The World Bank successfully priced its largest outcome bond to date for Amazon reforestation in a deal that is also the first to link investors' returns to the removal of carbon from the atmosphere.
The US$225m nine-year principal-protected deal will fund reforestation and tree-planting projects by Brazilian carbon removal startup Mombak, using so-called carbon removal units to connect investors' financial returns to the project's outcomes.
The deal is the first in the World Bank's influential series of outcome bonds to support reforestation and the first to support the Amazon or any project in Latin America. The innovative use of CRUs introduces a new model for mobilising private capital to support reforestation, the World Bank said.
"This is our fifth outcome bond and it's by far the largest, and that's important in terms of expanding the investor base for this kind of instrument. We've opened up a whole new range of investor possibilities," Michael Bennett, head of market solutions and structured finance at the World Bank's treasury, told IFR, adding that the result was at the "high end of expectations".
The deal is also a first for HSBC, which acted as structurer and sole lead manager.
"We've helped to open up the outcome bond market – we're proving that this can be scaled up significantly," said Asif Sherani, head of DCM syndicate for EMEA and public sector DCM at HSBC. "We should hopefully see more and more of these [deals]."
The World Bank has been issuing outcome bonds since 2021 in an effort to tackle a range of related environmental topics. Previous deals include a US$50m water purification project in Vietnam in February 2023 that was linked to the sale of carbon credits from avoided emissions.
The Washington-headquartered supranational is working on a pipeline of outcome bonds, which includes more transactions involving carbon credits and sequestration. It expects to issue at least one more outcome bond this year.
"Both agro-forestry and regenerative agriculture could be underlying projects for future outcome bonds for the World Bank," Bennett said.
Deal structure
All of the deal's US$225m principal is protected and proceeds will be used to support the World Bank's sustainable development activities globally. Forty percent of the coupon is made up of a fixed component guaranteed by the World Bank, with the rest coming from a variable component linked to generation and sale of CRUs.
Investors will forgo some of the ordinary coupon payments, which will release US$36m to support Mombak's reforestation projects through a hedge transaction with HSBC, which consists of an interest rate swap and a forward flow agreement where HSBC acts as an intermediary between the World Bank and Mombak for cashflows.
This means Mombak is financed directly with private sector funding at a favourable rate, while the World Bank is facilitating a lower cost of capital from its Triple A rating and preferred creditor status.
Mombak will use the money to buy land or partner with landowners to reforest degraded pastureland with up to 100 native tree species. Its reforestation projects are aligned with the World Bank’s priorities in the Amazon and are not financed by IBRD lending.
The CRUs will be purchased through an offtake agreement with Microsoft, which signed one of the largest nature-based carbon removal offtake agreements globally in December with Mombak. The latter agreed to provide up to 1.5m carbon removal credits that Microsoft said was expected to remove 1.5m tons of carbon through reforestation.
"Investors are not taking price risk on the CRUs, they are taking the sales proceeds of the credits sold to Microsoft at fixed prices, so they're just looking at project risk," Bennett said.
The CRUs will be verified by a third party linked to the offtaker, such as Verra or Gold Standard.
The bonds could offer investors a premium compared with regular World Bank bonds of a similar maturity if the projects generate and sell CRUs as expected. If that happens, the coupon will step up in 2028 and 2029 and there will be a further step-up between 2030 and maturity in July 2033, Sherani said.
The projected yield of 4.362% is higher than the 3.928% that a World Bank conventional US dollar bond issue with nine years remaining maturity is trading at today, according to LSEG data.
Stephen Liberatore, head of ESG/impact for global fixed income at Nuveen, which said that it is the largest investor in the transaction, said the deal "provides attractive relative valuation".
Bespoke pricing
Pricing was a bespoke process. "The risks associated with it are all very unique, so there isn't really an outcome bond curve you can look at. Even if there were other comparable bonds outstanding, by their very nature these are niche, structured products. The level of trading activity for these is extremely limited, if any," Sherani said.
Investors focused on a pickup relative to the World Bank's curve and how much that relates to the project's risks. Risks include land acquisition and whether the trees planted will grow sufficiently to generate enough CRUs. Investors also have to become comfortable with the deal's coupon step-up mechanism.
Land purchase risk was mitigated by splitting disbursements to Mombak into 11 payouts until December 2026 linked to land acquisition milestones. Investors will receive a special coupon in January 2027 if the land has not been purchased.
"For us, it was important to consider scenario analysis and understand how the bond would perform in a variety of situations," said Stuart Chilvers, a fund manager at asset manager Rathbones, which bought into the deal.
Around 15 investors joined the deal, including large asset managers and pension and insurance funds from the US and Europe. Sherani said the buyer base included some accounts that had never invested in an outcome bond. Repeat investors include Nuveen, T Rowe Price and Denmark's Velliv, Pension & Livsforsikring.
There is considerable investor appetite to support the environmentally critical Amazon rainforest, which is likely to generate more ESG financing, including a potential use of proceeds for a sovereign jumbo deal for Brazil, which is set to host the UN's COP30 meeting in 2025.
Additional reporting by Luke Acton
Corrected story: Amends nationality of Velliv in penultimate paragraph.