How two Mexican developments could catalyze Latin America’s green bond market
March 16, 2017 |
Latin America is lagging behind global trends when it comes to green bonds, but two big developments in Mexico may herald a change
Globally, green bonds are booming. The instruments accounted for $40 billion in new issuance in 2015, following years of rapid growth, according to OECD calculations. Yet Latin America is sitting out the frenzy.
“We found a market failure on financing energy efficiency in Mexico,” says Maria Tapia, a lead investment officer at the Inter-American Investment Corporation (IIC). “There is a lack of available financing.”
Energia Eolica, a Peruvian windfarm operator, was the first Latin American company to issue a green bond in the cross-border market with a $204 million transaction in December 2014. Since then, only six trades have followed.
That’s in part because many environmentally-friendly projects in Latin America need less capital than can be comfortably financed in the global bond markets. Weak credit ratings at potential issuers also hinder access to the growing pools of capital directed at green endeavors.
In the US and Europe, green bonds took flight through issues from supranational agencies, says Suzanne Buchta, a managing director and the head of green bonds at Bank of America Merrill Lynch.
“To get off the ground, investors shied towards entities with higher credit ratings,” she says. “The growth now comes out of emerging markets, so it’s about getting the word out about green bonds and increasing investor demand for them.”
Although Latin America’s first green bond came from a Peruvian issuer, now Mexico is leading the way in the asset class.
It’s there that the IIC is hoping to address the dual concerns of size and creditworthiness with a securitization program. If the trial goes well in Mexico, it may roll it out to other parts of Latin America.
“Banks don’t accept financing an energy efficiency project based on the benefits of energy savings,” Tapia says, adding that such projects are often far smaller than the 300-megawatt size that is an unofficial benchmark for attracting financing from commercial banks or other private-sector investors. “So for us to correct this, we chose to look at green bonds.”
The IIC is establishing a pool of energy efficiency projects that qualify under the Green Bond Principles, guidelines set forth by the International Capital Markets Association. Once this is ready, a special-purpose vehicle will issue an IIC-backed green bond.
“When we go out to the market, we want to achieve the AAA rating and be labeled green,” Tapia says. “The idea is to create a capital markets solution to encourage the private sector to tap the green bond market.”
The pilot securitization in Mexico is poised to launch this year. Tapia hopes the transparency in international capital markets will heighten the awareness and merits of such a program.
“What is clear is that there is a pool of green climate funds out there,” she says. “We’ve received inquiries about how to reach those funds, so we’re trying to develop a structure to offer these funds to clients.”
Another advance in environment financing came in September, when the New International Airport for Mexico City (NAICM) issued a $2 billion cross-border green bond. The transaction signaled not just a shift in investor perceptions toward socially responsible securities but also an innovative means of structuring green bonds.
Half of the transaction had a 20-year tenor, the longest ever for a green security. Despite that unprecedented feature, investors lunged for the paper, putting in orders for $4 billion of debt — the largest-ever order book for a Latin American green bond.
The borrower pulled out all the stops to make the deal as attractive as possible, says Mike Fitzgerald, a partner at law firm Paul Hastings. In particular, despite being a quasi-project-finance deal, it featured no construction risk. Rather, receivables from the existing airport have been channeled through a trust to pay for the expansion project.
“This financing mechanism is intended to straddle both [airports] through these charges that are placed in a trust,” he says. “It was a little unusual; because of the size, [NAICM] wanted to have the largest appeal to the most-available kinds of financings worldwide.”
By structuring the transaction in line with the Green Bond Principles, NAICM opened itself up to an investor base dedicated to socially responsible investments.
“From an economic approach, you want to make sure your deal is structured in such a way so it has access to these pools of capital,” Fitzgerald says. “This was a first for an airport, and with access to as many pools as possible, it gets the best execution."
Green bond opportunity: Banco Nacional de Costa Rica
When Banco Nacional de Costa Rica looked at issuing a bond last year, the green bond format was not on the table. It wasn’t until Bank of America Merrill Lynch pointed out that 60% of the proceeds from the borrower’s previous cross-border bond supported energy efficiency projects that it began considering the format, BNCR’s deputy general manager Bernardo Alfaro says.
“Our intentions were to issue vanilla 144A-type bonds and replace some of our short-term funding for green projects and support new projects that were under analysis,” he says.
But with more energy efficiency projects ahead, Alfaro was enticed to study the Green Bond Principles. With a push from its relationship banks, BNCR issued a $500 million 2021 green bond, opening itself up to new investors in the process, says Alfaro.
“During the investor road show, we were able to reach places that we would not have reached otherwise, like Switzerland and Germany.”
BNCR’s green bond had a new-issue premium of just 10 basis points, and bookrunners BAML and JPMorgan tightened spreads significantly on the day of issue, Carlos-Ivan Lopez, BAML’s head of debt capital markets for Latin America, says.
“You can’t guarantee this kind of squeeze to issuers, but we have seen precedents in the US market where multitranche deals, with one green portion [the green tranche] ends up with a lower new-issue premium,” he says. LF
NAICM’s use of environmentally friendly materials to build one of Latin America’s busiest airports allowed it to conform to the Green Bond Principles. The airport will be powered by clean energy and incorporate a water reuse system, says Kurt Vogt, a managing director for sustainable finance at HSBC, the green structuring advisor on NAICM’s bond.
Even for carbon-emitting industries, such as airports or paper-exporting firms, there are ways to invest in clean energy, he says.
“For a corporation transitioning into low carbon, they can invest in alternative fuels, or water, to make operations more efficient,” Vogt adds. “By doing that, the company has an opportunity to talk about it to investors, and investors, in turn, care about social and environmental governance.”
The Central American Bank for Economic Integration is one potential borrower attracted to green bonds by the opportunity to highlight its commitment to combating climate change.
“There are investors that are now only looking at your green aspects,” says Ricardo Rico, the head of capital and financial markets at the A1/A/A-rated development bank, who says his team already has the documentation in place for such a deal. “You have to demonstrate to investors that you are seriously committed to green.”
Growing buyer base
The depth of appetite shown by the airport transaction may herald a busier future for green bond deals in Mexico and beyond. Three-quarters of investors in the Americas are planning to increase their low-carbon investments in the coming years, says Vogt.
“They are driven by pressures from different stakeholders,” he says. “They have pressures from depositors such as pension funds that think about climate change and money as a catalyst to deal with it.”
HSBC’s Vogt says the largest barrier for growth is “the lack of credible opportunities” in Latin America. He also marks green bonds’ lack of transparency as an area of concern.
“What is missing is proper disclosure and understanding what the risks are and how they are measured,” Vogt says. “Without that, investors can’t be sure of what they are investing in and whether or not anything is being done to reduce risk in an adequate manner.”
Gema Sacristán, chief investment officer at the IIC, says investment-grade multilateral agencies can assume construction risk on green-oriented projects, alleviating some investor concerns.
“If we take a really big role at the beginning of a project by taking construction risk, then later on, once the project is done, we could refinance this in the capital markets,” she says. “Once the project is completed, then you have a steady generation of cash flow.”
The IIC’s Tapia says banks must convince issuers that green bonds bring benefits to investors. She also says the banks play a key role in compelling institutional investors to view energy efficiency portfolios and putting investors in a position to take risks on companies seeking green investments.
“It’s about educating investors and creating a tool to analyze the risks in a portfolio related to climate change,” Tapia says.
Under the Green Bond Principles, an issuer must ring-fence their proceeds to qualify for a green note. The borrower must also describe how it chooses the projects being financed and their environmental impact.
Proponents describe green bonds as a win-win for issuers and investors: Borrowers can tap into pools of green capital, and buyers can tout their sustainable investments. But some investors want to see green bonds really stand apart.
“Unless you are an investor that particularly wants it in your portfolio, then it makes no difference to buy a bond that is green or not,” says Edgardo Sternberg, a co-portfolio manager at Loomis, Sayles & Company. “There is no price difference and no incentive.”
What’s more, with green bonds still a rarity, measuring value is tough, he says.
“Like anything new in Latin America, the question is what to trade green bonds for, and what are you comparing them to?” Sternberg says. “If you buy green, you are likely to hold them for a while because there is no price discovery or benchmark in the Latin American space.”
Jason Trujillo, a senior analyst at Invesco, says such bonds don't merit better pricing for the borrower.
"I don't think you see people looking at green bonds and broadly thinking that they are any different," he says. "[Issuers] should not expect a materially better yield than if they were to issue a non-green bond."
Alex Rau, a principal and director at green bond advisory firm Climate Wedge, says that, over time, the pricing dynamics should change as the market grows.
“The market is just not big enough yet for a lot of investors to shift their portfolio off to green instruments,” Rau says. “In the longer term, I believe there will be a slight price premium. The trends are favorable but not quite there yet.”
Still, for some borrowers, any chance to broaden the investor base is welcome.
Paul Hastings’ Fitzgerald says currency fluctuation and geopolitics have left a wave of uncertainty around Latin American investments. And as long as that uncertainty exists, bond issuers must address the need to build a diverse order book, he says.
“Green bonds provide another attractive means of financing,” he says. “The greater the availability these dedicated pools of capital become, then the better things get in terms of pricing these transactions.”
Meanwhile, opinions still vary over what should constitute an environmentally friendly use of the proceeds, says Rau.
“Take energy efficiency measures at a coal-fired power plant," he says. "You may be making it greener, but it’s still not green — its power source is not always environmentally friendly.
"Measures are open to debate, but what’s important is ring-fencing the proceeds. It makes sure funds are going to green investments only.”
ICMA’s Green Bond Principles are the base, but Rau says the standards and definition over what constitutes a green bond must improve.
“Some questions have not been ironed out, but we are in a growth period for the green market,” he says. “In the long term, standards need to ensure that green bonds’ overall market integrity is not undermined.” LF