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Examining emerging markets: Chile opening new frontiers with SLBs
Emerging market debt expert Jana Harvey, BlueBay Senior Portfolio Manager, discusses Chile’s ongoing commitment to environmental, social and governance (ESG) with the addition of social targets and why it matters.
Chile’s continuing commitment
Last year, Chile successfully launched the first ever sovereign sustainability-linked bond (SLB) with a step-up coupon structure, with Uruguay following shortly afterwards with another innovative step-up-step-down SLB structure. SLBs are a product first launched in 2019 in the corporate space by Enel, an Italian multinational manufacturer and distributor of electricity and gas.
Following a sharp increase in issuance in 2021, its popularity waned somewhat since, with issues around appropriate pricing models, unambitious targets, small penalties as well as lack of price advantage in the primary market. This held both issuers and investors back from fully embracing the concept. Presently, with USD 216 billion of SLB bonds outstanding globally [source HSBC, as of 10th July 2023], the SLB market remains the smallest part of the ESG-labelled bond universe. Yet, we believe it remains an area to watch.
These structures open up a new instrument for countries that may not have enough projects for ‘use-of-proceeds’ bonds but still want to attract ESG-minded capital. They could also serve as a powerful tool to hold countries accountable for meeting their ESG commitments, such as the presently non-legally binding Nationally Determined Contributions (NDCs) under the Paris Agreement, helping to reduce risks that future administrations will backtrack on commitments, by making non-adherence costly. Furthering its leadership in this field, Chile has continued to showcase its commitment to environmental and now also social objectives by issuing a dual-tranche $ and single-tranche EUR SLB bonds at the end of June, opening up new frontiers for sovereigns within sustainable finance.
Chile adds a social target to new SLB issuance
Similarly to previous issuances, the new SLB bonds are offering investors a step-up coupon of various sizes from 2030/31 onwards, should Chile not adhere to a range of key performance indicators such as:
- commitments to the reduction of greenhouse gas emissions
- an increased share of renewable energy in the national electric system
This time, however, the country has expanded the original framework to include a new 3rd key performance indicator covering the ‘S’ in ESG. This social element targets an increased percentage of women on the boards of companies subject to the oversight of the Financial Market Commission (local markets regulator), at 40% from a 14% baseline in 2022. The introduction of a social KPI is yet another ‘first’ in the area of sovereign SLBs, where, until now, KPIs have been dominated by environmental goals.
Innovative liability management
This transaction was even more meaningful given the long-dated nature of the issuance (including bonds maturing in 2054) as well as the connected liability management exercise, which offered holders of Chile’s plain vanilla sovereign bonds to exchange these for the new SLB-linked instruments. This move thus further increases Chile’s ESG-labelled bond debt stock, which is already one of the largest amongst its sovereign peers worldwide, amounting to 31% of total debt outstanding (third after Andorra and Hong Kong), before this latest tranche, with the ultimate goal of a 50% share of ESG bonds in its public debt stock. The transaction, along with the liability management exercise, further shows Chile’s commitment to improving its environmental and social performance, as well as the confidence of the sovereign in fulfilling these ambitious objectives.
A meaningful direction
ESG-labelled bonds present an important channel for emerging markets to raise much needed sums to fund investments bringing them closer to achieving important ESG objectives, such as the Sustainable Development Goals and NDCs. With the rise in demand for ESG-minded investments, we predict more countries will come to the market over the next 12 months with the intention to issue an ESG-labelled bond. While ‘use of proceeds’ bonds will be the natural first choice for many, we suggest the SLB concept should be seriously considered.
We believe these innovative instruments are a unique opportunity for countries to showcase to investors their commitments to improve their environmental, social and governance characteristics, tying their future cost of funding to the fulfilment of their goals – instruments suitable to both emerging and developed markets alike. The embrace of the concept shouldn’t be hindered by some of the obstacles mentioned above, which the market will eventually work its way through. We hope other countries will follow the emerging market pioneers, Chile and Uruguay, on this path towards a more sustainable future.
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