October 25, 2023
Accelerating sovereign sustainability-linked bond transactions: Building the ecosystem
The wall of bond maturities facing many sovereigns in 2024-2025 and the prospect of market lock-out has created an urgent need to identify refinancing solutions fast. Given the backdrop of tight global credit conditions, rolling climate and commodity shocks, and crushing debt overhangs, sovereigns are unlikely to access the bond markets on acceptable terms in the near term.
The window of opportunity for Sustainability-linked Bond (SLB) issuance (see blog on understated benefits of SLBs) is also narrow given the long lead times of erecting the data architecture.
Urgency calls for process innovation as much as product innovation. Fortunately, the immediate task of establishing a data architecture for a specific issuance is ideally suited to accelerator programs that can significantly speed up the structuring of an SLB. These include tried and tested techniques from the field of “design thinking” such as streamlined diagnostics, design sprints, and rapid match-making among stakeholders.
The aim of the Accelerator Program is to help Debt Management Offices (DMOs) quickly do the following:
- converge around targets and KPIs;
- diagnose potential gaps or blockages in the data pipelines feeding them;
- surface interagency coordination barriers and align incentives to remove them;
- facilitate selection of credit enhancement and MRV providers.
The main output of the program is a design blueprint and technical specifications for the front- and back-ends of an SLB. The outcome is not an actual transaction, but rather a roadmap for getting the issuer market ready and executing an SLB transaction in short order. It empowers the DMO to engage with third-party providers, advisors, rating agencies, and underwriters on an equal footing with clearly articulated needs and requirements.
If designed well, the program can significantly cut the time to market and lay the foundations for subsequent issuance.
Figure 4. SSDH’s Go-To-Market Accelerator Program
The Accelerator does not constitute capacity building per se, which typically tackles overarching fiscal and Public Financial Management (PFM) objectives by building up human resources and promoting institutional changes over a longer time horizon. Instead, the Accelerator aims to fulfill a specific near-term financing need while also supporting broader upgrades. The two missions are therefore entwined and complementary.
A secondary outcome of the Accelerator is to compile a playbook for repeating the process in subsequent SLB offerings, thereby helping to build out the data architecture as well as developing a pipeline of transactions.
This takes into account the reality of high staff turnover rates at many DMOs, implying that the same capacity building exercise such as training to use debt sustainability analysis tools may need to be repeated several times over. With the Accelerator, new teams can run successive rounds of the program by following the instructions of the playbook and guidance of an implementing partner.
The Accelerator addresses a major constraint on the growth of the SLB market – the paucity of deals coming to market. However, to be fully effective as a catalyst for sustainability-linked sovereign financing more broadly, it needs to be aligned with parallel efforts in the climate and nature finance community. This includes efforts to both develop pipelines of green and nature positive projects as well as building out domestic ecosystems of solution providers.
Many such initiatives already exist and have demonstrated success (for example, see TECA). However, few of these micro or sectoral accelerators are closely aligned with the sovereign medium-term fiscal frameworks or financing plans, creating a critical disconnect with broader government strategy towards achieving climate change and biodiversity commitments.
There is an opportunity for the SLB Accelerator to act as a coordinating mechanism for these disparate initiatives. The SLB targets can serve as the lodestar around which start-ups, project owners and partners coalesce and collectively work to achieve the same KPIs. In that way, the SLB acts as a catalyst for climate and nature action by helping to build a pipeline of projects and to foster an ecosystem of projects, data, carbon/biodiversity credits and MRV providers, be they established enterprises or start-ups.
These same providers can feed into SLB issuances, thereby creating local ownership and private sector buy-in for the bond. Furthermore, by supporting employment in the domestic nature and climate ecosystem, it also hits broader sustainable development goals.
Figure 5. An Accelerator Stack
For instance, consider an SLB that targets climate resilience and includes measures of property catastrophe (cat) or agricultural insurance penetration as a KPI — a novel design that will be explored in greater detail in our next blog series. The government can take several actions to promote insurance market growth in an economy: compulsory coverage (e.g., prop-cat riders on mortgages), premium subsidies, favorable solvency regulation, openness to cross-border reinsurance, inter alia. However, whether such policy measures actually translate into more insurance policies ultimately depends on the actions of market actors on the ground, especially those that target the most vulnerable segments of society.
Over the past decade, a new crop of technology entrepreneurs has introduced innovative technology solutions and business models (insurtechs) that target the bottom of the pyramid. They include providers specialized in improving digital access for underserved communities, facilitating the onboarding and underwriting of new policyholders using artificial intelligence and GIS, and streamlining claims handling.
These solutions can be replicated across jurisdictions as a way to boost insurance penetration, but they depend on an enabling policy and regulatory environment to thrive, in addition to venture capital and technical assistance to survive initial growth phases.
Programs that incubate and foster these startups can receive significant support from an overarching policy framework that establishes a clear policy direction and a government imperative to grow specific lines of business that improve climate resilience at the macroeconomic level.
An SLB can provide that clarity and commitment in the form of a collective goal and shared performance benchmarks. It can also unlock funding or guaranteed off-take agreements via quasi-SLB-UoP bond structure – another innovation in the SLB design that we will examine in the next blog.
The example shows that the value proposition of an SLB does not rest only on greenium, financial incentives, and policy lock-in. Its hidden power lies in the ability to catalyse upgrades of public financial management frameworks and systems towards greater climate and nature alignment.
This is the understated potential of SLBs that is often obscured in debates which point to the inadequate materiality of KPIs and weak potency of incentives. These critiques are entirely valid and will be discussed in our next blog series on addressing the shortcomings of first-generation SLBs.
Other blogs in this series: