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Lack of Information, Regulation, Peso Volatility Holding Green Bonds Back in Mexico

Mexico seems set on becoming a sustainable finance leader, but a lack of information and clear-cut regulations, and an increasingly volatile peso, seem to be holding potential green bond issuers back.

Mar 15, 2017 // 5:08PM

Mexico, Latin America’s second largest economy and one of the worst polluters in the region, is making significant efforts to tackle climate change.

In line with the Paris agreement, the government vowed that by 2024, 35% of the energy used in the country would be derived from renewable energy sources, which has many of the country’s public and private sector entities mulling whether or not to issue green bonds, debt securities issued to finance projects that promote climate change mitigation, reduction of the carbon footprint or other environmental sustainability initiatives.

While these instruments have become quite popular in the international markets, in Latin America, green bonds have had a slow start, in part due to the relatively low liquidity in the market, which compels investors to be more cautious.

Nevertheless, Mexican issuers seem eager to take advantage of all the benefits these securities have to offer. In October 2015, Nacional Financiera (Nafin), a Mexican development bank, issued a green bond in the international market, with some success. The transaction had a total value of US$500mn, but registered demand of US$2.5bn, meaning it was five times oversubscribed.

The notes were given a AAA rating by Standard & Poor's, Fitch, Moody´s and HR Ratings.

It was followed by a number of local issuances, again by Nafin – with a peso-denominated MXN2bn bond – and then the City of Mexico, which issued a MXN1bn note. The purpose of this transaction was to fund projects with the aim of reducing greenhouse gas emissions and redistribute the city’s water supply.

Finally, Mexico’s central government sold US$2bn in green bonds in September last year with the aim of partially financing the new Mexico City Airport, making this South America’s largest green bond issuance to date.

“If you take into account the size of the local capital markets, and if you consider the magnitude and the short period in which these placements have been made, you can say that environmental finance is evolving quite well in Mexico”, said Jesus Gonzalez, partner in charge of Sustainability, Risk Management and Corporate Governance at KPMG in Mexico.

Mexico Corporates Missing Out

The country still faces many challenges in its quest to incentivize clean and sustainable projects, and its corporates could be missing a trick in failing to attract growing pools of liquidity devoted purely to sustainable initiatives.

In Mexico, any entity with a credit rating is eligible to issue these instruments, including development banks, corporates, local governments; so far, only state-related entities have tapped into the green bond market and gone through the motions of having their bonds certified as ‘green’ by a third party.

“In general, green bonds are relatively new instruments, and it takes more time for corporates to understand the requirements they must fulfil. This why educating businesses is key if Mexico wants to encourage green bonds issuances,” Gonzalez said.

He believes that an increasing number of global investors are interested in projects that have a positive environmental impact, but that in Mexico, there is still a misconception that only big corporations can issue these kinds of instruments.

The other primary challenge Mexico is facing, a problem that has been encountered by a number of global issuers, is that of the credibility of the projects that need financing.

Some within the industry are calling on Mexican regulators to fill gaps in legislation that help provide guarantees to investors that the projects in which they are being used are truly “green.”

“The BMV is making a significant effort to implement policy and make sure all the international standards are met, this is the only way investors, not only in Mexico but also from oversees, are going to become more interested in this type of financial securities; investors need to be assured of the integrity of the projects” Gonzalez added.

For Peer Stein, Head of Climate Business and adviser at the International Finance Corporation (IFC), the Mexican government needs to “translate the international green bond principles into national guidance for issuers and investors, and simplify the tagging and reporting of the impact on green assets underlying green bond transactions.”

While there is no set international standard for green bonds yet, the way other issuers have responded to the credibility issue is by publishing yearly reports and having third parties audit the projects in order to guarantee their positive impact.

Bond in Dollars, not Pesos

As of the end of 2016, Mexico had issued six green bonds and raised US$1.3bn in outstanding climate bond debt, yet of these issuances, four were denominated in US dollars and only two in pesos.

For Stein, it may not be a question of more standards, though the on-going work on definitions and taxonomies within associations like ICMA or the Climate Bonds Initiative will help. But those standards need to be accessible to local investors for the domestic green bond market to evolve.

“As any market, it will take some time for a domestic green bond market to emerge, as both issuer and investor preferences and practices will need to evolve.  Making it simpler for issuers to identify and report on green assets will certainly help, while at the same time, investors also need to identify green bonds as an asset class that they are interested in”.

According to Gonzalez, in Mexico in particular the situation is more complex and unlikely to change in the near future, as many investors are shying away from any peso-denominated assets – in part due to the recent spike in the currency’s volatility.

“Capital holders wants to protect themselves from the volatility of the peso, so it is more likely we will see more issuances in dollars.”

The Mexican peso has suffered one of its worst periods in decades after Donald Trump was elected President of the US in November last year. After many attempts by the government to intervene and save the currency, the government is yet to restore investor confidence in the peso. Unfortunately, this may put the development of a domestic green bond market on the backburner for the moment.

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