There are several financing options for green projects, including grants, green bonds, carbon credits and sustainability-linked bonds (SLBs). There are a number of reasons why we believe that a properly defined and monitored SLB should play a critical role.
An SLB can directly address any sustainability-linked key performance indicator (KPI) that is measurable and easy to monitor, and directly related to mitigating climate change. Given that the administrative costs of protecting the Amazon are not particularly large (the entire budget for Brazil’s Environmental Ministry is about $325 million), an SLB could serve as an important signalling mechanism for both Brazil and investors. As Brazil embarks on a new environmental policy, an SLB could solidify and safeguard Lula’s plans.
How might the SLB work in practice? One possibility is that Brazil commits to an aggressive path of deforestation reduction (similar to its previous plan in 2003) and is rewarded or penalised by lower or higher coupon payments based on the results. Investors get to participate directly in efforts to protect the Amazon while benefitting from a sizeable sovereign spread.
SLBs are preferable to the other financing tools available, in our view.
Regular sovereign bonds, for example, have been shown to have a limited correlation with environmental outcomes over the medium term. While some investors have excluded investments in countries such as Brazil on environmental grounds, the actual effects (measured in terms of underperformance relative to peers) have been rather short-lived.
Likewise, we think that a green curve is not the best way of dealing with the preservation of the Amazon directly. Green bonds could certainly play a role in incentivising other environmental and social goals, but we think that the Amazon is in a different category given its global importance.
Carbon credits could be also cumbersome given the size of the Amazon, as monitoring costs would be substantial. Legally, the Amazon is already protected, so it would fail to qualify as a project available for new credits, which generally aim to create additional impact from efforts that would otherwise not receive financing. While technicalities could be tweaked and carbon credits could be structured to protect the areas at highest risk of deforestation, we believe this approach would fail to deliver the scale that is needed to protect the Amazon rainforest over the long term. Similarly, small grants could help finance some of the costs around monitoring and policing but are unlikely to provide a large enough incentive for Brazil to act quickly.