Driving Mexico’s Sustainable Transition with ESG Bonds
Thematic and sustainability-related bonds are attracting increasing interest among issuers in Latin America and the Caribbean (ALC). In Mexico, in particular, they can be key to a sustainable transition in the financial sector and securities markets.
These bonds – collectively called ”labelled bonds” – are a relevant financial instrument to achieve the UN Sustainable Development Goals (SDGs). For the market to continue to develop and maximize their positive impacts, a clear understanding of the challenges and, of course, the opportunities they present is important.
Labelled emissions are a financing alternative whose main objective is to generate positive social, environmental, or sustainable governance (ESG) impacts. These issues are facilitated and attract ESG investors to the extent that the issuer has a clear interest in generating positive impacts and is willing to implement improvements in its company's ESG policies. The credit risk rating is maintained from a financial and risk perspective, but the ESG consideration increases the demand for the issued instrument, with a consequent decrease in the cost of issuance.
The risk-return trade-off in these cases includes the non-financial benefit: a positive impact that is expected to be at least medium-term. Key to investor comfort are the availability, transparency, and quality of information before and during the term of the bond. The idea is to avoid what is called "green-washing," that is, for the issuer to fail to comply with the use of the funds or not be committed to the impact targets.
Avoiding this risk is essential, as it implies a reputational risk for the investor. To do this, it is necessary to present an action framework that influences resource use and goals, and to have a second party opinion to validate the ESG effort. In addition, these issues must also be in line with ICMA principles. To date, this is voluntary, but the market values alignment with these principles.
One of the most frequent queries from clients is whether it is better to issue a thematic bond or a sustainability-linked bond. The answer is that the best instrument will be the one that best aligns with their impact and financial goals, which will largely depend on the resource use and goals set.
Thematic bonds are more rigorous in the use of funds: if a bond is issued with a significant green portion (greater than 50%), it must be earmarked for projects that, for example, mitigate climate change. In sustainability-linked bonds, resource use is more flexible since they can be used in different projects, but together they must encourage the company to meet sustainable and measurable targets by a certain date. If these targets are not met, the issuer will be punished with a rate increase. There is also the possibility that the issuer may be rewarded with a lower rate for meeting its targets.
IDB Invest and BIVA, Mexico's Institutional Securities Exchange, are working to strengthen ESG capabilities in the Mexican and LAC markets, with tools such as the Green Bond Transparency Platform and the ESG Experience Platform.
This joint experience has allowed us to observe that, among the challenges to developing the capital market through thematic or sustainability-related issues, there are three that we can identify as the most important: attracting new issuers, reporting and monitoring, and developing internal ESG capabilities.
Attracting new issuers is no easy task given the credit risk, size of the company, financial sophistication of the client, and market conditions. Client attraction requires ongoing outreach to provide clients with the necessary information on the benefits of developing internal capabilities and alignment to ESG policies.
ESG reports generated by issuers are essential elements to provide transparency and confidence to the market regarding resource use and the progress and achievement of targets. At the same time, it is important that as many investors, regulators, rating agencies, or any interested party demand quality information, question, and perform monitoring on a quarterly basis. This way, information standards in the market improve.
The development of internal ESG capabilities is essential to implementing thematic issues from structuring to instrument maturity. The benefits include greater market confidence and a commitment to contribute to achieving the SDGs.
Both Mexico and LAC in general have the potential to attract more ESG issuers and investors, and this will become easier as better information, clearer processes, and ESG skills development become available.
Technology can and should be a great ally to transition to a greater number of organizations, unify data, integrate multiple issuer collaborators to generate ESG reports, make the use of funds transparent, monitor goals and their correct selection, streamline integration processes, ensure information security, and provide certainty to investors.
For example, in the not too distant future, the blockchain is a tool that ensures greater data accuracy and transparency due to its decentralized nature. Mexico must continue to move forward in terms of data generation so that it has verified information on organizations and their sectors, in order to increase transparency in the market as a whole.
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