Sustainable Financing Newsletter

Issue
05

Plugging the Infrastructure Gap in Latin America

“We are confronting a serious climactic problem,” said Peru’s President, Pedro Kuczynski, in a broadcast following March’s floods, which were the worst in the country’s history. Vulnerability to climate change is an issue across Latin America, as the IDB observes in its most recent Sustainability Reporti. “Our research indicates that damages caused by the intensification of flooding, droughts and other natural disasters will likely approach $100 billion a year by 2050,” this notes.

The potential impact of unchecked climate change on the broader Latin economy is dramatic. According to the International Finance Corporation (IFC), the losses associated with climate change could amount to as much as 5% of the region’s gross domestic product (GDP) if global temperatures increase to 2.5 degrees Celsius in the second half of this centuryii.

The Latin American Infrastructure Gap

On the other hand, proactively addressing challenges presented by climate change through investment in green infrastructure has the potential to create extensive socioeconomic opportunities as the region continues to be hamstrung by its outdated and inefficient infrastructure. According to an IMF analysis published in June 2016iii, “in Latin America and the Caribbean, the level and quality of infrastructure is inadequate.” This, adds the IMF, has been identified as “one of the principal barriers to growth and development, despite upgrades to the region’s infrastructure network over the past decade.”

The Caracas-based development bank, CAF, puts the magnitude of the region’s infrastructure deficit into perspective, calculating that Latin America will need to invest at least 5% of its GDP annually over the next few years in order to take a “leap towards competitivenessiv.” This compares with an annual average of just 2.8% between 2008 and 2015.

The Leapfrog Opportunity

Duncan Caird, HSBC’s Head of the Infrastructure and Real Estate Group, Americas, says that by mobilising public and private sector finance to address the infrastructural challenges they face, governments throughout the region may be able to achieve three key objectives. Investment in infrastructure may simultaneously boost economic growth and living standards, arrest or reverse environmental damage and help deepen the region’s capital markets, says Caird. This, he adds, may allow Latin America to grasp what he describes as the “leapfrog” opportunity that China has embraced in by linking infrastructure investment with broader sustainable development and environmental goals. [See article on Page 12 on China’s One Belt, One Road initiative]

The good news, says Patrick White, HSBC’s Head of Public Sector, Americas, is that public sector stakeholders throughout the region are already responding constructively to the challenge. “Regional and national development finance institutions have issued green bonds to tap private investor demand for investment opportunities linked to green infrastructure. Central banks and finance ministries are also actively engaging in the dialog around catalysing private sector financing for sustainable development.”

For example, Mexico City (CDMX) became Latin America’s first city to issue a green bond in December 20161. The proceeds from this $50 million five-year deal from CDMX, which was oversubscribed by two and a half times, are earmarked for investment in climate-resilient infrastructure and transport. CDMX has also launched a Resilience Strategyv a holistic, proactive blueprint for sustainable urban development. Announced in September 2016, this Strategy – named “Resilient CDMX: Adaptive, Inclusive and Equitable Transformation” – is a five-pronged plan to “implement solutions that meet the challenges posed by globalization, urbanization and climate change, and their impacts at the social and economic level.”

Ambitious Targets

Over 30 countries in the region have submitted their Intended Nationally Determined Contributions (NDC) to the battle against climate change2. Moreover, cities throughout the region are enthusiastically embracing many of the principles enshrined in the C40 Agenda. Governments throughout the region have also underscored their commitment to addressing the infrastructure challenge via energy reform, promoting rising private sector investment in the sector. As part of the reform process, many have established ambitious targets aimed at increasing the share of renewables in energy generation. For example, Chile’s 2050 Energy Agenda sets a quota for renewables of 70% by 2050, while Mexico’s Estrategia Nacional de Energia has directed that 35% of energy should be derived from renewable sources by 2024. In Peru, the target is 60% by 2025, and in Brazil, the 10 Year Energy Plan for 2015 to 2024 calls for at least 23% of domestic energy supply to be contributed by wind, solar and biomass by the end of the period.

Pivotal to the achievement of these ambitious targets will be the availability of public and private sector funding from local as well as international sources. Among multilateral lenders, development banks such as the World Bank and IDB are spearheading the growth of a market for sustainable lending in the region. IDB has established a goal of increasing the financing of climate change-related projects in Latin America and the Caribbean to 30% of the IDB’s and IIC’s combined total approvals by 20203. In March 2017, the World Bank established a $480m 20-year guarantee to support Argentina’s Fund for the Development of Renewable Energy (FODER, in Spanish), which facilitates financing of projects under the RenovAr Program. Argentina has set a target to achieve 20% of domestic electricity consumption from wind, solar, biomass, biogas and small-scale hydro sources by 20254.

Latin America’s Green Capital Market

In the capital markets, meanwhile, an increasingly deep and diversified green bond market has been taking shape across the region. Mexico has led the way, with the sale of $2 billion of green bonds providing part of the funding for the capital city’s new airport widely regarded as a landmark for sustainable finance in Latin America. Aside from being the largest green bond ever placed by a Latin American borrower5, the Mexico City Airport Trust issue made a notable contribution to the internationalisation of the region’s sustainable capital market, attracting significant demand from Asia. Mexico has also just seen the issuance of the first Sustainability Bond from a Latin American issuer. In June 2017, Grupo Rotoplas, a Mexican water solutions firm issued an MXN2bn dual tranche Sustainability Bond to finance projects that enhance access to water and sanitation such as drinking water fountains in public schools and rainwater harvesting systems.

The recent green bonds from Latin American issuers built on the precedent set in December 2014 by Energia Eolica, the owner and operator of Peru’s two largest wind farms, which was the first Latin American company to issue a green bond in the cross-border market with a $204 million 20 year transaction6. Sporadic issuance followed with bonds from borrowers ranging from Brazil’s BRF Foods and Suzano Papel e Celulose, to Banco Nacional de Costa Rica (BNCR) and the Mexican Development Bank, Nafin.

In 2016, however, a number of other significant initiatives were taken towards establishing a credible and durable framework for green bond issuance in the region, notably in Brazil. Having ratified the Paris Agreement on climate change in September, Brazil published its new Green Bond guidelines7 the following month, developed by the banking federation FEBRABAN, in conjunction with the Brazilian Business Council for Sustainable Development (CEBDS).

Also in October, a number of local and international investors, managing assets worth R$1.61 trillion, signed up to the Brazil Green Bond Statement8. This was an affirmation of their belief that “green bonds or other green asset classes can be a new investment option to fulfil our fiduciary duty with our clients and beneficiaries in a responsible and sustainable manner.”

A third landmark passed in Brazil in 2016 was the announcement in December by the development bank, BNDES, of the establishment of a green energy fund, Fundo de Sustentavel9.

Green Bonds in 2017: Gathering Momentum

In 2017, a number of issuers have supported the development of a broader and more diversified green capital market in Latin America. Again, Brazil has led the way, with Fibria Overseas Finance issuing a $700 million five year bond10 in January, which was the largest green bond ever from a Brazilian corporate. Demand of $3.5 billion for the Fibria bond, with 40% of orders coming from dedicated green accounts, was a striking barometer of the strength of appetite for exposure to top quality Latin American corporates in green format.

So too was the response from investors to the passage of another landmark for Brazilian green bonds in May, when BNDES launched the first green issue from a Brazilian bank in the international capital market, which was the development bank’s first international issue since 2014. The proceeds of the seven year, $1 billion benchmark, which generated demand of $5 billion from more than 370 investors, are for investment in wind or solar projects. This builds on the bank’s pedigree as a key provider of finance for renewable energy in Brazil. According to BNDES, between 2003 and 2016, in the wind power sector alone, the Bank approved 87 loans worth R$ 28.5 billion, supporting an increase in installed capacity of about 10.7GWvi.

Colombia has also seen some encouraging developments in the sustainable finance space. At the end of 2016, Bancolombia, the country’s largest commercial bank, issued its first green bond, raising COP350 – equivalent to $115 million – to expand financial services for private sector investments that help to address climate change. IFC was the sole investor in the Bancolombia transaction, which was the first green bond issued by a commercial bank in Latin America.11

Among other Colombian borrowers, Davivienda issued a 10 year green bond for COP$433 billion (approximately US$150 million) in April12. According to IFC, which again was the sole investor in the Davivienda issue, “this is the largest green bond issue by a private financial institution in Latin America, demonstrating Davivienda’s commitment to financing projects with a positive climate and environmental impact. The issuance responds to Colombia’s target of reducing its pollutant emissions 20 percent by 2030. The funds will be used to finance projects in the areas of sustainable construction, cleaner production, energy efficiency and renewable energies (water, biomass, wind and photovoltaic solar energy).”

Chile, meanwhile, saw its first corporate green bond in May, when the forestry, pulp and paper company, Inversiones CMPC, launched a $500 million 10 year transaction13. The proceeds from the CMPC issue are for investment in areas ranging from sustainable forestry to biodiversity preservation, sustainable water management, pollution prevention and energy efficiency.

Growth Potential

These deals are likely to represent the tip of an iceberg for green bond issuance in Latin America. IFC reports that it has identified more than US$1 trillion in climate financing opportunities in Latin America and the Caribbean through to 2040. More specifically, it estimates that in Colombia, there is an investment potential of $27.5 billion in renewable energy to 2030. In Brazil, that figure is around $152 billion and in Mexico, around $75 billion.14

While this financing will be raised from a number of public and private sources, several recently-announced initiatives are expected to underpin strengthening demand from local and international investors for Latin American green bonds. For example, Latin America and the Caribbean is likely to be among the main beneficiaries of the $2 billion Cornerstone Fund recently launched by IFC and Amundi, which is the largest green bond fund ever created. IFC explains that it is investing up to $325 million in the Green Cornerstone Bond Fund, which will buy green bonds issued by banks in developing countries. “Amundi will raise the rest of the $2 billion from institutional investors worldwide and provide its services in managing emerging market debt. The fund aims to be fully invested in green bonds within seven years,” IFC reports.

More significant than its size is the role the Cornerstone Fund will play in ensuring that investment is allowed to flow into projects that may not be suitable for backing from other private sector investors. As GlobalCapital put itvii, “there has remained a yawning gulf between the large pots of money managed with a view to greenness in the developed world and the tough, often risky and small-scale projects in the developing world that are most in need of funding for climate-minded investors.”

The Regional Investor Base

Among individual countries in the region, Mexico has taken a number of important steps towards supporting the growth of a local investor base for green issues. Mexico2, launched in 2013, was the second carbon platform in the region (following the opening of Costa Rica2 earlier the same year), while the Mexican Stock Exchange (BMV, in Spanish) has won international recognition for its state-ofthe- art requirements for listing green bonds. In December 2016, the Mexican Stock Exchange and the non-profit Climate Bonds Initiative jointly convened a Consultative Board for Climate Finance (CCFC) in Mexico comprising representatives from major local pension funds, insurance companies, development banks and investment funds. More recently, in May 2017, 57 Mexican investors (including Afores, or local pension funds) with assets under management of almost $214 million, put their names to an agreementviii supporting Green Bonds.

The Consultative Board for Climate Finance (CCFC) works to integrate sustainability into the Mexican finance industry; and the good response from local institutional investors to date sends an important market signal – they want to see more green projects, long term climate solutions that will be the basis for creating a robust green bond market.

Alba Aguilar Priego,
New Markets Director, SIF ICAP, Grupo BMV

With other countries in the region likely to explore similar initiatives to encourage the growth of domestic demand for green bonds, the longer term outlook for supply and demand is brightening.

1 Mexico City issues 1st muni bond from Latin America! MXN 1 bn (USD 50m), 4th from Mexico!, Climate Bonds Initiative
2 NDC Registry
3 IDB aims to double financing for climate change, IDB
4 World Bank to promote private investment in Argentina's renewable energy sector, Clean Technology Business Review
5 Mexico could ignite Latin America’s green bond market, Mexico News Network
6 How two Mexican developments could catalyze Latin America’s green bond market, LatinFinance
7 Initiative of the Year - Brazil's Green Bond Guidelines, Environmental Finance
8 The Brazil Green Bonds Statement, Climate Bonds Initiative
9 BNDES - O banco nacional do desenvolvimento
10 Brazil Set for Bond-Sale Surge After Petrobras’s $4 Billion Haul, Bloomberg
11 Colombia's first! COP 350bn (USD 115m) GB issued by Bancolombia: Funding for renewable energy and sustainable buildings, Climate Bonds Initiative
12 Colombia's Davivienda issues COP-433bn green bond to IFC, Renewables Now
13 April Market Blog, Climate Bonds Initiative
i Inter-American Development Bank (IDB) Sustainability Report 2016
ii IFC Press release, June 14th 2016
iii International Monetary Fund, June 9th 2016
iv CAF - banco de desarrollo de América Latina, May 11th 2017
v CDMX Resilience Strategy, September 6, 2016
vi BNDES - O banco nacional do desenvolvimento, May 9th 2017
vii GlobalCapital, April 27th 2017
viiiMexico Green Bond Investors Statement, May 31, 2017

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Chapter
03

Plugging the Infrastructure Gap in Latin America

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