Rumours that a Latin American sovereign would be the first to test the sustainability-linked bond (SLB) structure became reality on Tuesday. Chile announced it would begin three days of marketing meetings, before aiming to price dollar- and euro-denominated tranches next week.
One of the bankers involved in the dual-currency deal – which is being led by a French syndicate of BNP Paribas, Crédit Agricole and Societe Generale – was understandably cautious about making any specific predictions when speaking to Euromoney on the day of the launch, given that Russian tanks were entering Ukrainian territory, but the confidence of the syndicate seems high.
“We have three days of marketing ahead and then, after that, there’ll be advice based on that investor feedback, whether and how to proceed,” he told Euromoney. “But the target is potentially to issue both in dollars and euros on the basis of two key performance indicators (KPIs): one linked to a reduction in carbon emissions and another related to increasing the proportion of non-traditional renewable power going into the national grid.”
A lot of governments are uncomfortable with KPIs
Chris Gilfond, Citi
Chile’s first KPI target is to reduce its absolute greenhouse gas emissions to 95 million tonnes of carbon dioxide-equivalent by 2030. In 2018, Chile’s total emissions were 112.3 MtCO2e, with an additional component that the country’s total carbon budget between 2020 and 2030 cannot exceed 1,100 MtCO2e.
Secondly, Chile has pledged to have at least half of its electricity generation from non-conventional renewable energy sources by 2028, and to reach 60% by 2032.
For the purposes of this SLB, non-conventional renewable energy includes: wind; small run-of-river hydro–plants up to 20 megawatts of installed capacity; biomass; biogas; geothermal; solar and ocean energy; and green hydrogen.
Sustainalytics called the emissions target “very strong” and “ambitious”, while the renewable energy target is “strong” and “ambitious”.
The deal’s structure is essentially based around the target date of 2032 and provides for two step-up penalties of 25 basis points each – should neither KPI be achieved – for the 15-year, euro-denominated bond, and step-ups of 12.5bp for a dollar, 20-year tranche (paid for longer).
The sovereign says that structure gives a maximum total penalty of 150bp over the life of the euro notes and 200bp over the life of the dollar notes.
However, while a sovereign SLB has not been tried before, the structure has been enjoying a growth in popularity in LatAm in particular. One banker says that from previous corporate transactions, it is clear what investors expect from such deals.
“The ESG investor base, as well as the proxy of second-party opinion providers, are looking for ambitious targets,” says the banker. “They don’t want to allocate capital to deals that have targets that are already 90% fulfilled. Chile’s targets are ambitious – and it’s putting its budget on the line.”
For and against
However, another senior international debt banker away from the deal is less than enthusiastic about sovereign SLBs.
“It’s a bit like having a meal and leaving the check for the next person,” he reckons.
Chris Gilfond, head of LatAm capital markets at Citi, echoes this view.
“A lot of governments are uncomfortable with KPIs – they say they just can’t sign up to those politically because they are essentially locking into future targets that they can’t control,” he says. “It’s a pretty fluid conversation, but I think investors have a growing sense that KPI-structured bonds aren’t as compelling as use-of-proceeds green or environmental, social and governance (ESG) bonds.
“As investors think about the impact of their investing, there’s a growing voice that says: ‘We prefer the use of proceeds concept because then we know that our money is being channelled into specific ESG initiatives, as opposed to just imposing a penalty in five years if the issuer does not meet the targets’ – in that case no one wins and the ESG agenda has not advanced.”
The amount of focus we have seen from investors in social and responsible investing is huge
Patrick Cassereau, Morgan Stanley
The question that the Chile transaction may partially answer is whether or not investors will be interested in deals that align countries to ambitious environmental targets, but, in practice, do not create a strong-enough link to the policy of future governments.
However, one banker working on Chile’s deal argues that this is a feature not a bug.
“Part of the ambition of this deal is to show that Chile is making a strong ESG commitment that, over 20 years, will by definition cycle through multiple administrations,” says the banker.
Alexei Remizov, managing director and head of LatAm DCM at HSBC, agrees with the underwriter’s assessment of the ambition of the bond, but suggests future sovereigns will want to have potential upside for this ambition.
“As a means to encourage continuity in sustainable policy frameworks through political cycles, it’s a good ambition,” says Remizov. “But it’s a two-way street – I think sovereigns will want also to include step-downs.”
Patrick Cassereau, head of fixed income capital markets, LatAm, at Morgan Stanley, echoes this sentiment.
“Sovereign issuers believe that they should have [the potential for] a reduction in coupon as part of SLBs,” he says. “Right now, the only variable is on the negative side – if you don’t reach a certain performance, there is higher cost of debt. What some sovereigns have suggested is that if they overachieve – if they hit aggressive targets – the cost of debt should be reduced.”
However, other bankers believe that step-downs might materially impact demand for such deals, as they could prevent pension funds from investing in them, as they need long-term certainty on yield.
Greenium focus
The greenium of Chile’s landmark transaction will be closely watched, given the issuer’s decision to embrace potentially volatile markets. Generally, green deals have been losing pricing advantages when markets lose their calm.
“When the market is volatile, investors tend to be less focused on these issues – credit and liquidity issues become paramount – therefore the gradient of green savings becomes less visible,” says Andre Silva, head of LatAm DCM at BNP, who spoke to Euromoney before Chile’s SLB was announced and therefore was not talking specifically in relation to that deal – which the bank is now managing.
“I still believe there is a gradient, but the practical pricing benefits of these transactions become harder to identify during such volatile markets.”
Meanwhile, Morgan Stanley’s Cassereau says the issue is reversing in the market.
“Issuers can have anywhere between 5bp and 15bp of green savings – let’s say around 10bp on average,” he says. “But I believe that soon this will be inverted – the market will charge more if you don’t have social structure. I don’t know if that will be in two or four years, but it’s not going to take 20 years. It’s happening very fast.”
I think investors are very agnostic about the use-of-proceeds model
Samy Podlubny, UBS BB
The pace of change is, according to Cassereau, a reflection of the huge shifts in investor behaviour being witnessed in the international capital markets.
“I can tell you that independently if the structure is SLB or green, the amount of focus we have seen from investors in social and responsible investing is huge,” he says. “Huge and exponential. Even just three or four years ago you could have sophisticated issuers coming to market without having to answer ESG strategy questions. Now it is hard to find companies with no sustainability reports or professionals focused on these issues – because the scrutiny and analysis that investors are doing in terms of these bonds is intense.”
While most bankers believe investors are open-minded about the relative attractiveness of green and SLB bonds, Samy Podlubny, head of DCM and structured debt at UBS BB in São Paulo, believes the SLB is emerging as the preferred structure.
“I think investors are very agnostic about the use-of-proceeds model,” he says. “There was some scepticism in the SLB space, but I think that was just some growing pains, and I think now we are seeing more momentum towards the SLB market. It’s just a good fit between what investors expect – in terms of embedding KPIs. My gut feeling is that we end up with the SLB model as dominant. It will also allow more creativity.
“Whereas I think investors are a little more agnostic about the use-of-proceeds – and that all use-of-proceeds bonds will need environmental elements anyway, so the greenium will evaporate in that format – and non-environmental use of proceeds will have premia. It will evolve to be that way around.”
Likely candidates
While the market might be about to embrace the idea of sovereign SLBs, not all countries will be able to rush to market. Investors might be willing to see through the tenor/administration mismatch in countries with relative consensus about policy in this area, but other countries – with more volatile policy swings – won’t be likely candidates.
However, one banker does not think that should preclude Brazil from tapping green liquidity by issuing green bonds – potentially a combined use-of-proceeds bond that also incorporates KPIs.
However, the first test of the market will be Chile’s SLB. And before wrapping up the call to start the marketing calls for the transaction, the banker working on Chile’s SLB was in bullish mood – and prepared to be even more provocative on the potential user-base for the structure.
“Five years ago, we could never have envisaged a green or SLB bond for a carbon-intensive company because, by definition, it’s not green,” he says. “But a lot of investors have started to come round to the realization that we need to transition to this green future and so why shouldn’t they work with these industries on reducing their carbon intensity or emissions – and encourage and finance their move to a lower-carbon future?
“So, why shouldn’t today’s big oil companies issue SLB bonds – and give investors a chance to have an impact on their transition to broader energy companies? Because if a company is working on financing their transition, they don’t necessarily need to finance a $500 million wind farm – they may need to finance a range of efficiencies and other varied capex.”
