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“Brazil is back,” then-President-elect Luiz Inácio Lula da Silva told a crowd at the COP27 climate summit this time last year, marking a break from the environmental pushback under his predecessor Jair Bolsonaro.
Since then, he and his officials have been repeating that message to anyone who will listen – including sustainable bond investors who, as I write below, responded quite enthusiastically.
Today, in the run-up to the intense debates on this topic at COP28, we are looking at the extent to which the private capital sector is or is not rising to the challenge of green finance.
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Is investor enthusiasm for Brazil’s sustainable bonds justified?
A decade or two ago, the average fixed income investor would have been baffled by the marketing materials for Brazil’s first sustainability bond, issued this week to finance President Luiz Inácio Lula da Silva’s green agenda.
Until recently, promises regarding forest conservation, renewable energy and gender equality were not part of the marketing of government bonds. But today’s investors have clearly warmed to the idea: the $2 billion Brazilian issue has received $6 billion in orders.
This enthusiasm allowed the government to sell the seven-year bonds at an interest rate of 6.5 percent, well below the 6.8 percent it had previously targeted when marketing the securities.
This is especially encouraging given that it has been a tough few years for developing country government bond issuers as interest rates rose around the world.
This sustainable bond issuance has reduced the difference – the additional financing costs – between Brazil and countries like Mexico, which enjoy investment grade credit ratings. That’s a top priority for Brazil, which lost its own rating in 2016 amid a massive political and economic crisis.
The investor interest reflects optimism about Lula’s green promises, which followed four years of rampant deforestation in the Amazon under former President Jair Bolsonaro. As the Treasury Department investor slideshow noted, the rate of deforestation dropped dramatically in the first half of this year (albeit to levels that are still deeply concerning).
But this isn’t just about Brazil. a recent report from S&P Global on green, social, sustainable and sustainability-related bonds (GSSSB) made it clear that government bonds are an increasingly important part of this awkwardly named market segment.
Government bonds accounted for 18 percent of GSSSB issuance in the first half of this year – up from 11 percent last year and 7 percent in 2019. Latin America has been a relatively strong gainer in this area, with seven countries in the region GSSSBs before Brazil joined the party. Chile has been particularly active, with $30 billion in emissions to date.
Other issuers include state-owned companies in major oil-producing countries such as Saudi Arabia and the United Arab Emirates, sparking debate about how much this type of debt actually drives progress on sustainability.
Interesting in this context is the issuance by Brazil, which is also a major oil producer. The government’s investor presentation gives it enormous leeway over how the funds will be deployed. Eligible categories of “social projects” – which will receive up to half of the proceeds from this week’s issue – include “job creation,” which covers almost everything.
But the government has also committed, through a newly formed body, to publish an annual report setting out how the proceeds from GSSSB issuances are being used. The first of these, due to be published within the next twelve months, will give this week’s bond buyers an idea of whether their enthusiasm was justified.
Climate funds have their work to do
One of the fiercest debates at the COP28 climate summit – which starts in just 15 days – will be about how to mobilize the huge flows of green investment needed in the developing countries where most people live.
A report published today points to some interesting developments on that front, but also cause for concern.
While private capital funds focused on climate strategies in developing countries had a banner fundraising year in 2021 – raising $6.2 billion – that figure fell to $2.7 billion last year, according to the new report. Research from the Global Private Capital Association. This year, the funds have regained some momentum, raising $2.4 billion by the end of June.
Given the enormous role that private capital will have to play in tackling the climate and energy transition challenges in these countries, investment flows here are meager.
a higher education published last November by an expert group chaired by economists Vera Songwe and Nicholas Stern, concluded that climate-related investments in developing countries should reach $2.4 trillion per year by 2030. The GPCA report published today shows that climate funds targeting developing countries have raised a total of less than $30 billion since 2015.
Within this, the largest revenue in the first half of 2023 was raised by Beijing-based IDG Capital, which raised $709 million to invest in clean technology. Cape Town-based Inspired Evolution raised $199 million and Vinci Partners, headquartered in Rio de Janeiro, raised $185 million for low-carbon infrastructure in Africa and Brazil respectively.
This reflects a long-term trend among asset owners, GPCA chief executive Cate Ambrose, to invest in emerging markets by allocating capital to fund managers based in those regions.
There is also a clear move among fund managers towards greater geographical specialization. In 2020, 85 percent of climate funds focused on developing countries had a ‘multi-regional’ investment mandate. In the first half of 2023, 89 percent had an explicit focus on one region.
Tellingly, most of the world’s largest climate-focused funds – such as Brookfield’s Global Transition Fund and TPG’s Rise Climate Fund – were excluded from the GPCA study because they want to deploy the majority of their capital in developed economies, according to the analysis.
A notable exception was Actis’ Energy 5 fund, which has raised $4.7 billion to invest in clean energy infrastructure in developing countries. Many more such funds will be needed if private capital managers and their investors are to play their part in tackling the world’s most pressing challenges.
Hedge funds have profited from the slump in clean energy stocks, making short bets on wind energy companies.
According to the Intergovernmental Panel on Climate Change, CO2 emissions are on track to be 9 percent higher in 2030 than in 2010 – compared to the 45 percent drop that would be needed to limit global warming to 1.5 degrees Celsius .