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Uruguay launches sovereign bond linked to climate goals

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Construction of wind turbines near Tarariras, in the department of Colonia in Uruguay. Almost all of the country’s electricity comes from renewable sources, but its government is exploring new financing instruments, such as a sovereign green bond, to help other sectors in the transition to net-zero. (Image: Picardo Photography / Alamy)

By Fermin Koop (IPS)

HAVANA TIMES – Sustainable finance continues to thrive in Latin America, as governments and businesses take advantage of growing investor interest in instruments that protect biodiversity and respond to the climate crisis. In 2020, over US $ 16 billion green, social and sustainable bonds have been issued in the region.

Although their purpose may vary, these bonds share similar characteristics. A business or government is in debt and these funds must be used exclusively to achieve a specific environmental or social objective, such as the development of clean transport infrastructure, the expansion of renewable energies or the achievement of sustainable development goals. As green bonds continue to grow, Uruguay will be the first Latin American country to borrow at an interest rate linked to meeting its climate commitments

However, with the growth of sustainable finance, new types of even more innovative debt instruments have emerged, such as the one that is now proposed by Uruguay. The government of President Luis Lacalle Pou is working on a bond whose funds will not be allocated to a specific objective, but will rather be used to finance different initiatives, and at a variable interest rate.

This rate will depend on whether or not Uruguay meets a previously established environmental objective, such as its nationally determined contribution (NDC) to the Paris Agreement. In other words, if the country reduces its emissions as it pledged, it will be rewarded with a lower rate. And if he doesn’t comply, he will be penalized with a higher rate.

So far, the only country to have developed such an instrument has been Luxembourg, which issued $ 1.5 billion in debt in 2020. According to Uruguayan Environment Minister Adrián Peña, the country’s bond will be between $ 800 million and $ 1 billion, without precise date for its emission still fixed.

Developing countries like Uruguay are particularly vulnerable to the climate and biodiversity crisis, and need financial support to meet their environmental or climate commitments. This is where sustainable finance comes in, as an instrument to support the transition of their economies.

Sustainable finance in Latin America

The mechanisms of sustainable finance continue to multiply and diversify. Argentina and Colombia, for example, recently called for an expansion of debt-for-nature swaps, a tool already in use that would allow them to reduce their debts and also achieve environmental objectives. Elsewhere, financial experts have pushed for the creation of new instruments like the obligation now proposed by Uruguay.

“Debt swaps were very popular decades ago. But now the picture has changed a lot. It is more complicated to know who owns the debt and how it is traded, ”said Jochen Krimphoff, WWF head of green sovereign bonds. “In the long run, the more you manage your natural resources sustainably as a government, the more your economy can thrive in a sustainable way. “

A green sovereign bond indicates a country’s commitment to strategies for sustainable growth and low greenhouse gas emissions, which can stimulate private sector investment in green initiatives. It can also allow for more effective collaboration between different sectors of government, as Peña pointed out.

“It seemed to us that we had a lot of knowledge to contribute to the Ministry of Finance, which did not know much about our problems. This is where the idea for the link came from, ”the minister told Diálogo Chino.

In 2019, Chile became the first Latin American country to issue a sovereign green bond, which has so far raised $ 7.44 billion after successive issuances. The country has also issued social and sustainable bonds, as have Ecuador, Mexico and Guatemala, according to the Climate Bond Initiative.

The energy and transport sectors benefited the most from funding, as did the land use planning sector. In the case of Chile, the funds from its green bond have been used to stimulate clean transport, such as Santiago’s electric buses and the construction of new underground lines.

“There are a lot of investors who want to invest in these instruments,” said Pablo Cortinez, consultant in sustainable finance. “The fiduciary obligation and the profile of investors are changing and more and more people are calling themselves green. The region’s largest economies, such as Brazil and Argentina, are expected to bet on green sovereign bonds. “

For Marcela Ponce, head of climate finance for Latin America at the International Finance Corporation, 2020 has been a pivotal year for green sovereign issuance, and 2021 is not far behind. “Since COP26, Latin American finance ministries have shown a great appetite for the green bond market,” she added.

The new Uruguayan bond

Unlike Chile, Uruguay will not issue a green bond per se, as the funds can be used for any purpose. However, by tying the bond’s interest rate to the NDC, the government will create an additional incentive to direct funding towards initiatives that help it meet its climate change goals.

Uruguay submitted his NDC in 2017, in which it proposes targets for reducing carbon intensity by gas for three specific gases: carbon dioxide, nitrous oxide and methane, with reductions of 24%, 48% and 57% respectively by 2030, on an unconditional basis. A new NDC is expected to be submitted in 2022.

About 70% of Uruguay’s greenhouse gas emissions come from the agricultural sector, two-thirds of which come from beef production, according to the most recent emissions inventory. The government hopes that better pasture management will significantly reduce emissions.

“Uruguay bears a high political cost with the new sovereign bond. But if it succeeds, it would be an important step for the region, ”said Sebastián Ramos, partner in the banking and finance department of Ferrere, a Montevideo law firm. “The learning curve is steep as it is the first in the region with such a sovereign bond.”

Juán Giraldez and Stephanie Fontana of the international law firm Cleary Gottlieb describe the debt instrument that Uruguay wants to push as “the next frontier of sovereign financing”. However, they also highlight the risks and challenges given its novelty, and as something so far only developed by Luxembourg.

For the bond to be successful, governments must be able to justify to their investors the choice of the precise target on which the interest rate is set, versus other possibilities – the NDC, in the case of Uruguay. In addition, the objective must be achievable during the lifetime of the obligation and a third party in charge of monitoring the effective achievement of the objective must be defined.

“With the bond that we are designing, Uruguay will have a fiduciary mandate to take care of the environment and reduce carbon dioxide emissions,” Uruguayan Minister of Economy Azucena Arbeleche said in a meeting. “The incentives of the investor and the issuer will be aligned for the achievement of a certain indicator.”

Further details on Uruguay’s sovereign green bond, including a date for the first issue, are expected to be confirmed in early 2022. Supporters of these instruments hope that if successful, it can be a catalyst. for their growth and adoption in Latin America, which could stimulate sustainable transitions across the region.

This article was originally published by Chinese dialogue

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