Financing Sustainable Development in Brazil and Mexico
This is an Insight article, written by a selected partner as part of Latin Lawyer's co-published content. Read more on Insight
In recent years, many countries around the world have increased their focus on the preservation of the environment, the promotion of socially driven policies and the level of scrutiny of corporate governance of the companies that operate within their borders. This focus has been driving these governments to implement environmental, social and governance (ESG) policies and procedures as part of their public policy to promote a change in how we interact with the environment, how conscious we are of our society and how transparency and ethics should be one of the key drivers when doing business.
This wave on implementation of ESG policies and procedures has also reached the corporate world. In recent years, there has been an increasing focus by corporate stakeholders to elevate the ESG standards of their corporations with the aim of attracting investment and ensuring the delivery of goods and services that are aligned with the needs of the XXI century. As such, many corporations have started to implement ESG policies and procedures to their operations, which has created a new market where there is a demand from key investors and market participants to engage in financial products that integrate ESG policies and an offer from corporations to provide such products.
This new market now sees, in addition to corporations, several sovereign, sub-sovereign and state-owned entities that have entered the sustainability race by issuing debt the proceeds of which are used to, among others, achieve their ESG targets. Powered by criteria and principles prepared and published by several international organisations (e.g., the United Nations, multilateral development banks, etc.), investors and other financial institutions have helped design a variety of ESG-related products and eagerly compete among them to sell such products to their clients. This new ESG-financing market is growing at a fast pace across virtually every country in the world, including the Latin American countries.
This chapter summarises the current framework for the issuance or extension of sustainable debt, while describing recent market and legislative developments in Brazil and Mexico, two of the biggest economies in Latin America and perhaps the most active when it comes to ESG-related financing products, and provides a general review of the international standards that serve as the reference for the ESG-financing market in the world.
Green and Blue Debt
ESG financing is based on the application of certain principles and standards that have been considered as the frame of reference for the issuance of ESG-related debt. The idea behind such principles and standards is to provide guidance as to which type of debt can be labelled as ‘Green’ or ‘Blue’ financing. The key to obtain such label is primarily driven by the use of proceeds. ‘Green’ debt is mainly related to the financing of certain eligible projects that seek to achieve climate-related or environmental goals, while ‘Blue’ debt is mainly related to the financing of certain eligible projects that seek to achieve maritime preservation and clean water goals. The sustainable financing market is mainly comprised of green bonds, but a growing number of blue bonds are starting to take a larger stake as potential issuers explore additional financing options that adjust to their ESG policies.
Standards for the issuance of green debt
Green debt is the main type of sustainable debt in the market but while its use has been spreading quickly in the past years, there are no statutory provisions that govern the labelling of debt as ‘Green’. To cover such regulatory void, several standards have been implemented and are broadly followed by both issuers and investors. Among those are the International Capital Market Association (ICMA) Green Bond Principles and the Climate Bonds Initiative (CBI) Climate Bonds Standard and Certification Scheme.
In addition to these internationally recognised principles and standards, some governmental authorities and other market participants have issued classification systems that are known as ‘taxonomies’. These taxonomies are more comprehensive than the sole guidance of the principles and standards and help issuers and investors to have a clear path of when a debt should be labeled as ‘Green’.
The main principles used for the classification of green debt are the following.
ICMA’s Green Bond Principles
As a market standard, ICMA’s Green Bond Principles (the GBP) seek to assist issuers in the labelling of debt as ‘Green.’
In order to achieve such purpose, the GBP requires that the debt intended to be labeled as ‘Green’ complies with the following:
- the net proceeds of the debt to be issued must be exclusively applied to finance or refinance eligible green projects, which shall be appropriately described in the definitive legal documentation;
- a clear process for project evaluation and selection should be established;
- the net proceeds should be managed by the issuer appropriately; and
- the issuer should keep available up-to-date information regarding the use of proceeds until full allocation (collectively, the Core Components).
Moreover, the GBP recommends that the debt to be labeled as ‘Green’ includes:
- an explanation of the debt’s compliance with the Core Components, and that such compliance be included in a framework or the legal documentation available to investors; and
- that the framework or the legal documentation be subject to an external review prior to the issuance, in order to assess their alignment with the Core Components and, following the issuance, to verify the tracking and the allocation of proceeds of the debt to the intended eligible projects (the ‘Recommendations’).
While it is not required for the debt to be compliant with the GBP, external review is included in the Recommendations and, if used, it must consist of any of the following:
- a second party opinion carried out by a recognised expert in environmental sustainability matters;
- an independent verification against a determined criteria aligned with the Core Components;
- certifications tested by accredited third parties; or
- the assessment of the issuance by a rating agency.
CBI’s Climate Bond Standards
In addition, CBI’s Climate Bond Standards (the CBS) allow issuers to certify their Green debt. The CBS is a voluntary labelling scheme for both entities (such as the issuers) and the investments (such as the debt itself). Certification with the CBS will depend on the sector where the issuer operates, but it includes most of the sectors where large companies operate (e.g., agriculture, bioenergy, basic chemicals, low-carbon transport and waste management, cement, hydrogen and steel, among others).
Certification with the CBS requires issuers to establish internal processes and controls both prior to and following the issuance of debt and requires an external review at both stages, which constitutes a departure from the GBP, where external review is solely a recommendation but not mandatory.
In addition to the adherence to certain standards and principles, governmental authorities have been seeking to establish classification systems to identify categories that are relevant to the achievement of ESG targets and thresholds (Taxonomies). These Taxonomies are actively promoted by governmental authorities and may follow market conventions or accepted principles such as the GBP.
In recent years, several governmental entities have published Taxonomies, the most relevant being the one adopted by the European Union in 2020. Since then, several other countries have followed suit and adopted their own Taxonomy (such as Colombia, the first Latin American country to publish a Taxonomy in April 2022).
Blue debt is a growing product in the sustainable financing market. Blue debt, in contrast with green debt, does not have a clear set of standards such as the GBP, but is usually aligned with the GBP to the extent possible (with the particularity of having its focus on maritime preservation rather than climate-related goals) in order to be labelled as blue debt. Because of the lack of generally accepted standards or a global guidance on how to apply the GBP to blue debt, issuance of blue debt was generally left to the discretion of the market participants, who used to apply a heterogeneous criterion to decide when to label an issuance as a blue debt.
To resolve this issue and to provide clear guidance for issuing or investing in blue debt, in September 2023, through a collaboration of ICMA, the International Finance Corporation (IFC), the Asian Development Bank, the UN Environment Programme Finance Initiative’s (UNEP FI) and United Nations Global Compact, a global practitioner’s guide for bonds to finance the sustainable blue economy was published (the Practitioner’s Guide). Now, with the publishing of the Practitioner’s Guide, clear criteria, practices and examples for the issuance of and investing in blue debt exists and is expected to be used broadly by market participants when issuing or labelling blue debt. The Practitioner’s Guide gathers information from market trends for blue debt as well as the IFC Guidelines for Blue Finance, the UNEP FI Sustainable Blue Economy Finance Principles and associated Blue Finance Guidance and the UN Global Compact’s Practical Guidance to Issue a Blue Bond, among others, which were the principles and standards used for the labelling of blue debt before the publishing of the Practitioner’s Guide.
While still following the framework of the GBP, the Practitioner’s Guide includes eight eligible project categories, which allows issuers to have a better understanding of what may constitute blue financing. These project categories are descriptive rather than prescriptive and are the following:
- coastal climate adaptation and resilience;
- marine ecosystem management, conservation and restoration;
- sustainable coastal and marine tourism;
- sustainable marine value chains;
- marine renewable energy;
- marine pollution;
- sustainable ports; and
- sustainable marine transport.
With the publishing of the Practitioner’s Guide, issuers are expected to have better guidance of what constitutes blue debt, which may have an impact on the share of blue debt of the sustainable finance market.
In addition to green and blue debt, there is a large market for sustainability-linked debt, either in the form of bonds or loans. Sustainability-linked debt is based on the possibility to increase or decrease the interest rate payable on the financial instrument depending on the performance by the issuer or borrower with predetermined ESG targets and thresholds agreed upon the parties. This allows issuers and borrowers to improve their ESG indicators throughout the life of the financing due in order to achieve an economic benefit.
Sustainability-linked debt, in contrast with green or blue debt, is not dependent on the establishment of particular eligible projects to be financed with the proceeds of the debt, but solely dependent on the performance by the issuer or borrower of their ESG targets and thresholds, irrespective of the use of proceeds. In addition, and similar to green and blue debt, there is no formal statutory or regulatory framework that governs sustainability-linked debt. Now, also similar to green and blue debt, ICMA has published certain voluntary principles to cover the void, and those require the following:
- establishment of key performance indicators (KPIs) that can be measurable and verifiable by external review;
- such KPIs should be adequately calibrated and include performance targets;
- the debt financial and structural characteristics (such as the interest rate) should be variable;
- the issuer or borrower should keep up-to-date information that allows monitoring of KPIs performance; and
- external review of KPIs and compliance with performance targets must be obtained.
It is important to note that sustainability-linked debt take a more holistic approach to the issuer or borrower’s business, seeking to incentivise and measure its improvement against their predetermined ESG targets and indicators instead of solely verifying use of proceeds and financing of eligible projects.
The ESG lending market in Latin America
Similar to the bond market, the lending market has implemented a number of ESG-related initiatives and procedures to attract market participants. Initially, most ESG loans to Latin American corporations were characterised by a certain level of greenwashing in the absence of any real monitoring by financial institutions or the credit parties. This was not a particular feature of Latin America but rather due to the early development stages of the ESG financing market worldwide.
In an effort to reduce greenwashing, different forms of ESG loans with commercial financial institutions have been implemented with a focus on monitoring and compliance. These efforts have been left out for the most part to financial institutions and lending market associations such as the Loan Syndication and Trading Association (LSTA) and the Loan Market Association (LMA), which are the main lending associations that provide guidelines and forms financing institutions providing financing governed by New York law (in the case of the LSTA) or the laws of the United Kingdom (in the case of the LMA). In February 2023, these organisations issued a combined set of guidelines (the Green Loan Principles), which provide the following four key core components intended to clarify if a loan can be qualified as a green loan (including as a sustainability-linked loan (SSL)): use of proceeds, process for evaluation and selection, management of proceeds and reporting.
While neither the LSTA nor the LMA have any regulatory power, each of these organisations have an important impact on parameters and standards followed by financial institutions participating in the loan market. These standards and guidelines are often implemented in financings transactions in the US and the UK and similarly in cross-border transactions in Latin America governed by New York law or English law. As such, and similarly to what has occurred with many financing instruments, there is a percolating effect of these guidelines into Latin America. This is because any green loan financing occurring in Latin America will aim to meet these standards and impose on local borrowers or obligors the need to track and implement mechanisms addressed to ensure compliance and avoid, at least in the SSL market, an increase in the interest rate otherwise paid on the disbursed debt.
We have seen an increase in financial instruments that meet the green loan principles or that are SSL, which has increased the level of sophistication of the KPIs and the discussions and negotiation around these instruments in cross-border transactions occurring in Latin America.
ESG regulatory initiatives in Latin America
As mentioned above, Latin America has not been the exception in the wave of sustainable financing. Recently, borrowers and issuers have increased their use of this type of financing to cover their financing needs and more investors (either domestic or international) have increased their offer of sustainable financing products to meet such demand.
This growing market in Latin America, as expected, mostly follows the experience in other parts of the world and applies internationally recognised standards and principles as the framework for the issuance of sustainable debt. Nonetheless, certain countries have started to prepare their own set of rules or Taxonomies, to dynamise their internal markets and attract more sustainable investments. Examples from jurisdictions such as Brazil and Mexico, two of the biggest Latin American economies, show that regulatory trend.
There is no defined taxonomy or framework for ESG financings in Brazil, but international standards with respect to the use of proceeds of any financing, financing activities and environmental and social benefits (i.e., ICMA principles) are typically observed, and similarly to what occurs in other jurisdictions, are verified by a second party opinion as a condition for a financial instrument to qualify as green, social or sustainable. Despite the absence of a defined or mandatory taxonomy, according to the Climate Bond Initiative (CBI), as at the end of 2022, Brazil was the third-largest sustainable debt market in Latin America and the Caribbean (LAC). With the addition of US$7.2 billion in sustainable debt transactions during 2022, the Brazilian market’s total size reached a volume of US$31.9 billion. Brazil stands out as the sole country within LAC region to encompass all five essential thematic categories: green, social, sustainable, sustainability-linked, and transition.
According to the CBI, Brazil continues to assert itself as a prominent leader in the green bond market within the LAC region, with the greatest number of issuers and a cumulative principal amount of debt of US$15.2 billion in 2022. While the three main sectors where the proceeds of green bonds are used are renewable energy (56 per cent), land use (20 per cent), and transport (10 per cent), other sectors also received significant investments during 2022. Among these sectors were water supply services, sustainable forestry and biodiversity management, low carbon building and biomass production. In contrast, social bonds remain a relatively small component, comprising only 2 per cent of the Brazilian sustainable market, with a total value of US$699 million during 2022. Brazil is also the only country in Latin America to register a transition bond issuance, despite the small representation within Brazil’s sustainable debt market (2.1 per cent).
Most recently, Companhia Energética de Minas Gerais (Cemig), a state-owned company, closed a ground-breaking sustainable debenture issuance, for an amount of 2 billion reais. This issuance stands as the largest of its kind ever closed in Brazil.
The most frequently employed instruments for financing sustainable development in Brazil include infrastructure incentivised debentures (which are debentures issued under Law No. 12,431, 24 June 2011, as amended, whose interest and capital gains are tax-exempt, subject to the condition that the funds are used to finance infrastructure expenses), certificates of agribusiness receivables, agribusiness letters of credit, certificates of real estate receivables and debt instruments related to rural products, which stand out both in terms of number of transactions and the sizing of these types of issuances. Each of these debt instruments is entitled to relevant tax benefits, regardless of whether they are Brazilian bonds, as well as the potential reputational and financial value of the green, social or sustainable classification itself.
During 2023, incentivised debentures have seen an increase in the range of sectors with eligible projects due to their substantial environmental or social benefits. These sectors include education, health, public safety and the prison system, urban parks, conservation units, cultural and sports facilities, as well as social housing and urban redevelopment.
Brazil has also been at the forefront of passing several regulations on ESG financings. The recent enactment of Rule No. 160 by the Brazilian Securities Commission (CVM) pertaining to public offerings requires that prospectuses relating to the offering of green, social or sustainable securities provide detailed information in respect of the assumptions and methodologies by third parties for a security to be labeled as ‘sustainable’. Apart from this requirement, the public offering regulations set forth by CVM for thematic bonds are, for the most part, identical to those governing standard bond offerings. As there are no other specific rules and no penalty provided for under current regulations, an important aspect of these instruments is addressing defaults triggered by violations of ESG-related provisions. On this issue, market precedents show that remedies such as the removal of the sustainable label or a step-up of interest rates are preferred over events of default or acceleration.
In addition, CVM also established criteria for categorising sustainable investment funds. To protect against practices such as greenwashing, CVM implemented stricter regulations pertaining to transparency and accountability in relation to the objectives of ESG funds, which are now mandated to delineate their socio-environmental goals, articulate the investment strategy for attaining them, specify the metrics and parameters for information disclosure, and specify the third-party responsible for providing a second-party opinion related to the offering. Such new rules also prohibit the use of sustainability-related terminology if the investment policy incorporates environmental, social and governance factors into portfolio management without actively pursuing socio-environmental benefits.
Other Brazilian governmental authorities are engaging in the sustainable finance markets with the aim to provide legal certainty and clarity to market participants. In September 2023, the Brazilian government introduced Brazil’s Sovereign Sustainable Bond Framework, with the assistance of the Inter-American Development Bank (IDB) and the World Bank. This framework provides guidelines for the issuance of sovereign debt securities financed by budgetary allocations that directly contribute to advancing Brazil’s sustainable development goals. Beyond its potential to diversify the investor base for public debt, the launch of this framework also marks the initial step in establishing a foreign market reference for the Brazilian private sector. This, in turn, has the potential to foster the issuance of sustainable bonds in the corporate sector, with far-reaching effects on the sustainability agenda both within Brazil and globally.
Also in September 2023, the Brazilian Ministry of Finance announced the public consultation process of the government’s proposal for a Brazilian Taxonomy. This marks the government’s first attempt to establish a Taxonomy that will set the regulatory framework for investors, companies, regulators and governmental entities regarding, among others, sustainable financing. This Taxonomy is expected to be formally published in 2024, and will be mandatorily adopted in 2026.
Currently, the Brazilian government is in the process of establishing a regulated carbon market following the ‘cap and trade’ model. Two crucial aspects of this project include the integration between carbon credits traded in the regulated and voluntary markets and the classification of carbon credits as securities, subject to regulatory oversight by CVM, giving them a special treatment with the exclusion of compliance costs.
In Mexico, the National Banking and Securities Commission has not issued any regulations governing ESG financings. Most of the efforts to regulate the issuances of ESG bonds in the Mexican market have been left to the various stock exchanges that operate within the country. These stock exchanges have issued a set of internal regulations that govern the requirements that securities need to meet in order to be listed as ‘Green’, ‘Social’ or ‘Sustainable’. Such internal regulations follows the Green Bond Principles, as issued by the Consulting Council on Green Finances, a consulting group integrated by a significant number of financial services providers, which generally follow the ICMA Green Bond Principles.
In addition, the regulations of the stock exchanges in Mexico only incorporate certain guidelines on use of proceeds and second-party opinion principles as formal requirements for the listing of a security as ‘Green’, ‘Social’ or ‘Sustainable’, as follows.
Use of proceeds
The classification of a security as ‘Green,’ ‘Social’ or ‘Sustainable’ will require the following:
- For a security to be considered as ‘Green’ and thus be listed as such, the proceeds must be used exclusively to finance or refinance, whether totally or partially, renewable energy, sustainable construction, energy efficient, clean transportation, water, waste management, agriculture, bioenergy, forestry, and other similar related projects.
- For a security to be considered as ‘Social’ and thus be listed as such, the proceeds must be used exclusively to finance or refinance projects aimed to support specific community causes, or otherwise in support of a particular social group or sector.
- For a security to be considered as ‘Sustainable’ and thus be listed as such, the proceeds must be used exclusively to finance or refinance projects that combine the activities of both, social and green bonds, instruments or certificates.
To list any security as either ‘Green’, ‘Social’ or ‘Sustainable’, the issuer is required to file, along with its listing application, a certification or opinion issued by a specialised independent party, evidencing that the proceeds will be in fact allocated to environmental, social, or sustainable activities, as applicable.
In addition, the Green Bond Principles in Mexico also require that the issuers of ‘Green’ securities:
- disclose in the relevant offering documents their decision-making process to determine that the project that will be financed or refinanced will in fact result in environmental benefits;
- disclose in the relevant offering documents the eligibility criteria for each project;
- disclose in the relevant offering documents the environmental objectives of the relevant project; and
- the proceeds of the offer need to be formally segregated by the issuer to ensure that such proceeds are in fact allocated to the relevant environmental project.
In addition, while the relevant securities remain outstanding, the issuer must report to the market on an annual basis on the allocation of proceeds to the relevant projects, and an assessment of the environmental impact attributable to such securities.
Many industries are focusing on having more sustainable, carbon-free policies and procedures applicable to their business, and the financial markets are no exception to such trend. With an increased demand for sustainable financing, market participants are enhancing the offering of sustainable finance products by moving towards its homogenisation. To assist in such endeavour, international standards, such as the GBP, along with new Taxonomies issued by governmental authorities are reducing the gap in the interpretation of what can be considered as sustainable financing and what cannot, reducing the risk of practices such of ‘greenwashing’.
With the growing amount of ESG financing in Latin America, countries in the region are actively promoting ESG policies and activities and are willing to start working on regulatory frameworks that may assist issuers and borrowers to incur in more sustainable financing. While there is still much work ahead, the path is set for sustainable financing to grow and continue consolidating as an attractive financing source for corporate and sovereign issuers around the world.
 Juan Pablo Moreno and Francisco García-Naranjo González are partners and Luis A Schrader is an associate at Mayer Brown LLP, and Beatriz Lavigne is an associate at Tauil & Chequer Advogados in association with Mayer Brown LLP.