazil is the largest overall Latin American market for bonds that are labelled green, followed by Chile and Mexico.
Still, Latin America has a long way to go when it comes to selling green bonds. To date, according to the Climate Bonds Initiative, only eight Latin countries have floated green bonds, with the first issued just five years ago. For comparison, the far larger US market issued $51.3 billion in green bonds during 2019.
The challenge for green finance in Latin America is two-fold: financial incentives of both supply and demand are lagging seriously behind the moral imperatives of green finance.
“If you are an international investor and want to invest in sustainable investments in the region, you don’t have many opportunities,” says Gema Sacristán, chief investment officer at IDB Invest, the private sector development arm of the Inter-American Development Bank.
IDB Invest is determined to help the new asset class get off its feet. This year the agency told LatinFinance it aims to support at least 10 bonds with a combined value of more than $350 million. In the first half of 2020 alone, IDB Invest has mandates to nurture the first green bond by an energy company in Colombia and the region’s first private-sector bank green bond, which is expected out of Brazil.
“The region is moving, but we have a long way to walk,” says Sacristán. “For sure we need to accelerate.”
Hervé Duteil, chief sustainability officer for the Americas at BNP Paribas, has been working in the green space for six years. At first, he says, it was very difficult to get treasurers and financial officers to sit down with sustainability advisors.
That’s no longer the case. Corporate representatives and investors all over the globe are increasingly asking detailed questions, he says, and putting sustainability high among their priorities. Bankers are hearing about green financial initiatives left, right and center — from newspaper headlines to client requests.
Though green bonds have been key to starting these conversations, and BNP Paribas was one of the underwriters on Chile’s green bonds, Duteil views green bonds, in general, as “the least useful product in the sustainable finance tool kit.”
A far greater opportunity for impact, he and others argue, can come via sustainability linked loans that can be applied to green and brown sectors alike. The overarching goal of these loans is to make a bank’s credit portfolio more resilient long-term, while nudging clients toward meaningful environmental targets.
“In the old world, things are linear: You go from A to B. In terms of management you have pyramids, and in terms of financing you have a rate that relates directly to the probability of losing money on that transaction,” says Duteil. “In today’s world, things don’t function like that. We are communities, we are networks, think of Facebook.”
Duteil advises his BNP Paribas colleagues to think about green finance as “completely core” to their advisory business, rather than as just another financing tool. Sustainability can help them proactively win over a client, or serve to defensively reduce ratings risks and potential losses.
“I think now the tide has turned,” declares Duteil. “Sustainability has made its way into mainstream finance.”
Perhaps one of the clearest signals of green mainstreaming is Larry Fink’s January letter to chief executives. The BlackRock CEO kicked off the year by announcing that the world’s largest investment firm will put sustainability at the center of its investment strategy going forward. The $7 trillion asset manager said it would immediately stop investing in companies that “present a high sustainability-related risk,” such as coal producers.
Similar priorities are echoing at other large asset managers, who see a greater focus on sustainability as a way to manage investment risk. The thinking is that climate change is a major economic peril that ricochets throughout portfolios and economies, affecting housing prices, insurance markets, productivity, food costs and more. That makes sustainability a smart business decision.
In Latin America, Duteil says investor momentum needs to increase to truly change the direction of finance. The region’s pension funds haven’t noticeably changed their asset allocations or ventured forcefully into buying sustainable products.
But signs indicate that institutional commitments to sustainability may very well be on the horizon. Pension funds, which largely drive investment decisions in the region, very much watch and mimic one another. So, a pledge to embrace sustainability by a single large fund could trigger a domino effect of environmental commitments.
In a move that could have outsized repercussions, Chile’s pensions superintendent mandated in December that the country’s AFP pension funds must incorporate—and document—climate risk into their analysis. This translates into a public explanation of how their investments impact the environment.
Chile’s AFP system, whose $193 billion in assets represent about 70% of the country’s GDP, is one of the largest, most progressive and most influential pension systems in the region.
Eduardo Atehortua, head of Latin America (ex-Brazil) for the United Nations’ Principles for Responsible Investment, describes the new criteria for the Chilean pension managers as “an important milestone” for Latin America that could be replicated in countries such as Colombia and Peru, which have similar pension systems. Until now, it has fallen on pension administrators such as AFP Cuprum in Chile and Protección in Colombia to voluntarily sign onto the UN principles.
Atehortua, who is based in Colombia, views the limited technical capacity of investment and risk teams at financial institutions as the main challenge to greater adoption of green finance in Latin America. There’s a great deal of education still to be done, he says.
Another major challenge, he says, is a lack of investment opportunities. Publicly traded companies need to improve their green credentials, he says, and more governments ought to prioritize green projects like renewable energy, electrified public transport and construction of sustainable buildings.
Along that vein, says Atehortua, the Chilean green bonds are “really advancing the cause.”
After selling the equivalent of $2.3 billion of green euro and greenback bonds in June and July, Chile sold the equivalent of another $1.6 billion of green euro and greenback bonds this past January.
Andrés de la Cruz, a Buenos Aires-based partner with global law firm Cleary Gottlieb Steen & Hamilton who advised the Chilean Finance Ministry on its bonds, says Chile tailored the narrative surrounding the issue to highlight its commitment to a green agenda.
Under the country’s Green Bond Framework, proceeds will go to “eligible green expenditures,” such as renewable energy projects, electric public transport, and clean water.
Following Chile’s June success, de la Cruz says a “good number” of clients contacted his firm to explore similar financing opportunities.
Colombia, Costa Rica, Mexico and Peru are among sovereigns that are reportedly considering green bonds.
Mexico hired BNP Paribas, Credit Agricole and Natixis to run a European roadshow in February for a possible bond offering that would adhere to a framework linked the UN’s Sustainable Development Goals.
Jose Olivares, Peru’s director of public treasury within the finance ministry, told LatinFinance in December the country wants to add an ESG (environmental, social, governance) element to its 2020 funding plans.
One stumbling block may be the perception among issuers that green finance is more cumbersome or expensive than other funding mechanisms. Bankers and lawyers who work on these deals insist that they aren’t much more complicated than plain vanilla bonds and loans.
But they also admit sustainability finance involves additional groundwork and a commitment to ongoing transparency. That means they require an investment of time and costs for additional reporting requirements to continually answer the question: “Do the projects funded by green money provide an environmental benefit?”
Beyond environmental outcomes, clients want to know the impact of green finance on their immediate bottom line. The answer, advisors say, is not always clear at the outset.
“When our clients ask us about the benefits of green finance, I always tell them it’s reputation — public opinion on climate change is shifting. The other thing I tell people is: climate risk is investment risk,” says John Guzman, a partner in White & Case’s São Paulo office.
Guzman advised Brazilian forestry products company Fibria Celulose on its 2017 issuance of green bonds. The $700 million deal was five-times oversubscribed, resulting in pricing that came in 42.5 basis points below initial expectations. Approximately 40% of the notes were allocated to green accounts. Sustainalytics provided the second-party opinion on the bonds.
The proceeds were earmarked for restoration of native forests and conservation of biodiversity, waste management, water usage efficiency and renewable energy.
Reforestation is necessary to sustain a paper and pulp business, so it made sense for Fibria to finance that capital expenditure under the umbrella of green finance. At the same time, the issuance resonated with green investors because water and forest conservation rank high among global environmental priorities.
Guzman says this sort of project involves deeper thought and discussion with all the parties involved. On the surface, he says, green bonds require additional work compared with normal bonds— but green bonds are not complex transactions.
Guzman says he’s currently working on a green deal, and that he expects more activity going forward in green finance, particularly in the infrastructure sector.
The way BNP Paribas’ Duteil sees it, industries like pulp and mining produce essential products, such as paper and lithium for batteries, that currently do not have viable substitutes.
So the challenge becomes finding ways to lessen their environmental footprint.