Chile and the Rise of Sustainability-Linked Finance


Landmark bond serves as model to finance the vast environmental and social ambitions of countries

Photo by Cerró Dominador

When Chile issued the first sovereign sustainability-linked bond earlier this year, it may have seemed like another incremental development in the sometimes esoteric world of ESG finance. With hindsight, however, this could turn out to be a landmark moment: the breakthrough of a new type of financing with broad appeal that could one day soon eclipse more conventional green bonds and loans.

The differences are more than technical, says Richard Sanders, Director, Sustainable & Positive Impact Finance at Societe Generale Americas. The green (or social) financings that investors have grown used to in recent years were a huge step forward in promoting and funding ESG-linked goals. But they are limited in their very nature because each loan or bond is linked to particular projects or assets: a green bond to build a wind farm; a blue bond to invest in sustainable fish stocks; a social bond to refurbish low-cost housing. 

However, not every corporate can identify specific projects or itemize a high-enough level of spending to allow it to issue such “use of proceeds’ instruments – think of most of the service industry. Such companies have been unable to take advantage of this new and often cheaper type of financing. 
The proceeds from sustainability-linked bonds and loans (SLBs and SLLs), by contrast, can be used for general corporate purposes. But the loan or bond is linked to specific targets: key performance indicators (KPIs) that are both relevant to the issuer’s ESG-strategy and clearly measurable. In terms of measurement, the targets associated with the KPIs should ideally be ambitious as compared with the corporate’s past performance and able to be benchmarked using external references or definitions.

Embedding Sustainability

This mechanism opens up the rapidly growing pool of ESG-linked capital to a much wider range of companies, and as a complement to use of proceeds bonds, allows an issuer to finance its sustainability ambitions more flexibly. And it forces them to be more ambitious and holistic. First, since they are no longer compartmentalizing “green” finance to a particular project but embedding sustainability into the way they plan, budget and operate across the firm. And second, to align with the best practice guidelines for such bonds developed by the International Capital Markets Association (ICMA). This is to preserve the integrity of sustainability-linked financings, notes Peter Borgesi, Vice President in Debt Capital Markets at Societe Generale Americas.

The mechanism opens up the rapidly growing pool of ESG-linked capital

Chile is now taking this a step further. Sovereigns, of course, have massive levels of environmental and, particularly, social spending and a competitive source of funding is eminently desirable. Still, it is a big public policy commitment for a government, particularly from an emerging market country, to tie itself and its successors to challenging, predetermined targets. Particularly over the life of a 10- or 20-year bond and with the risk of paying a higher coupon if it fails to hit them.

The $2 billion, 20-year issue by Chile this past March, which is linked to the country’s ambitions with respect to the Paris Agreement on climate change, specifies both that the country will emit no more than 95 million metric tons of carbon dioxide by 2030; and that 60% of its electricity production will be generated from renewable energy by 2032. 

Under the bond’s step-up structure, investors will receive an extra 12.5 basis points of interest a year if one target is missed and 25 bps if it fails on both – more than wiping out the 10-15 bps discount that SLB issuers have been attracting recently, according to Mr Borgesi.
Nevertheless, the government decided to go ahead: “Chile is a country with plentiful environmental resources, strong institutions, and a government with a forward-thinking mentality. The combination of these factors has allowed Chile to put together an ambitious decarbonization strategy with sustainability-linked financing playing a key role,” says Paul Miquel, Country Head for Societe Generale Chile.  

Just the Beginning

While not every country has Chile’s advantages, many other sovereigns are interested in this evolving market. Uruguay and the United Kingdom have said so publicly and it is easy to imagine countries from Europe to Asia and even Africa using it to fund broad environmental goals – from cleaning up oceans and rivers to protecting biodiversity. One could also imagine sustainability-linked bonds with “social” themes - linked to, say, reduction of poverty or the achievement of average income thresholds, argues Mr. Sanders. 

In terms of potential, Chile was also the first country in the Americas to launch a green bond, as recently as 2019 – and it has since issued over $30 billion in green, social and sustainable use of proceeds bonds. Meanwhile, last month’s pioneering SLB attracted $8 billion of orders, four times the amount placed, so investor interest is clearly high. Societe Generale, which has been involved in the sustainable finance market since its inception and was the structuring agent and one of the bookrunners for Chile, can attest that sustainability-linked financing has now really come into its own as a key financing tool in our attempt to build a fairer, cleaner and truly sustainable world.