This article first appeared in Bonds & Loans Magazine.
Chile's impeccably timed and well-executed debut foray into the Green bond market set a number of milestones, building on a growing pipeline of Green and ESG-linked transactions in the Americas, and reinforcing the trend that these formats are viable components of the funding toolkit for a broadening range of organisations. More impressively so, Chile executed its inaugural Green issuances in USD and EUR Benchmarks both within the course of one week, successfully fulfilling the ambitious goal of making an impactful statement across the world's two deepest markets.
|Chile's USD and EUR Debut Green Bonds at a glance
1st Latin American Sovereign Green Bond
|Issuer:||Republic of Chile|
|Ranking/ Structure/ Type:||Senior Unsecured, Bullet, SEC-Registered|
|Deal Size:||USD1,418 million||EUR861 million|
|Pricing Date:||June 17, 2019||June 25, 2019|
|Maturity:||January 2050||July 2031|
|Coupon:||3.500 per cent||0.830 per cent|
|Issue Price:||99.439 per cent||100.00 per cent|
|Issue Yield:||3.530 per cent||0.830 per cent|
|Spread vs. Benchmark:||UST + 95 bps||MS + 50 bps|
|Issuer Rating:||A1/ A+/ A (Moody's/ S&P/ Fitch, all stable)|
|Governing Law:||New York|
|Listing:||London Stock Exchange International Securities Market|
|Bookrunners:||BNP Paribas, Citigroup, HSBC||Credit Agricole CIB, JP Morgan, Societe Generale|
|Green Structuring Support:||IDB, Climate Bonds Initiative, Bookrunners|
|Legal Advisers to Bookrunners:||Shearman & Sterling|
|Legal Advisers to Issuer:||Cleary, Gottlieb, Steen & Hamilton|
|Use of Proceeds:||General purposes of the government. In addition, Chile has the intention of investing an amount equal to the proceeds from the sale of the notes into projects that may qualify as "eligible green expenditures" as described in it's Green Bond Framework|
One of the unique characteristics of the global green bond market in its infancy was the dominance of financial institutions and quasi-sovereign or sub-sovereign institutions, with corporates and sovereign borrowers treating the format more cautiously.
But in that sense, Latin America has bucked the global trend. Although the first certified Climate Bond out of the region was issued by Mexican state owned lender Nacional Financiera SNC (Nafinsa) in October 2015, the first movers were in fact Peruvian wind farm operator Energia Eolica in December 2014 and Brazilian food producer BRF SA, the former raising USD204 million through 20-year notes and the region's first green project bond and EUR500 million in 7-year notes, respectively.
Transactions like these have paved the way for many other pioneering transactions from a broad range of organisations, from CAF – The Development Bank of Latin America (which issued the first Uridashi green bond in Latin America), to the Government of Mexico City (which placed the first sub-sovereign green bond in Latin America), Fibria Celulose (the region's first SEC-registered green bond), and Grupo Rotoplas (the region's first sustainability bond).
Sovereign participation in the green and sustainability-linked funding market is also growing, and rapidly. Globally, the share of total green bonds issued by sovereigns has grown from 1 per cent in 2016 to 16 per cent in 2019, according to Climate Bonds Initiative (CBI) data, and emerging market sovereigns in particular – like Poland, Fiji, Lithuania, Indonesia, Nigeria, and most recently, Chile – have played important roles in using a wide array of green and sustainable formats to finance key projects that help mitigate the effects of climate change.
According to Patricio Sepúlveda, Head of Public Debt, Finance Ministry, Republic of Chile, there were several reasons behind the decision to power ahead with this landmark deal.
"We wanted to demonstrate and reaffirm the government's commitment to tackling climate change. We have also been in close discussions with the Inter-American Development Bank and Vigeo Eiris over sustainable financing options and wanted to show commitment to this sector. Finally, we were very excited about becoming the first sovereign on the continent to tap into this market."
The mining sector is a key contributor to the country's economy, but recent months have been challenging for the industry, with strikes and social unrest taking their toll on output. This provided an opportunity for the government to take tangible steps towards its goal of shifting Chile's energy mix to more sustainable sources and fully eradicating coal plants by 2050, with a green transaction becoming an important milestone ahead of the 25th United Nations Climate Change Conference (COP25) to be hosted in Santiago in December this year.
The environment was supportive and timing was of the essence. As global geopolitical risks subsided, EM fund inflows resumed and US 30-year Treasury yields stabilized for a prolonged period, all combining to create a favourable issuance window, while the relatively low supply of ESG-linked assets out of Latin America compared with conventional issuances helped create scarcity value.
In 1H2019, Chile embarked on nondeal roadshows in the US, Europe, and Asia, establishing an ongoing dialogue with key investors; identifying Green Bond portfolios was a central part of the execution strategy.
On Monday 17 June 2019, Chile announced a new long USD 30-year Benchmark Green bond offering with initial price thoughts (IPTs) of "T+120bp area", launching with a final spread of T+95bp. Shortly after, on Tuesday 25 June 2019, the sovereign also announced a new 12-year EUR Benchmark Green tranche with IPT of "MS+75bp area", eventually launching at a final spread of MS+50bp.
The impressive 30-year tenor was picked to reinforce the country's longer benchmark. The EUR tranche allowed it to set a new 2031 benchmark, in line with investors' preference to a 12-year tranche over 20-year, and giving the sovereign more flexibility over the repayment schedule.
Unlike developed countries, it is still quite rare for emerging markets sovereign and sub-sovereign government budgets to have sizeable investment or subsidy programs specifically focused on climate change mitigation and other environmental goals.
Geopolitical risks were high, particularly US-China trade tensions, which weigh heavily on metals demand among other things; nevertheless, constructive market fundamentals allowed for a 25bp tightening from IPTs. As a result, both deals enjoyed negative new issue premiums of -5bps (USD) and -10bps (EUR), which may have received investor pushback compared to "vanilla" bond issues, a testament to the successful marketing and execution deployed by the Chile team and banks.
"The -5bps new issue premium was particularly significant as it provided additional insight into [USD] price discovery for this particular duration," Sepúlveda says. At its peak, the order book for the USD tranche showed oversubscription of around 13x (vs. new money) composed of global high-quality asset managers: 48 per cent of notes were placed with US investors, 36 per cent with EU and UK based ones, and other regions picked up the remaining 16 per cent.
The EUR green tranche, at its peak, saw the order book oversubscribed by around 4.7x (vs. new money). It was also dominated by a variety of funds, including asset manager accounts (67 per cent), insurance and pensions funds (25 per cent), and others (8 per cent), and underpinned by European accounts, which picked up 85 per cent of allocations.
Notably, ESG-focussed investors represented 76 per cent of the overall make-up for the EUR tranche, and 35 per cent for the USD-tranche, an anticipated breakdown given the previously diverging focus on this product.
Alongside this, Chile launched a debt tender offer targeting its USD 2020s, 21s, 22s, 25s, 26s, 42s and 47s (all USD bonds except 2028s; USD5.1 billion outstanding). The USD523 million of net new money was in line with targets and approvals – the bond was also composed of Switch Participation of USD540 million and Cash Tenders of USD311 million (notional amounts), making this the first sovereign green issuance executed as part of a liability management exercise (with the full amount being committed to green projects).
"That this deal was executed alongside a liability management exercise shows that green formats are increasingly getting integrated with the mainstream funding toolkit," explains Divya Bendre, Vice President of Sustainable Finance, Real Assets & Structured Finance at HSBC Securities, which regularly tops the league tables for largest green bond underwriters globally and has won various awards and recognition for its pioneering work in the green segment, including the CBI Green Bond Pioneer Award.
The sovereign also achieved its lowest ever yields in both currencies for their respective tenors: 3.53 per cent for the USD and 0.83 per cent for EUR tranches. Other highlights included low spreads, record demand from global markets (12.8x the amount offered for USD bonds, and 4.7x for the EUR bonds), and an important broadening of Chile's investor base towards institutional investors with green mandates.
The deal marked the first sovereign green bond in the Americas and the first sovereign green bond issuance in EUR issued by a non-European sovereign. The transaction also marked the first fully green dual-tranche debut in emerging markets.
How Green Bonds enhance the link between funding and policy
Proceeds from the issuance will go towards clean transportation, renewable energy projects, protecting natural resources and marine areas, as well as improving energy efficiency, water management and land use, as described in the Chile's Green Bond Framework.
Instead of relying solely on country level policy frameworks, the Ministry of Finance referenced the IDB's Sustainable Infrastructure Framework and the CBI's Climate Bonds Standard for its use of proceeds eligibility criteria.
"Unlike developed countries, it is still quite rare for emerging markets sovereign and sub-sovereign government budgets to have sizeable investment or subsidy programs specifically focused on climate change mitigation and other environmental goals. A significant amount of work is currently underway globally to develop national and multi-lateral project pipelines and financing plans to align with countries' Paris Agreement NDC commitments. While these initiatives are starting to scale up, the Green bond market is already helping to link government budgets and public sector project pipelines with internationally accepted environmental and social criteria, and science-based taxonomies. The Republic of Chile Green Bond sets a great precedent for other issuers on leveraging a combination of national, regional and international frameworks for creating robust definitions on green finance. We believe this approach can help emerging market issuers enhance their access to international private capital flows for sustainable development," Bendre says.
The issuance will undergo an annual assurance report conducted by an external auditor on the allocation and its conformity with the agreed green bond framework.
"We had to be very meticulous in describing the future use of proceeds during our preparation," admits Sepúlveda. "We heard that Peru is planning to tap the ESG market in the near future, and it is worth emphasizing that obtaining the green certificates and coordinating between ministries, external advisors and banks is not an easy feat."
One of the factors that enabled the success of this placement was the selection of banks. The Ministry was in touch with multiple partner banks since October 2018, and selected those with the best experience and expertise in ESG products.
"This was a very positive experience and we are already looking to do a follow-up green bond on the international markets, perhaps as early as next year, and are exploring local currency options as well," Sepúlveda concludes.
Juan Pablo Gallipoli, Director of Debt Capital Markets at HSBC Securities says the transaction sets an important precedent for other sovereigns in the region and more broadly.
"There are a number of sovereign borrowers in the region that have been inspired by Chile's green transaction, and the success of this transaction – from start to finish – is a key aspect of that. But more importantly, if you look more closely at the selection process and use of proceeds, you realise how broadly applicable – and deeply useful – these formats can be. Some borrowers may not feel they are as strong on climate finance, but they may be looking to finance other sustainable development projects, for example related to education or gender, and investor demand is clearly there and only growing. By going through the entire process, governments and others can more closely align how they finance themselves with tangible projects and important higher-order objectives – like the creation of a more sustainable future."
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