As Latin America’s largest economy, it is perhaps no surprise that Brazil has a vibrant market for labeled bonds, with a significant chunk of the region’s green, social, sustainability and sustainability-linked (GSSS) debt transactions originating from that jurisdiction. But until late last year, the sovereign was notably absent from the dealmaking.
By the time the government issued its first sustainable bond in November, local corporates were strides ahead in both domestic and international issuance of GSSS notes, as were other sovereigns from the region. But the stage is now set for Brazilian issuers to play a bigger role in the market.
“With the sovereign coming to market, we would hope that that spurs additional growth, whether that be the paper and pulp companies, the banks or other corporates in the space,” said Romina Reversi, the New York-based head of sustainable investment banking for the Americas at Crédit Agricole CIB.
Brazil published its much anticipated sustainable bond framework in September of 2023 and finally dipped its toe in the market two months later. Still, it was already trailing well behind other sovereign issuers, such as Mexico, Chile and Colombia.
“When we talk about sovereign issuances, Brazil was definitely a late-comer and this happened because, until 2022, the federal administration was not a big fan of sustainability, even though the Brazilian issuance had been prepared since 2021,” says Gustavo Pimentel, a Rio de Janeiro-based senior partner for sustainable finance at ERM, which provided technical assistance to the treasury for the sustainable bond framework.
Once the new administration of President Luiz Inácio Lula da Silva came to power in early 2023 with an ambitious green agenda, much of the technical heavy-lifting had already been done; though it was not a priority for the federal government under Lula’s predecessor, Jair Bolsonaro, sustainability work rumbled on in lower-level government areas, Pimentel said.
A NEW BENCHMARK
The sovereign’s presence in the labeled bond market has helped shape the yield curve by providing a benchmark (given the risk-free rate offered by the Republic) and has given a boost to market volume: $2 billion from its inaugural issue last year and a similar amount from a follow up deal last month. The issuance also attracted a diverse base of investors to the market and, importantly, now provides a launch-pad for the country’s wider sustainable taxonomy, market participants note.
“A sovereign bond issuance typically has very important effects in the market: it establishes yield curves and provides stability, all of which makes it easier for corporates to enter the market,” said Sean Kidney, London-based CEO of the Climate Bonds Initiative. “If you decide that the main markets are useful to channel capital for policy-related purposes — in this case related to climate change — then doing a sovereign bond is a very useful thing to do. It gets headlines and encourages everyone else.”
A recent study by the IMF suggests the number and the size of corporate green bond sales typically increases after a sovereign debut. Sovereign green bond issuance also improves the quality of green verification standards in the corporate bond market more generally, according to the June report.
The Brazilian treasury opted for both the November and June issuances to be of a seven-year tenor based on the interest of corporates that typically issued with this maturity timeframe, said ERM’s Pimentel.
On a more symbolic level, sovereign bond issuance, along with sustainable taxonomies, represent measures to attract capital in the right direction, Kidney added.
“Essentially the country is getting better terms of trade to support its climate investments and that is an incredibly important story in the context of anxiety that action in climate change is going to cost more…There is preferential money, and that is the key message,” he said.
TRANSPARENCY
Investors have welcomed the Brazilian government’s transparency with regards to how it will use funds raised in GSSS bond sales. Its framework has an entire section on transparency and impact, which is a unique approach to inclusion, market participants highlighted.
“It is encouraging to see that Brazil gave us some guidance and they also gave a very good level of detail on the projects that are going to be financed,” says Nicolas Jaquier, a London-based Portfolio Manager at Ninety One.
As use-of-proceeds instruments, it is also important for investors to understand how the funds will not be spent, which in Brazil’s case included projects in the mining and fertilizer sectors.
Brazil’s sustainable bond framework and issuance are part of the government’s Ecological Transformation Plan, which includes the establishment of a carbon emission trading system, changes in taxation to reflect negative environmental externalities, concessional funding for innovative climate solutions through the National Climate Change Fund, and adoption of corporate disclosure standards for companies accessing capital markets.
The country is also a late-comer in terms of developing a national sustainable finance taxonomy, with Colombia, Mexico and most recently Panama already publishing their frameworks.
The Brazilian government is due to start a public consultation on a sustainable taxonomy timeline in November and aims to finalize the framework by the end of next year. It will then give companies and financial institutions a year for implementation.
“The work done on the sovereign bond was a good launch-pad for the taxonomy work as we looked into several possibilities for use-of-proceeds including private and public budget bonds,” Pimentel says. “It provides a good starting point for the taxonomy work.”