Sustainability bonds will not be adopted by sovereigns in developed markets anytime soon, as these issuers remain focused on traditional product-use bonds rather than those linked to key performance indicators.
Speaking at the launch event of the Public Sector Debt Outlook 2023 Report by the OMFIF Sovereign Debt Institute on January 26, Gregory Smith, Emerging Markets Fund Manager at M&G Investment, said there is “a big, clear difference” between emerging and developed sovereign markets. issuance of SLBs.
There have only been two sovereign SLBs issued – from Chile and Uruguay – and there is no sign that any developed market sovereigns will bring SLBs in the near future. In a survey of public sector borrowers as part of the Public Sector Debt Outlook 2023 report, only three sovereigns said they would issue SLBs this year and these were all from emerging markets. Meanwhile, only two of the 13 panelists at the event said they expected to see major issuers from developed markets bringing SLBs within three years.
Patrick Barbe, head of European investment grade fixed income at Neuberger Berman, said developed market sovereigns were focusing more on project-based bonds than KPI-linked bonds. He added that the increases may need to be “adjusted” to be more attractive to investors, especially since developed market sovereigns have tighter spreads than emerging market ones.
After last year’s SLBs of Chile and Uruguay, emerging market sovereigns will continue to lead the way for sovereign SLBs. Brazil could be a potential candidate for an SLB. Luis Felipe Vital, head of public debt operations at Brazil’s National Treasury, said the sovereign was considering a first environmental, social and governance-related transaction, but declined to say whether it would be in SLB format.
“Over the past year, I’ve seen some of my peers like Uruguay, Chile and Mexico and they’ve done some very interesting ESG-related transactions in the external market. It’s something I congratulate them on and Brazil can’t wait to be in the same place in the near future,” Vital said.
He added that Brazil was working on an ESG framework with the World Bank and the Inter-American Development Bank, with plans to bring the deal to the external market in 2023 after being absent from the external market in 2022. due to volatility.
“On the SLB side, it’s not just about finding cheap funding,” said Jana Harvey, senior portfolio manager, emerging markets, at BlueBay Asset Management. “SLB instruments serve a crucial function in ensuring that sovereign states and investors meet their environmental commitments.”
Another problem affecting the development of the SLB market is that there is no consensus on the two-way pricing feature of SLB, which was introduced by Uruguay with its first agreement last year. According to the survey of borrowers as part of the Public Sector Debt Outlook 2023 report, three-quarters of respondents were unsure whether this was a good idea.
In addition to SLBs, the growing use of ESG ratings is also a hot topic, with two-thirds of borrowers surveyed saying ESG ratings are increasingly integrated into their investor relations. This is particularly the case for public sector borrowers in emerging markets, where the figure is almost 80%.
“I think we’re all headed in the right direction,” Smith said of the growing use of ESG ratings by sovereigns. “I guess the thinking around ESG has been much better developed for corporates and it’s now picking up with sovereigns and you see it in ratings and research. But we still have a way to go… rating agencies general public certainly include ESG risks in their ratings, which is a real positive point.
However, there are issues with ESG ratings. “I find that ESG ratings are not as uniform as credit ratings and that creates an automatic problem,” said Isabelle Laurent, deputy treasurer and head of financing at the European Bank for Reconstruction and Development. “So are you looking at the effect of, say, the environment or the social impact on a business or are you looking at the impact of the business on the environment and on social issues? People evaluate very different things and look at them from very different angles.
Burhan Khadbai is Head of Content at OMFIF’s Sovereign Debt Institute.
