Uruguay’s experiment in sovereign sustainability-linked bonds
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Uruguay’s experiment in sovereign sustainability-linked bonds

Uruguay has made strides in ESG (environmental, social and governance) investing with the issuance of a sustainability-linked bond (SLB), making it only the second sovereign issuer to do so.

  • Sovereign sustainability-linked bonds are a debt instrument that hold a government accountable for environmental policy, potentially closing the credibility gap of emerging market ESG initiatives
  • Uruguay’s issuance will be tied to its ability to make progress towards
    goals outlined in the Paris Agreement
  • If successful EM sovereigns could establish a new source of financing, attracting a larger investor base while enhancing their sustainability goals

A SLB is a new type of debt whereby the market holds the issuer – in this case the Uruguayan government – accountable for its environmental policy actions. The bond’s coupon will be tied to Uruguay’s ability to make progress towards goals outlined in the Paris Agreement. The issuance makes headway in solving a credibility issue which exists with current ESG debt, where issuers often aren’t held to any specific standards for policy change. We are excited about an innovation that should offer transparency and impact – the ultimate goal for ESG investors. If it works, we expect to see this model copied by other sovereigns in the future.

Tapping into a rapidly growing market

ESG investing is a rapidly growing segment of the debt market with room for innovation. ESG-labelled bond issuance made up 5.1% of global bond issuance in 2021, up from 0.3% in 2015, according to the Institute of International Finance (IIF). It sees potential for the volume of ESG debt issuance at 4x current levels by 2025 . So far, issuances are concentrated in green bonds (Figure 1), which promise to put money towards climate and environmental initiatives. Sustainability-linked bonds are general purpose bonds – ie they don’t finance a particular project – but the issuer commits to pre-set targets related to environmental sustainability.

Figure 1: total global volume of thematic bond issuance (USD billions)
Total global volume of thematic bond issuance (USD billions)

Source: Ministry of Economy and Finance of Uruguay, Sovereign Debt Management Unit/Credit Agricole, October 2022.

Mechanics of the SLB

The Uruguayan government has two pre-set targets, to be measured as of 31 December 2025 relative to a base year:

1) 50% reduction in greenhouse gas emissions per unit of real GDP from base year 1990; and

2) 100% maintenance of forest area from base year 2012.

The bond has a penalty/reward structure for performance, with a step-up in the coupon if targets are missed and a step-down if they are exceeded (Figure 2).

Figure 2: example payment path if both targets are missed
Example payment path if both targets are missed

Source: Columbia Threadneedle analysis, October 2022

Tying payments to environmental outcomes adds a layer of accountability for the government, creating a much more transparent ESG debt instrument. For investors, assessing the risk-adjusted return profile for Uruguay becomes easier thanks to more frequent data publications. The SLB saw strong investor demand on the primary market at 4x oversubscribed and priced at favorable terms, despite the possibility of a coupon step-down.

Putting in the effort

Uruguay is able to achieve this issuance as an investment grade, credible issuer that already ranks highly on various ESG indicators (Figure 3). Chile, another EM high-grade country, is the next best example, and issued the sovereign market’s first SLB in March of this year. As investors we will be assessing an issuer’s effort in meeting these targets as part of our ongoing due diligence. Uruguay’s targets are ambitious. The pace of emission intensity reduction, for example, will need to be above historical performance – a challenge given much of the infrastructure transition towards a lower carbon economy was done in the past decade. Most of Uruguay’s carbon emissions come from cattle raising, a key export.

Figure 3: EM credit and ESG ratings
EM credit and ESG ratings

Source: Columbia Threadneedle Investments (CTI) analysis of data from Standard & Poor’s, Moody’s and Fitch, October 2022

How do SLBs benefit investors?

The market will be monitoring Uruguay’s progress and pricing in the probability of it hitting the targets. Even though the coupon change won’t be assessed until early 2027, the sovereign spread will fluctuate as data and news is released throughout the tenure of the bond. Having a third-party enter the contract to verify both the validity of the targets and results at each measurement period keeps the government honest in their progress, and helps investors assess country risk. There should be a scarcity value to this bond and it trade with less volatility given the objectives of its investor base.

Uruguay is setting off on what will be an iterative process for future sovereign debt issuances. As ESG becomes an increasingly important factor in portfolios, we expect other countries to follow their lead with similar instruments. Investors want greater differentiation in their portfolios, measurable impact and the ability to engage with governments – all elements that a bond like this potentially accomplishes. Uruguay’s issuance is a step in the right direction for EM debt, and we are excited to see how it plays out.

12 December 2022
Kate Moreton
Kate Moreton
Emerging Market Sovereign Analyst
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Uruguay’s experiment in sovereign sustainability-linked bonds

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For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients).

For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk.  Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

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In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414.  TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act.  TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

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Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients).

For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk.  Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414.  TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act.  TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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