HR Ratings: ESG Bonds Essential in Battle Against Climate ChangeBy Peter Appleby | Wed, 09/30/2020 - 09:18
Q: What are the immediate threats to Mexico and its economy from climate change?
A: There is a clear threat from climate change to Mexico, and the country’s role in the Paris Agreement attests to the understanding Mexico has of this threat. Though global warming is mostly associated with fossil fuel industries, its impact will affect the daily life of millions and so action must be taken to limit this.
Mexico is heavily reliant on industries like tourism and farming, and these industries make up a large part of the economy. In states like Sinaloa or Sonora where many people rely on farming to live, the draughts and harsh weather effects that will become more common as global temperatures rise will take their toll on farming communities. The knock-on effect from this to the financial sector will be seen in the form of unpaid loans and an inability of individuals and companies to repay credit or debt. This could happen in large numbers. The COVID-19 pandemic and many banks’ decisions to suspend the repayment of credits and mortgages for a period of six months would be the closest thing to this scenario. Financial institutions in Mexico must be prepared for this scenario and must create strategies within their internal policies that will provide them with sufficient financial protection to face this challenge. This includes measures like increasing their preventative reserves and including climate risk in their credit risk analysis. Banxico has pushed this issue and is already in talks with many of the country’s banks.
Another problem is the insurance sector. With increased damages to property and land from weather events, the price of insurance will rise in line with the need for businesses and individuals to pay for this increasingly more important service. However, higher prices will be problematic for many.
Q: How is HR Ratings adapting to the growing importance of sustainability in Mexico?
A: HR Ratings is including environmental, social and governance (ESG) analysis within its ratings process . We are doing this because there is a clear increase in ESG assets in the financial industry. Additionally, we are incorporating internal policies to measure the social and environmental impact of our daily work within the same ESG scope. Another area that HR Ratings is promoting is the analysis of the green bonds market. This is not a credit analysis.
We can provide an analysis of green, social and sustainable bonds and we have been doing so since 2016. We can offer second opinions on these issues, which communicate to the market the issuer’s ability to report and measure environmental and social impact of its activities or projects to be financed.
Q: How much potential do green, social and sustainable bonds have in Mexico and what are the obstacles restricting their increased use?
A: Citibanamex and BlackRock have recently launched an ESG fund and the BMV launched its ESG Index. There are many projects from diverse actors around ESG issues. According to figures HR Ratings recently reviewed, Mexico is No. 3 in the Latin American region in terms of green, social and sustainable bonds placed. Since 2016, seven green bonds have been placed on the BMV in total, along with one socially focused bond and nine other sustainable bonds.
Politics is also having an impact on this market, as is the economic slowdown that is happening in the world and Mexico. Between January and July 2020, only two green bonds will be issued on the BMV. In comparison to the rest of Latin America, only Chile and Brazil are outperforming Mexico in the number of issuances of these bonds. They also surpass us if we consider the amount issued.
A difference between the Mexican market and others in the region is that in Mexico, the private sector is the dominant force in bond issuance. Having said that, in Latin America, only Chile and Mexico have issued sovereign bonds. The Mexican bond was placed in the international market on Sept. 14. But when we talk about the national market, only the Mexico City government has delved into this. Recurrent issuers are mostly from the private sector and development banks. Ideally, it is the development banks and governments that should be the first to act in new market openings like this because they are better suited to take on that risk. For example, the European Development Bank issued the first ESG-compliant bond in 2007 (green bond). Though we would like this to be the case in Mexico, it is not. The private sector has placed these bonds despite the lack of a suitable legal environment and activity, making the placement more financially risky. Among the main private players involved in this area are Rotoplas, VINTE, BANOBRAS and BBVA.
It is important to mention the demand for green, social and sustainable bonds in the Mexican debt market. Every time a bond is issued, there is an overdemand on a scale of 1:3. This is a very good signal for the growth of the market, regardless of the slowdown seen in 2019-20. We can therefore be very hopeful for the future of green, social and sustainable bonds in Mexico.
Q: What would HR Ratings suggest as the main way banks and institutions can improve their green commitments in Mexico?
A: HR Ratings is an observer of financial events and can only offer an opinion to those institutions that request it. The commitment of the banking sector to, on the one hand, ESG policies and, on the other, to instruments such as green, social and sustainable bonds is clear and the Association of the Banks of Mexico has issued a protocol focused on sustainability. Meanwhile, some private banks have signed up to the Equator Principles. Environmental risks are not the only issues banks are confronting; they are also looking at ways to improve their energy efficiency plans and examining gender equality internally, among other concerns. Banxico is also working toward these ends.
All of this is positive and suggests a bright future for the growth of green banking in Mexico. However, while there is a clear effort toward this from the commercial side of the banking industry, development banks and the government have done less. This is not to establish deficiencies or lags but to highlight the difference between Mexico and other countries.
One of the main challenges in Mexico is that many industries are simply not aware of these themes, which must be promoted. Aside from this, capacities within the banks themselves must be improved to better understand the ways that ESG criteria and environmental risk analysis can be used within the traditional financial market. In the 1980s, there was a huge effort to integrate risk into financial institutions and dedicated departments were set up, like the Integral Unit of Financial Risk Administration (UAIR). The same thing needs to happen now for green investment and to increase the institution’s understanding of climate risks. This area should also support the credit end of the banks.
There is a lack of activity from state and municipal governments generating public policies and issuing green bonds, which itself links back to the inactivity of the federal government. The private sector is far ahead of the public sector. For example, BIVA has just signed up to the Sustainable Stock Exchanges Initiative led by the United Nations. The public sector needs to catch up.
Q: Is the COVID-19 an opportunity for greater integration of sustainable bonds in the Mexican market?
A: This is not an opportunity but simply a process that must take place in Mexico where HR Ratings now forecasts a 9.5 percent contraction in 2020 with a slight recovery in 2021. There is a big debate at an international level regarding the ESG criteria and green markets. The question is why these markets have not grown more.
Having spoken to friends, including Sean Kidney of Climate Bonds Initiative, it has become clear that we should not see the value of sustainable financial instruments from the perspective of a purely financial benefit, though of course, this is what the issuers of the bonds are hoping for. Sustainable bonds should instead be seen from the point of view of risk and the benefit delivered to the environment, public health and social security savings. Sustainable bonds are not for short-term benefit.
These discussions are ongoing in markets, mainly European, that are more deeply involved with green bonds and whose markets are, therefore, more adjusted to them. These include Norway, Germany and the UK. Whereas these countries have 30 years’ experience with sustainably focused bonds, Mexico has less than 10. In those markets, benefits have been found in the cost of the bond issuance and for placement agents. Both Morning Star and Bloomberg have empirically found that portfolios dedicated to sustainable bonds demonstrate greater stability in profit over time than those that do not include sustainable bonds. While this is not categorical evidence to support the benefits of these bonds, it is certainly a strong signal of the potential financial benefits that could be expected in the future.
Mexico still has a great number of challenges to overcome to move toward greater integration of a sustainable bonds market but it is on the right track. Regulatory authorities could also do more, as the government of Japan has done, for example, to reduce the cost of placements for sustainably focused bonds. This would offer an added incentive for more issuers to consider the green market.
HR Ratings was authorized in 2007 and is Mexico’s principal ratings agency. Its ratings include government entities, corporations and financial institutions.