Not only did Chile bring the world’s first sovereign sustainability-linked bond, in March 2022, but it has also brought the most recent – a 10 local-currency SLB structure in July this year.
In between these transactions, Chile also issued two other dollar-denominated bonds – one of which was a 30-year note – as well as a euro-denominated deal.
Chile’s first SLB transaction had two sustainability performance targets (SPTs, key indicators built into deals – if the issuer hits them they get better financing rate – if they miss them the investor receives a pick-up in yield) related to the country’s environmental commitments – reducing greenhouse gas emissions and increasing the proportion of renewable power within the national grid – while subsequent bonds included a social SPT related to minimum female representation on corporate boards.
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Despite a year of high-profile issuance, all is not well in the sustainability-linked bond market. Teething problems could soon become an existential crisis, raising the risk that investors might decide to abandon the asset class altogether.
Moving beyond science-based targets creates difficulties for investors trying to quantify the ambition inherent in these goals.
Patricio Sepúlveda, head of Chile’s public debt office, tells Euromoney that he discussed the problem of asymmetrical information for these new types of SPTs with Djellil Bouzidi – who is an academic and whom Sepúlveda met while studying financial economics in Belgium at the Catholic University of Leuven in 2000 – but he believes the issuer shouldn’t be responsible for articulating the degree of ambition that is required to comply with SLB transactions’ SPTs.
“It’s not something that I think we, as an issuer, can provide – I may have an opinion, but other ministers may have different opinions,” he says. “The ambitiousness of the target is the most important element of the transaction, and it is obviously very important for the investors to understand this, but it needs to be defined by the second party opinions – the SPOs.”
Sepúlveda believes it is an area that requires improvement.
“There needs to be greater transparency in the market," he says. "It’s not an easy task but, in the same way that rating agencies have a system based around the probability of a borrower repaying the debt, we need SPOs that develop clear methodologies that assign probability of SPTs being met.”
Step-up
Meanwhile, Sepúlveda is already incorporating Bouzidi’s other general criticism of SLBs, which relates to the need for variable pricing: Chile’s sovereign SLBs are structured by applying the concept of present value to harmonize the value of step-ups across their portfolio of five outstanding bonds. At the time of issuance of the euro and dollar deals the market pricing was such that no adaption needed to be made for the currency denomination but the tenor of the deal had a big impact.
For example, the shortest deal – the 10-year Eurobond – included a 50-basis point step-up; the 30-year bond’s maturity meant a 5bp step-up equalised the potential ‘penalty’ cost with the other issuances.
Sepúlveda makes the point that taking a portfolio approach to SLB issuance creates very important dynamics when compared with issuing a single bond.
He expects that Chile will have roughly $9 billion-equivalent of SLBs outstanding in the international markets by the end of this year, or roughly 6% of all the country’s public debt in this market.
He says that the combination of having consistent triggers across a swathe of bonds amplifies the commitment Chile has to these goals.
We are not speaking about creating impacts in only the next two or three years. Some policies – education, for example – take 20 years to come to fruition
The portfolio approach also lowers the cost of complying with the added regulatory and reporting requirements that come with SLBs, which also have positive secondary impacts of embedding stricter internal processes around the issues defined in the SPTs.
Lowering the deal-specific costs of SLB issuance also enhances the greenium upside of such deals, and Sepúlveda says the greenium is important.
“It’s never an easy take to quantify the greenium,” he says. "We can’t be exact because we have never issued a plain vanilla bond at the same time as an SLB, but we can say for certainty that the greenium is material."
The new-issue premium of Chile’s first SLB was calculated to be -15bp. With a plain vanilla bond expected to have required a new issuance premium of around 10bp at the time, the greenium was slated to be around 25bps.
The most recent – the local-currency bond – saw a new-issuance premium of -7bp. A traditional bond was estimated to have required between 8bp and 13bp, meaning the greenium was around 15bp to 20bp.
Going private
The financing innovation was broadly welcomed within Chile when the SPTs were aligned to long-term environmental goals.
Sepúlveda says there has been some criticism of the most recent deals’ SPTs to gender equality – especially as they also include private-sector companies.
The bond was sold before the government has been able to pass a law requiring private firms to improve their gender balance.
If this fails, future administrations will be on the financial hook for this administration’s failed aspirations.
Sepúlveda concedes there has been some criticism, but he is unequivocal that SLBs can and should be used to advance all types of public policies – he is looking at using biodiversity-related SPTs in future deals.
“Yes – success in achieving these deals’ SPTs will require the efforts of the next administration as well as this one,” he says. “But this is something that is very normal in public policy. We are not speaking about creating impacts in only the next two or three years. Some policies – education, for example – take 20 years to come to fruition.”
Sepúlveda says he has considered SPTs related to education but that the calibration of specific targets makes it a difficult tool for public policy advancement in this area.
As well as in the public sphere, Sepúlveda says the government is also hoping to advance SLB financing within the country’s private sector.
To date, issuance has been very limited, with deals issued in the local markets. Sepúlveda says he is in talks with the Santiago stock exchange about how to incentivize companies to use the structure in local markets.
Meanwhile there has been some progress in the international markets, with CMPC’s $500 million combined green and SLB bond a landmark from the country’s private sector.
