Brazil’s long-awaited first environmental, social and governance-labelled bond – a $2 billion 2.5% March 2031 deal on November 13 – has paved the way for the sovereign to build a big sustainable finance portfolio in the coming years, according to bankers and investors.
Those who bought the deal say the government’s investor-friendly strategy in the build-up not only made this inaugural issue a success – the order book peaked at $6 billion – but should ensure the country sees support for future financings.
“We’ve been anticipating this deal since the issuance of the ESG framework in September,” says Graham Stock, senior emerging-market sovereign strategist at RBC BlueBay Asset Management. “The sovereign trailed it very well – including the broad spending categories for the use of proceeds which came in October, which was very helpful. And their timing was great on the back of a pretty strong treasury rally.
“We think it’s a really good alignment of Brazil’s issuance strategy with their broader policy framework, which is heavily skewed towards climate and environment.”
Given the stated preference of investors to commit to environmental and climate projects over social spending, 50% to 60% of this deal’s proceeds are earmarked for these types of expenditures, with social categories receiving the remainder.
Underwriters Itaú BBA, JPMorgan and Santander decided to go with a green use-of-proceeds transaction after discussions with investors revealed a strong preference for this format over a sustainability-linked bond (SLB) structure.
Tight deal
The seven-year bond was launched with initial price thoughts of 6.8% yield, but the strength of the order book meant it could be tightened to a final yield of 6.5%. The deal priced at 98.572 for a 181.9-basis point spreadover US Treasuries – the tightest for a Brazil deal in nearly a decade.
We think it’s a really good alignment of Brazil’s issuance strategy with their broader policy framework, which is heavily skewed towards climate and environment
Pushing on pricing took the book down to $4 billion, and some investors thought the banks were too aggressive. But Pedro Frade Rodrigues, head of international debt capital markets at Itaú BBA, thinks final pricing was fair.
“Those criticisms are welcome – we could have pushed it further and we could have pushed less,” he says. “Hopefully in the medium-to-long term everyone will be happy, and the secondary market has been supportive.”
Final allocations were skewed to non-resident investors, with around 75% to Europe and North America. Latin America (including Brazil) took the rest.
Frade Rodrigues estimates that between 20% and 30% of orders came from ESG-dedicated funds and he attributes the underwriters’ ability to secure a 6.5% yield to the stickiness of those orders. He sees the issue’s ‘greenium’ at 10bp to15bp.
“Without the ESG accounts we could have printed a $2 billion deal, or one that priced at 6.5%, but not both,” he says.
Laszlo Lueska, partner and portfolio manager at Octante and who manages a non-ESG-dedicated EM sovereign fund, put the deal’s new-issue premium at around 25bp.
“We’ve actually bought some more in the secondary market, and it has been trading positively,” he adds.
Brazilian finance minister Fernando Haddad said pricing was in line with investment grade countries and that the deal was recognition of the return of credibility to the Ba2/BB-/BB rated issuer.
Lueska argues it didn’t “fully reflect IG pricing”, but he agrees that the government’s recent decision to maintain its fiscal targets has helped compress the sovereign’s spread.
Benchmark curve
The Brazilian government’s aim is to set a curve that will become the benchmark for offshore ESG funding for Brazil. Investors expect that Brazil will include SLB transactions in time, but say that this was not a practical option for the country’s first deal despite sovereign SLBs being issued by Chile and Uruguay in recent months.
“It’s not unusual for issuers to begin sustainable finance programmes with the use-of-proceeds format, and I think there was a particular challenge for Brazil in terms of issuing an SLB,” says Stock, who is also co-chair of the Investor Policy Dialogue on Deforestation.
“Less than one year ago, Brazil had an administration that had a much worse record on environmental issues. If Brazil had wanted to go for an SLB, I think it would have been expected to include a sustainability performance target [SPT] about progress on deforestation.”
Stock argues that Chile’s and Uruguay’s environmental SPTs, which link the cost of public finance to their formal Nationally Determined Contributions (NDCs) under the most recent COP, are not contentious domestically. However, there is no such consensus about Brazilian policy around deforestation, nor has Brazil adopted a formal NDC to which it could have linked a SPT.
“On the non-deal roadshow, we heard a very strong preference among investors for a green use-of-proceeds structure,” says Luiza Dias Lopes Vasconcellos, head of ESG at Itaú BBA. “Investors were keen for the simplicity that this would bring for the reference period in the bond.
“Whereas SLBs have key performance indicators that are relevant over very long periods of time, which means that the current government may not be around [at the trigger period], this deal’s financing will be accomplished during this government and will not depend on any other administration.”
