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Will Sustainability Linked Bonds Work in Latin America?

Chile hopes to reduce CO2 emissions by producing 60 percent of its energy using renewable sources by 2032. This timeline is one of two KPIs in its sustainability-linked bond (SLB) issue. A coal-fired power plant is pictured. // File Photo: Chilean Government. Chile hopes to reduce CO2 emissions by producing 60 percent of its energy using renewable sources by 2032. This timeline is one of two KPIs in its sustainability-linked bond (SLB) issue. A coal-fired power plant is pictured. // File Photo: Chilean Government.

Chile recently began issuing bonds tied to its sustainable development goals. The sustainability-linked bonds (SLBs) are part of the Chilean government’s plan to sell $2 billion worth of environmental, social and governance, or ESG, bonds—the proceeds of which would go toward addressing greenhouse gas emissions—and provide incentives for a gradual transition to renewable energy. What are the main motivations behind the Ministry of Energy’s SLB issuance? How likely is the government to meet its key performance indicators (KPIs), and what happens if it comes up short? Will the SLBs attract a wider pool of bondholders, and how likely is it that other Latin American and Caribbean governments will start issuing similar bonds if Chile’s issuance is a success?

Luisa Palacios, senior research scholar at the Center on Global Energy Policy of Columbia University’s School of International and Public Affairs: “Chile’s $2 billion issuance of sustainability-linked bonds (SLBs) represents the many creative ways in which emerging markets can finance the energy transition. The SLBs (with a 2042 maturity) were 4.1 times oversubscribed. This shows the huge demand for these types of instruments, which are undeterred by the current heightened geopolitical uncertainty. An SLB could be more impactful than a green bond from an overall climate perspective, given that its performance indicators are linked to Chile’s climate commitments under the Paris climate accords and are not linked to one specific project. The key performance indicators (KPIs) entail an emissions target of a maximum of 95 metric tons of CO2 equivalent (known as MTCO2EQ) by 2030 and a total carbon budget of no more than 1,100 MTCO2EQ between 2020-2030. The second KPI is equally ambitious: to raise the share of renewable energies to 60 percent of total electricity generation by 2032 (from 27 percent in 2021). Such strong KPIs provide financial incentives to deliver on emission reductions, provide intermediate goals during the maturity of the SLB due in 2042 and give a strong macroeconomic signal to investors of the greening of Chile’s economy—which should help to reduce the risk of premium payments. With this issuance, the government is helping to create a yield curve in sustainable bonds, providing a reference that will not only facilitate Chilean corporate issuances of sustainable bonds, but even serve as a reference for other Latin American countries to follow Chile’s example. Chile’s SLBs might even serve as a template for incorporating adherence to climate goals as part of lending incentives (or even conditionality) for other types of lending such as development finance.”

Cristian Vallejo, partner at Manatt, Phelps & Phillips: “The sustainable bond issuance is part of Chile’s strategy to achieve its climate change commitments to the Paris Agreement. The issuance of green debt instruments has been incorporated into Chile’s financing operations in recent years. For instance, in 2019 Chile became the first country in the Americas to issue sovereign green bonds. The following year, Chile expanded those efforts to social and sustainable instruments. The SLB issuance is another significant step toward such efforts and confirms Chile’s status as one of the world’s leaders in sustainable finances. The SLB framework includes two KPIs. The first is a cap on absolute greenhouse gas emissions—95 metric tons of CO2 equivalent (MTCO2EQ) by 2030, and a maximum of 1,100 MTCO2EQ between 2020-2030. The second KPI is boosting the share of nonconventional renewable energy generation to 50 percent renewable sources by 2028 and 60 percent by 2032. ESG ratings firm Sustainalytics rated Chile’s first KPI metric as very strong, the second as strong and concluded that the KPI-related sustainability performance targets (SPTs) are aligned with Chile’s sustainability strategy and commitments. The SLBs will be linked to the SPTs’ achievement, namely, a premium is paid if an SPT is not met at the target observation date. If more than one SPT is not met, the premium will be cumulative. Given the positive reception of Chile’s prior emissions of sustainable instruments and strong commitment to its climate-related goals, the SLBs have already attracted significant interest. Other countries in the region are already following Chile’s lead. Last year, Colombia became the first country in Latin America to issue sovereign green bonds denominated in pesos, its local currency.”

Mariana Zepeda, Latin America analyst at FrontierView: “Chile’s SLB issuance is well-timed, particularly with the incoming Gabriel Boric administration, which is poised to further prioritize the country’s sustainable development goals and transition to renewable energy. The Covid-19 pandemic somewhat derailed Latin America’s sustainable development agenda, as governments reallocated budgets to respond to the health emergency and its economic and social ramifications, with renewable energy financing taking a hit. In fact, the OECD estimates that developing countries will face a $1.7 trillion shortfall if they are to stay on track with their sustainable development goals. While Chile’s fiscal position stands out as one of the strongest in the region, fiscal erosion has been unavoidable during the height of the pandemic. Not only is fresh financing essential, but Chile is also picking the right time to jump on the SLB bandwagon. After reaching a record $110 billion last year, the appetite for SLBs globally is likely to continue to rise, allowing for the involvement of a wider pool of bondholders in addition to lower borrowing costs. While issuing SLBs means that Chile will be liable for a premium in the bond’s interest rate if it does not meet its KPIs, these goals are not out of reach. The chance at success will be made greater if they become a higher government priority under the new administration, or if similar objectives are enshrined in Chile’s new constitution. Other countries may choose to follow suit, whether they are emerging from the pandemic with a stronger fiscal standing—such as Mexico or Colombia—albeit on slightly shakier terms, though their fiscal standings and overall credibility on the environmental and sustainable development front may shape bond demand.” 

Kathleen C. Barclay, former president of the American Chamber of Commerce in Chile: “Chile has adopted the 2030 Sustainable Development Agenda and is committed to a net zero carbon economy by 2050. The country’s financing strategy supports the achievement of this agenda, beginning with the issuance of green bonds in 2019. In 2020, Chile developed its sustainable bond framework. As of January 2022, environmental, social and governance (ESG) focused instruments represented 28.3 percent of total debt. Last month, the country published its Sustainability-Linked Bond (SLB) framework, which aligns with the International Capital Market Association’s Sustainability-Linked Bond Principles report. Chile has agreed to two key performance indicators. The first is a cap on absolute greenhouse gas emissions to 95 metric tons of CO2 equivalent. The second is increasing nonconventional renewable energy generation to 50 percent renewable sources by 2028, and 60 percent by 2032. These KPIs have been validated with a second party opinion provided by the analysts at Sustainalytics. The goals are ambitious but achievable. In the case of noncompliance, the coupon will increase. This mechanism provides an ongoing incentive for the country to meet established goals that are critical for the country and its people, given the risks that climate change poses to lives and livelihoods. Chile is the first sovereign to issue SLBs and to be held financially accountable for not meeting the established goals. Compliance is expected to expand access to financing and to lower the cost as investors look to increase exposure to ESG instruments. The Chilean issuance will serve as an incentive for other sovereign issuers and as a benchmark.” 

James Channing, international associate at Hunton Andrews Kurth LLP in Washington and a member of the Chilean Bar: “Chile has been ambitious in its energy transition process and sustainable energy, in particular renewables, both fundamental for the country to achieve energy independence. Chile also has a track record of successful sovereign ‘green debt’ issuances. Given these factors, a logical next step for Chile is to broaden its sovereign financing tools through the issuance of sustainability-linked bonds, taking advantage of its already ambitious energy transition goals by issuing debt that is tied to, and aligned with, its sustainability goals. Unlike green bonds typically issued to finance a specific renewable energy project or program, SLBs instead require the issuer to achieve certain key performance indicators. An unmet KPI would result in an increase in the coupon rate. In the specific case of the Chilean SLBs, the KPIs are: 1.) the reduction of greenhouse gas emissions, and 2.) a required share of renewable energy output in the national grid. Notably, in the first KPI, the goal is to achieve a maximum of 95 metric tons of CO2 by 2030, which is even more ambitious than the targets set by the Paris Agreement. Given the country’s traditionally solid capital markets system, the fact that SLBs may be structured with more flexibility than green bonds and the current appetite for ESG investment in the market, it comes as no surprise that SLBs are attractive to investors.” 

Wilfredo Araya, executive director at Golden Companies: “Chile has reinforced its position as a regional leader in the fight against climate change. Its diverse and resource-rich land has given the country unique opportunities for the development of new green businesses. Chile is on a clear path to meet two of its objectives, the most important is compliance with the Paris Agreement. To do so, it must meet two key performance indicators. The first is to reduce CO2 emissions to 95 metric tons by 2030, and cut emissions to no more than 1,110 metric tons of CO2 between 2020 and 2030. Additionally, the country must generate no less than 50 percent of its electrical generation using renewable sources of energy by 2028 and 60 percent by 2032. The ambitious environmental goals are accompanied by a responsible fiscal policy–namely, the new SLB bond in dollars maturing in 2042–which is expected to be worth at least $2 billion. This is four times more than initial projections. The SLBs will add to the $33 billion in thematic bonds, representing around 30 percent of the central bank’s stock, which is a powerful signal to investors and markets that Chile is serious about development through sustainable energy. Since SLB bonds are not related to a specific project, they are subject to the fulfillment of objectives, which, if any of them are missed, Chile will have to pay a premium on the bonds’ interest rates.” 

Rodrigo Andrade, director of Latin American studies in climate change at FLACSO Chile: “For decades, Chile has sought to transition from a middle-income country to a high-income country, and since the COP 21 climate change summit, to achieve sustainable development that integrates economic, environmental and social dimensions. The public-private investment strategy that aims to kick-start Chile’s post-pandemic economic reactivation coincides with the discussions around the text of a new constitution, which will undoubtedly contain a strong ecological feature. With the issuance of SLBs, the country has a unique opportunity to move decisively toward both sustainable and inclusive development. Chile’s sovereign bond issuance began in 2019 with the issuance of green bonds. This first transaction yielded positive financial results and demonstrated the country’s commitment to climate action. In December 2020, Chile published its Sustainable Bond Framework, which allowed it to issue social and sustainable bonds. With this, Chile decided to prioritize sustainable financing to turn itself into a truly sustainable country. Through the SLBs, the country is expanding its commitment to sustainable development and providing a clear and transparent vision of an ecologically sustainable and socially inclusive future. If this new financial instrument, with these new stimuli, can function well in Chile, it is possible that other countries in the region will be capable of realizing this transformation as well. Chile’s success in the transition toward renewable sources of energy seems more likely with each passing day. It’s possible the paradigm shift to a sustainable and socially inclusive economic model could be applied to other political processes that are trying to break through in Latin America.” 

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