LatAm green bonds - Building Momentum

Latin American green bond issuance has been hesitant in 2018. The green agenda is very much intact, however, and market participants expect a pick-up when market conditions improve, explains Keith Mullin.

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A "tsunami of green bond issuance" is expected from Latin America in coming years, to fund the region's need to build sustainable infrastructure.

This bullish prediction comes despite the current adverse conditions that have hampered issuance so far this year.

This paucity of activity in 2018 can be blamed on a variety of factors. One of these is the policy uncertainty unleashed by Andrés Manuel López Obrador's decision to shelve Mexico City's huge U$13bn part-built new airport, which generated shock headlines for Mexico's president-elect. Going for a cheaper option to refurbish existing airports in Mexico City and Toluca and add commercial facilities to the Santa Lucía military base may have short-run benefits for government finances. But the suspension jarred international investors, and this could come back to haunt the incoming administration in the form of capital outflows or delayed investment decisions. In the immediate aftermath of AMLO's decision, the combination of broader emerging market volatility and specific event-risk related to the project's suspension caused prices of the US$6bn of bonds sold to finance construction of the mega-airport's terminal buildings to tank.

Since all of the bonds were issued in green format, the cancellation of the airport project deflected some light onto the green bond market. Fitch placed its BBB+ rating on the green airport bonds on Rating Watch Negative on November 1, saying suspending construction could trigger a number of materially adverse scenarios for the credit quality of the issuer of the bonds – Grupo Aeroportuario de la Ciudad de México (GACM). "The absence of meaningful progress in a few months may result in a downgrade, possibly below investment grade," Fitch warned.

GACM had been the first airport group in the world to tap the green bond market (initially in 2016 with a follow-up in 2017) to finance construction of the massive 100% carbon-neutral terminal buildings. The debut received a lot of plaudits, even if the fact that the airport would eventually have been servicing six runways with capacity for 125 million air passengers detracted from its green credentials in the eyes of some.

Yield-starved investors had no qualms about financing what would have become the world's second largest airport, however. Positioning the issuer as a quasi-sovereign credit, underwriters Citigroup, JP Morgan and HSBC between them garnered US$15bn of demand for the US$4bn of 10 and 30-year green bonds sold in September 2017; and US$14bn for the US$2bn September 2016 debut, also in a 10 and 30-year combo.

Poor Market Conditions

Cancelling the airport project was arguably the biggest news event to hit the LatAm segment of the green bond market in the first 10 months of 2018. This year has been less than inspiring for international investors looking at Latin America: bitter and hard-fought elections in Brazil and Mexico; crisis in Argentina on the back of a sharp run on the peso as markets lost confidence in the country, the government was forced to go cap in hand to the IMF for budget support and hike interest rates to 60%; spill-over effects from the chaos in Venezuela.

Overall international bond new-issue volumes were down 11% at the nine-month stage, but new issues from LatAm borrowers fell 35% year-on-year, according to Refinitiv. LatAm green bond issuance has barely been a rounding error this year, whereas on a global basis green primary issuance is expected to outperform the overall bond market and end 2018 on a similar footing to 2017.

Of a little over US$104bn in labelled green and sustainable bond issuance in the first 10 months of the year (Crédit Agricole CIB data), LatAm issuance accounted for no more than three quarters of one per cent, looking at individual deals data. There was a complete absence of distributed international currency-denominated public green bond issuance from the region in the first 10 months of 2018.

Adding a green label might help at the margin but it can't reverse poor market sentiment. "Green investors are additive; they don't fully subscribe a deal. If we're realistic and look at how much demand typically comes from green funds, we might find a range of 25% to 50%. If a bond is going to struggle in tough market conditions, putting a green label on it might mean it struggles a little less but it's not going to make the difference between an issuer not being able to price and pricing brilliantly," said Suzanne Buchta, Global Head of ESG Debt Capital Markets at Bank of America Merrill Lynch.

Public and private-sector borrowers from Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico and Peru as well as LatAm-based supranationals CAF and CABEI have sporadically tapped the green bond market in a variety of formats in domestic and offshore currencies. But aggregate regional issuance has been no more than US$15bn since the debut labelled issue in December 2014 – the US$204m privately-placed 20-year amortising project bond from Peruvian windfarm operator Energía Eólica. For a region with three economies in the top 25 by world GDP, many consider this a disappointment.

That total includes the bonds that were not distributed to end-investors. The International Finance Corporation has been a driving influence on LatAm green bonds, buying 100% of Colombian peso issues from Bancolombia and Davivienda worth around US$265m, and the US$100m offering earlier this year from Argentina's Banco Galicia. A US$130m-equivalent COP issue in July from Colombian power producer Empresa de Energía del Pacífico was subscribed by IFC and local development bank Financiera de Desarrollo Nacional.

IFC officials believe developing the regional green bond market is crucial to strengthening the green agenda in the region. To step up the focus on green, the agency is launching a Green Banking Academy (GBAC) that among other things will offer executive education programmes. Better education and training will in turn create a virtuous circle that will support green bond market developments in Latin America and the Caribbean. See boxed item for more details of the GBAC.

Of course the Green Cornerstone Bond Fund, which the IFC launched in partnership with Amundi, will provide some significant impetus on the demand side: the USD1.4bn fund is expected to deploy USD2bn into EM green bonds over its lifetime, including re-investment of proceeds over seven years. "The expectation is that the emergence of this type of large specialised green bond fund will act as a strong incentive for bond issuers to opt to issue green bonds instead of non-green bonds, and hence boost the supply of green bonds" said Jean-Marie Masse, Chief Investment Officer at the IFC in Washington DC.

Among high points for the Latin American green bond market, the emergence of Brazilian pulp and paper companies has been noteworthy, none more so than Suzano Papel e Celulose. The company has issued green bonds in the dollar market – a US$500m bond that was subsequently tapped for US$200m – and in the domestic market: the company's eight-year BRL1bn green securitisation backed by an export credit note issued by Suzano was Brazil's debut domestic green offering.

"We believe the growing market for green bonds is a global trend and we are confident that we can accompany this movement," said Marcelo Bacci, Suzano's Chief Financial Officer. "By issuing in the green bond market, we have reinforced our position as a reference in social and environmental relations in Brazil, given that sustainability is a core pillar of our business."

"Suzano remains attentive to any funding opportunities that could emerge in the local and international markets, which includes the possibility of new green bond issues. We know that the market is expanding globally and, most certainly, we will tap it again as soon as new opportunities appear," Bacci said.

Bacci points out that because the company had already adopted the highest sustainability standards, it was able to issue green bonds without having to make any changes to its existing processes; the company's practices already having met the standards required to obtain the green seal.

"Investors increasingly value sustainable companies when deciding on capital allocation and they know that issuing green bonds is another confirmation of the good practices adopted by issuers," Bacci said. "Sustainability is part of Suzano's corporate DNA. We believe that adopting environmentally and socially friendly practices is essential for the continuity of any business. At Suzano, we incorporate this concept into our day-to-day routines and in our capacity to deliver results and share gains with all stakeholders, including the communities with which we have relationships and the environment itself."

Yet prospects are Good

The seeming inability of stakeholders to set the LatAm green bond market on an industrial-scale footing does not at all infer a lack of interest among borrowers in pursuing the green bond format and/or a lack of investor demand. Senior origination bankers are quick to point out that rather than any problem with the notion of green bonds in Latin America, it is the difficult market environment and the fact EM has come under pressure and witnessed extended bouts of severe volatility that has undermined efforts in 2018.

Philip Brown, Global Head of Sustainable Capital Markets Origination at Citigroup, says the bank has received mostly positive responses from Latin American clients on the sustainability front. "We have had advanced discussions with several corporates and banks across the Continent, with a view to following the success of some of the early movers in the market," Brown said. "There is a strong interest in green bonds among emerging market investors but several deals, both green and vanilla, have been postponed as a result of the broader market volatility. We have many active conversations going on across the Continent and I am confident we'll see a pick-up in Latin American green issuance next year."

Tanguy Claquin, Head of Sustainable Banking at Crédit Agricole CIB, says Latin American issuers are fine with the green concept and the level of interest is very high. "The problem is markets in general; not all LatAm issuers have had access to the international bond market in 2018." "It's true that after the trades from Nafin and BNDES, we expected a little more issuance [from the region] but there's nothing about the green aspect in principle that is holding LatAm borrowers back. We're having a lot of discussions with borrowers in the region about financing in general and about green bonds specifically.

"There are a number of elements in play and each case is a little different. Borrowers either haven't needed funding, or can tap the local markets, issue private placements or are recipients of green funding from multilaterals. Those alternatives reduce their capacity to issue international green bonds. But in general, the perspectives are very good," Claquin said.

BofA Merrill's Buchta similarly attributes the quiet LatAm showing to poor market conditions. "There is definite interest in this topic from Latin American issuers, and that interest is gaining momentum. As soon as markets are more amenable to transactions, I'm confident we will see an increase in green bond issuance from Latin America," she said.

Suzano's Bacci believes the scenario is very favourable for new issues in Brazil, while acknowledging the segment is still undergoing a maturation process. "We expect continuous improvement in the market over the coming years, which could present new opportunities for issuing green bonds. We observed very significant interest from investors in the green bonds we issued in the local market. Our BRL offering was one of the largest issues ever carried out by Suzano in the domestic market and we were able to attain very attractive costs, which effectively confirmed investor appetite for issues with this profile," he said.

Justine Leigh-Bell, Director of Market Development at Climate Bonds Initiative goes even further: "we are going to see a Tsunami of green issuance coming out of LatAm in the next two to three years given the level of momentum we are seeing and the amount of EU donor money going into the region for building capacity for green finance in the region," she said.

Local initiatives

For Leigh-Bell, the fact that developments in LatAm are being led mainly by government ambition is appealing. "It recognises the fact that green finance offers an opportunity to tap private capital to address development challenges," she said. "Momentum in LatAm behind green/sustainable labelled investment products is high despite low volumes of issuance relative to other emerging economies, particularly Asia. Political risk and capital market constraints are key barriers, but addressing market education is the low-hanging fruit."

In this context, Argentina and Central American countries, Mexico, Chile and Colombia are laying foundations to foster green, social and sustainable bond issuance. The Brazilian Federation of Banks (FEBRABAN) and the Brazilian Business Council for Sustainable Development (cebds) published their voluntary guidelines in 2016.

Mexico's Climate Finance Advisory Group – an independent body comprising the stock exchange; associations for banks, securities markets, pension funds, insurers and IFAs; development banks; issuers; and verifiers – has now published its Green Bonds Principles MX. These are based on the international Green Bond Principles administered by the International Capital Market Association (ICMA).

In October 2018, the IFC's Sustainable Banking Network (SBN), a grouping of regulators and banking associations from 35 emerging markets (and which has a green bond working group), published Creating Green Bond Markets – Insights, Innovations, and Tools from Emerging Markets, as a "critical beginning for SBN members to build and expand local markets for green bonds".

Buchta acknowledges that while domestic green bond frameworks or guidance from local regulators or government agencies are not essential for borrowers to access the international market (they can avail themselves of the international GBP), the support that countries opting to tackle the issue themselves can provide domestically offers an important level of comfort.

"That show of support can be motivating if issuers are toggling between 'why bother?' and 'why not do this?'; it might shift them to the 'why not?' side," she said. "The GBP secretariat always tries to work with local government agencies to make sure that whatever they might do is aligned with the GBP to avoid creating divergent standards, which could create confusion."

CBI's Leigh-Bell believes the green bond guidelines that countries in the region have put in place to set benchmarks have been a key development in the last two years. "These guidelines simply reflect the rules set by the international market on best practice with some nuances relative to the local markets," she said.

"CBI has been on the ground serving as a supporting partner to public and private stakeholders across the region to build local markets that will mobilise domestic capital while also looking to leverage international investors. We have market development programmes in Argentina, Brazil, Central America, Chile and Mexico, where the core focus is education and building capacity in the investment pipeline."