Rising demand for green and social bond issuance is allowing Latin American issuers to enjoy cheaper borrowing costs and a stabler investor base, though the lower returns for buyers means investors want to be sure they are getting what they pay for.
Proceeds of green, social, sustainability and sustainability-linked (GSSS) bonds from the region rose 6% year-on-year in the first five months or so, with a historic peak expected by some market participants for 2024.
A key advantage of GSSS bonds for issuers is that they typically carry a premium, providing them with a cost benefit over ordinary bonds. The so-called ‘greenium’ can be seen in yields offered by issuers of GSSS (or labeled) bonds in Latin America, which are lower compared with regular bonds.
Latin American labeled bonds offer a yield to worst (a financial metric that helps investors assess the minimum yield they can expect from a bond under various scenarios) of 6.6% with a 5.5 year average maturity, according to a Bank of America report published in April. This compares with 7.7% yield to worst and 5.9 year duration for non-labelled bonds.
“Greenium is real, and I think it’s linked to the high demand for green bonds, rather than the characteristics of the bonds themselves,” says Gustavo Medeiros, the head of global macro research at London-based investment firm Ashmore.
The Bank of America report also shows that as of April, 54% of labeled bonds outstanding in Latin America are investment grade and 46% are high yield. While there are no labeled bond maturities in 2024, a total of $2.8 billion comes due in 2025 and 2026.
As the need for capital to finance the green transition and social projects grows, so will GSSS bond supply, market participants say, because the demand from investors is there.
“We are confident that issuances will continue because the amount of capital that the world needs to finance the transition is huge,” Alan Siow, says the London-based co-head of global emerging market corporate debt at Ninety One.
“What is missing is not necessarily the funding per se, but the willingness of both companies and countries to undertake that and the commitments to raise the money. So we do not see this to be a significant block, we expect this to grow,” he added.
GREEN OR NON-GREEN?
However, in contrast with equity financing, which can promise several times future earnings in investments, the return on green bond instruments are by definition fixed — with a cap on returns for investors — which investors will take into consideration as part of their strategies. And there is also a limit to how low investors are prepared to go. Issuers “cannot compete the cost of capital down to zero,” Siow says.
“Premiums are definitely possible but it is not economic for that premium to be outsized,” Siow says. “At some point the returns don’t make any sense…And for us, therefore, the key constraint in all of these issuances is: If I have a green bond and a non-green bond from the same company or the same country, at some point I’m going to choose the non-green.”
Greenium is more prevalent in the corporate space than for sovereigns. According to a database compiled by the UN’s Economic Commission for Latin America and the Caribbean spanning eight years from 2014 to 2022, sovereign issuances have on average a higher volume, coupon rate and average maturity than corporate issuances when considering both traditional and GSSS bonds. However, in the case of GSSS bonds, the average sovereign coupon was almost 100 basis points lower than the average corporate coupon, the data show.
The report highlights Chile’s Celulosa Arauco y Constitución’s 2019 offering of $500 million worth of 5.15% sustainable notes due 2050, as “achieving the lowest coupon rate in the company’s history for a 30-year bond,” with proceeds to be used for a combination of green and social projects. Also in 2019, the company issued a non-sustainable $500 million principal bond maturing in 2049 at a 5.5% coupon.
Colombia’s two-part sale of 10-year notes in 2021 points to a smaller discount for sovereign issuers of GSSS bonds. Though of different sizes, the sovereign’s bonds were issued on the same date and are identical by design, except for the green commitment for one of the instruments.
‘STICKY’ INVESTORS
What a green or sustainable label can also achieve for sovereign issuers, however, is a ‘stickier’ investor base.
“Typically, a lot of the buyers who buy label bonds will hold them for the long term, so it is much less about fast money,” says Viktor Szabó, a portfolio manager on the emerging markets debt team at abrdn.
The fact that GSSS bonds’ investor base tends to be buy-and-hold means the notes will experience lower volatility, so ‘greenium’ may increase when credit spreads are wider, market participants also note.
At the same time, asset managers caution that while issuance may be rising at a steady clip, that doesn’t always mean that every single instrument should be considered a bona fide GSSS bond that fits with their end-investors’ ethos and therefore with a fund’s criteria for investing.
“One of the concerns we have is that in this rush to issue, less-than-great things are happening,” says Siow. “Our approach is that for every issuance we look at, green or not green, we want to make sure that we understand how the money will be used and whether or not the use of that money will actually deliver the benefits that the issuer claims.”
For investment strategies that do not have a specific green or sustainability angle, the due diligence process for investment is necessarily more thorough.
“Because we are bond investors and green bonds typically want a premium — i.e. we get paid less for investing in them — our threshold for investing is high,” Siow adds. “I want to be very sure that the green bond does what it says on the tin.”
