Chile has become the first sovereign to print a sustainability-linked bond (SLB), a transaction described by one asset manager as “an important milestone for the sovereign market”.
Although the issuer is understood to have harboured plans to sell a US dollar and a euro benchmark, it ended up testing the market with the US dollar tranche first, given uncertain markets in the face of Russia’s war in Ukraine, and it priced a $2bn (€1.8bn) 4.346% 20-year deal at 200 basis points over US Treasuries.
According to the Chilean finance ministry, demand for the SLB reached $8.1bn, “diversified not only by type of investor but also by geography”.
Jana Velebova, portfolio manager at fixed income specialist BlueBay Asset Management, which met the issuer during its roadshow as part of the asset manager’s due diligence, said the deal was a success and “an important milestone for the sovereign market”. She said she was unable to comment on BlueBay’s participation, however.
SLBs have been around for a bit more than two years, after Italian energy giant Enel introduced the performance-linked structure in late 2019, but the market has been dominated by corporates – until Chile’s deal no sovereign had issued an SLB.
This was in the context of market discussion about what would constitute credible key performance indicators (KPIs) and reporting for sovereign issuers, and debate about the structure for a sovereign SLB.
Unlike green bonds and other use-of-proceed bonds, SLBs are not ring-fenced for particular projects or spending and the payout to investors depends on whether the issuer meets agreed-upon KPIs.
Velebova said a World Bank paper from a few months ago provided some important guidance for sovereign SLBs.
Building on the International Capital Market Association principles for SLBs, the World Bank report set out to provide a framework for selecting KPIs and setting the associated sustainable performance targets for sovereign SLBs.
One of the things the report did was to screen datasets to identify potential KPIs that could be used by sovereign SLBs to determine sustainability performance objectives, with a specific focus on climate and nature-related objectives.
“We expect this structure to be as popular amongst sovereign issuers one day as it is amongst corporates”
Jana Velebova, portfolio manager at BlueBay Asset Management
Chile’s SLB framework comprises two KPIs: absolute greenhouse gas emissions and “share of non-conventional renewable energy generation in the national electric system”.
In a second party opinion on the framework, Sustainalytics said it considered the performance targets linked to the first KPI to be “ambitious” and those linked to the second to be “highly ambitious”.
The step-up structure will see investors paid a premium of 12.5bps if a target is not met, and 25bp if both targets are not satisfied.
Velebova said BlueBay believed the KPIs had been chosen carefully and “are coherent, ambitious and credible in terms of their alignment with Chile’s policies and objectives” and “also fairly in line with prevailing market practices”, with KPIs linked to environmental sustainability goals by far the most common in the corporate market to date.
Asked about the step-up coupon, she said the increase offered was also broadly aligned with those seen in the corporate world, where 25bps is by far the most common.
“Whilst at this point it won’t be a significant financial penalty given Chile’s overall debt financing costs, this will gradually rise as the sovereign issues more SLBs in the future. In the meantime, it has an important signalling effect in terms of Chile’s commitment to climate transition.”
She also said Chile’s decision to focus on a single US dollar tranche despite initial indications made sense given current volatile market conditions and the US dollar market typically offering deeper liquidity given a greater dedicated US dollar emerging market invesor base relative to Euro investors.
”The SLB structure is likely to appeal to a broader set of sovereign issuers who perhaps don’t have sufficient amount of projects to finance using use of proceed bonds,” she added. “Now that the example has been set, the door is wide open for other sovereigns to follow – we expect this structure to be as popular amongst sovereign issuers one day as it is amongst corporates.”
When Enel came to market with an SLB it also first issued a US dollar deal before turning to Euros.
In September 2020 the European Central Bank announced that SLBs would be eligible for its asset purchase programmes, a decision that was welcomed as an “exceptional exception”.
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