16 December 2015
There has only been a handful of green bonds from Latin America. This roundtable, organised by Environmental Finance with the help of the Inter-American Development Bank, explores how to scale up the market. Part two explores the role of governments and multi-lateral development banks.
- Peter Cripps - Editor, Environmental Finance
- Gema Sacristan - Chief, Financial Markets Division, Inter-American Development
- María Tapia - Lead Investment Officer, Inter-American Development Bank
- Alba Aguilar Priego - Nuevos Mercados, SIF-ICAP 4
- Eduardo Piquero - Director General, Mexico2
- Jose Humberto Alarcon Torre - Technical Secretary, Mexican Banking Association
- Anadi Jauhari - Senior managing director, Emerging Energy & Environment Investment Group
- Sophie Robinson-Tillett - News Editor, Environmental Finance
- Sean Kidney - CEO, Climate Bonds Initiative
- Kurt Vogt - Managing director, head of Latin America commercial banking coverage, capital financing, HSBC
- Alexander Rau - MD, Climate Wedge
- Ricardo Torresi - Regional Investment Manager for Latin America, Zurich Insurance
- Julian Broide - Head of Latin America structured finance, Bank of America Merrill Lynch
Kurt Vogt: If you want to develop real scale in the green bond market, the one actor that can have real impact is the government. If we look at some of the Latam countries, you can flex a little thing called withholding tax and say: 'If your bond is green, the withholding tax is not 5%; it is 2.5% or 0%'.
I do not think that something like this will impact government's finances. But it can turn around the whole conversation with CFOs.
Jose Humberto Alarcon Torre: What are we going to ask for to the Minister of Finance? What is best practice in this issue?
Sean Kidney: There are a lot of regulatory measures that can support investing. There are fiscal incentives that should be considered, such as Mexico's withholding tax Kurt mentions.
There is an interesting study that looks at the differential tax rates for accelerated depreciation of renewables in Norway and Sweden. In Sweden, the accelerated depreciation was about 15% higher. And 'voop', there was a renewable energy boost.
In Norway, it has never taken off, because the rate wasn't high enough to trigger substantive activity. This is sort of fine tuning of tax regimes is an example of what governments need to do.
Lastly, demonstration issuance would help a lot at the moment to get the market going!
Anadi Jauhari: It is estimated that infrastructure needs are estimated to be $500/600 billion a year – the region is consistently underinvested.
The development of clean and sustainable infrastructure requires policymakers, financiers and regulators to address many high-level issues. How do you create public/private partnerships? How do you create enabling legislation that attracts private capital? How do you bring government entities to agree to single-point approvals for renewable projects? How do you bring in the private investors who are concerned about political and regulatory risk?
Ultimately, the question is how do you bring down the overall cost of capital for sustainable and climate-friendly infrastructure in the region?
Peter Cripps: What role can green bonds play in bringing down that cost?
Anadi Jauhari: If you look at infrastructure, for every dollar of investment, more than three quarters is going to come from debt. The more efficient your capital markets, the more you are going to reduce the cost of capital.
Green bonds will be really critical in catalysing equity in building infrastructure. Green bonds could play a very big role in ensuring that climate-sensitive or climate-aligned infrastructure gets built.
Peter Cripps: What shape will that take? Will it be project bonds?
Anadi Jauhari: In Latin America, there is a track record of project bonds. If you look at 2014, more than a third of project bonds came from Latin America.
How do you create investable dealflow is really where I see the bigger challenge. There are many pieces of the puzzle that have to come together for you to bring the private sector in, to build the policy side, and you need to bring the multilaterals to provide competitive long tenor debt, credit enhancement and first-loss structures. There are many aspects of the green bond ecosystem to be built in the region, which will make green bonds an effective tool in financing of green infrastructure.
Peter Cripps: Does this region lend itself more to project bonds than the normal kind of use-of-proceeds green bonds that we have seen so far in the market?
Anadi Jauhari: If you look at LatAm, approximately 80% of GDP comes from investment-grade countries including Brazil, Mexico, Colombia, Peru, Chile, Uruguay and Panama. We do think that project bonds would be a good candidate in the context of Latin America as compared to other emerging markets, which tend to be sub-investment grade.
We have seen in the last two years in renewables, the Peru Metro line was a good example of a project bond, as was the Oaxaca wind farms with CFE. Over time, the market could grow to have participation from local investors especially in Mexico, Chile, Colombia and Peru.
Sean Kidney: I am going to argue project bonds are not going to make up a large part of the green bond market. They're going to be a useful piece of the puzzle, unlike in other markets, but by no means the largest.
In bond markets, you have to aim for a rating that will sell for your target investors, usually investment grade.
It's much harder to get a viable rating at a pre-construction stage. Post-construction, once a project is ticking over earning cash, is different.
Of course, all sorts of risk bridging tools, including IDB credit enhancements, will help with both pre and post-construction issuance.
The other way of getting a good credit rating is through a corporate structure. I mean, a corporation is just a risk-bridger - all it is doing is project development, using its existing balance sheet to get credit from old assets to fund new assets. So in a sense, it is the perfect vehicle for what we are talking about.
For us, the corporate green bond market is the most important to fire up.
Someone like CPFL Energia in Brazil for example, which is the largest renewable energy developer in Brazil, will do corporate bonds way before they ever do a project bond, because they have a passable balance sheet. And then as they develop green assets and make them solid and improve their balance sheet, it allows them to do more bonds.
We expect the non-government market to end up being 80% corporate and maybe at best 20% project and asset-backed securitisation.
Anadi Jauhari: The key is that project bonds achieve investment-grade ratings in foreign and or local currencies depending upon the targeted investor base. Unless the project benefits from strong investment grade counterparties, with revenue certainty, it will be challenging for projects to gain investment grade ratings.
However, large corporates benefit from larger balance sheets, strong credit quality, strong asset bases to issue green bonds competitively to fund their capex in sustainable infrastructure.
If you look at Latin America, the needs are the greatest in transport, water, and energy infrastructure. These sectors have huge capital demands and they have to be enhanced, either on a corporate balance sheet, wherever you can find a "home" where there is adequate credit quality. I think that is the right way to finance them. And I think, as the market evolves, there will be a way to finance this to achieve the right credit quality and the bundling of assets or putting them on a corporate balance sheet.
Julian Broide: I think one of the key elements to developing the market is that incentives have to come from the government or development institutions because investors need to show returns to their stakeholders.
I think the idea, for instance, of not having withholding tax or other taxes or in case of banks, wherever capital ratios hit or are affected, should be taken into consideration so people have incentives to invest.
On the other side, I think local markets are in a good position to absorb a lot of the supply that should come. Most of the markets, where we see a local market develop are investment grade, like Peru, Chile, Mexico, etc. But they are all made out of heavily regulated institutional investors like pension funds and insurance companies.
So how do we incentivise the development of green bonds in local markets? Clearly it is a marketing process – you need to create some added value for anybody for holding this kind of security, but also other economic incentives. But I do not think on the investor side, we are going to see a lot of subsidies to this market.
Ricardo Torresi: Local investors definitely have the desire, the ambition and the money to invest. But how do we incentivise the market to start purchasing these securities?
Sean Kidney: A key thing we have to do is make it easy for investors. For issuers, one of the barriers is cost. If it is going to cost $80,000 or $100,000 or $250,000, the CEO is not going to authorise that level of expenditure for uncertain price benefit. But if it turns out that it is not going to cost a fortune, the CFO will say, 'Okay, sure, why not?'
One of the key challenges, if you want to kick-start a market, is education that this can actually be very simple, as we have seen from some of the corporate issuers.
But some of the MDBs who have issued green bonds talk about the complexity of their accountability mechanisms around their environmental reporting. This is making it look like a lot of hassle and it does not need to be that way. And that has been a bit of a drag on the market this year. Guys, this is not helping!
Peter Cripps: Closing thoughts on the market's development please?
Alba Aguilar Priego: I think we have to work hard in the buy-side in Mexico because they still do not have green mandates or green portfolios. They do not know the difference between traditional investments and low-carbon investments, and they are very concentrated in oil and gas.
Julian Broide: At the end of the day, yes, I think we are at the stage where green bonds for some local investors is a good to have, which is great, but [they say] still pay me as much as you can. Maybe with marketing incentives, etc., it can change.
Peter Cripps: Closing thoughts on the market's development please?
Sean Kidney: Well, I am not going to talk about the size of the market. My form was not great on that! Having said that, we will get there, it will just be a year later than I expected.
I do think there is potential to get something going in two LatAm economies, Brazil and Mexico, in the first instance.
Chile and Colombia are other places where there have been a lot of people asking us questions. Banco Colombia, for example, is looking at whether they can do something.
I think what you will find happening is scattered issuance across the sector, realistically supported in the early stages by the likes of IDB and other development banks in the area.
Kurt Vogt: It is not about philanthropy. We are seeing some new investors looking not only for yield but also for socially responsible investments. In some cases, we need to be able, as bankers, to show the value of buying green as the millennials come of age and begin to exert their investment power.
This is two-fold: We need to help issuers bring legitimate green/ sustainability /social bonds to market and then help them find the appropriate investor base – sometimes pure green buyers, sometimes general investors who like the green approach. This is the work that we as bankers have to do and it is not a simple job.
In terms of predictions, I am very optimistic. Many good ideas come from a roundtable like this, and we just need to make them happen.
Alexander Rau: The one thing I do feel strongly about is that on the issuer side, we need to demystify the certification process a little bit. This is not a particularly complicated process. We need consensus on procedures and best practices as soon as possible so that the message to the people who are potential issuers is much more consistent.
Peter Cripps: Will it grow quickly or slowly?
Ricardo Torresi: I do not see the market exploding. I see it as gradually growing, which is perhaps better because you can avoid bad surprises.
Julian Broide: The market has a lot of potential but it will definitely take longer. Brazil has a lot of potential but also the speed at which it will recover from this credit situation may affect the element of this particular market as well.
Alba Aguilar Priego: We have a new commitment from the Mexican Stock Exchange. To admit green bonds in the special segment, the user is required to provide a second opinion or certification. The next step for the Mexican Stock Exchange will be to spread the criteria about the Green Bond Principles and the Climate Bonds Standards.
Peter Cripps: Thank you everyone for your input. It sounds as if the market has a huge amount of potential but it will not be quick one to grow.