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Give nations cheaper bonds to meet climate targets, says HSBC

(Bloomberg) – Borrowers in part of the booming sustainable debt markets have offered to pay higher interest rates if they miss climate or social targets. Now one country is also proposing rewards for good performance.

Uruguay this week released a sustainability-related framework that includes a bi-directional pricing structure that demands rebates on its lending rate if the South American nation achieves certain environmental performances. This includes areas such as reducing greenhouse gas emissions or preserving native forests. It also pays a higher spread when targets are not met.

The novel structure comes as global sales of so-called sustainability-linked bonds surged to more than $175 billion within three years of their launch, and after Chile became the first country to issue such bonds in March this year. While Chile’s deal only provided for a penalty on its bond coupon if it failed to meet greenhouse gas emissions and renewable energy production targets, Uruguay would be the first to propose a reward for good deeds.

Bloomberg News spoke to Anjuli Pandit, Head of Sustainable Bonds for EMEA and Americas at HSBC Holdings Plc, on the rationale for a two-way repricing of SLBs. According to data compiled by Bloomberg, HSBC is one of the top five insurers for global ethical bonds this year.

This interview has been shortened and edited for clarity.

Why not just step ups like other traditional SLBs?

Sovereign SLB absorption becomes difficult when there is only one tap, as this is not an accessible structure for many emerging markets that are sensitive to interest rate risk. If we want more disclosure from a sovereign, if we want more ESG and debt integration, we need to be constructive in the feedback we give when these deals come out. Also, the vast majority of investors we spoke to were very supportive of the pullback, and they intellectually and philosophically believe there should be a pullback.

As EM and government bond investors start to integrate more ESG into their holdings, they will be looking at a group of government bonds they are buying that have a fair number of non-conformances and are meeting their climate targets. Keep in mind that if a country falls behind on its climate targets, there are likely other things going on in that country.

Then if you only have a step-up mechanism, you don’t take that money out of your bottom line like you would in a business. Instead, you’re taking that money from the taxpayers, from the citizens, and that’s not the goal here.

Why is the step-down structure not working for some issuers?

When it came down to actually buying the product, many credit portfolio managers had mandates where they couldn’t buy bonds on a downgrade. You just couldn’t buy the criteria, and that’s when we realized that if you had to step down because you had less investor demand, it would actually hurt the bond’s performance.

In the case of European government bonds or government bonds from industrialized countries, their coupon is quite low. There isn’t much room to play with the up and down structure. The market also doesn’t want these swings from developed market instruments that they use for liquidity pools.

And it works for emerging markets?

Since emerging market funds and interest funds do not have these mandates, they cannot buy step-down products on them. There is no technical reason why someone cannot buy it. Maybe someone decides against it because they don’t want to take the step-down risk, but that’s another story.

What are the challenges for sovereign issuers?

There are many things that challenge states’ priorities, such as: B. Government changes, an economic crisis, Covid-19, etc. There’s even the discussion we’ve had on sovereign sustainability bond frameworks about what if the territory of sovereign changes? Also, a country must provide the amount of data and reporting required to even measure and set a target. And then to be able, despite everything that happens in those five years, to reach that goal and then even exceed it.

And the benefits?

There is less ESG risk in holding a government bond over the medium term if it achieves the goals it has set. The other thing that investors really like is the fact that the state can pay the greenium later in the bond’s life.

Why the focus on climate targets and not on other social ones?

Because it’s the target most closely comparable to benchmarks, and the most important for investors, as most focus on their portfolio’s greenhouse gas emissions.

In addition, GHG emission targets are a top priority for investors. I’m not saying the other goals aren’t important, but the climate goals will probably be the first thing many countries will look at.

©2022 Bloomberg LP

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