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Could Sustainability-Linked Bonds Incentivize Lower Deforestation in Brazil’s Legal Amazon ?

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  • Wang,Dieter
  • O'Reilly Gurhy,Bryan
  • Hanusch,Marek
  • Kollenda,Philipp

Abstract

This paper proposes a new relative evaluation and benchmarking framework for performance linked financing instruments. It argues that the carrots and sticks of sustainability-linked bonds should not use key performance indicators which are solely tied to outcomes. Instead, they should be based on its issuer’s level of performance with respect to a target. The paper defines performance as the part of the outcome that the issuer can influence. Otherwise, the issuer may be rewarded or penalized for factors outside their control. In such a case, principal-agent theory would predict a dilution of the performance-based instrument’s incentives. This framework is then applied to deforestation in Brazil’s Legal Amazon and estimate performance by accounting for the real effective exchange rate, global commodity prices, and prevalent deforestation trends. The results show that policy efforts helped lower deforestation in the 2000s, even after accounting for external factors. The trend reversal and acceleration in deforestation since 2012 are partly due to weaker policy and macroeconomic factors. Based on these results, the paper proposes an Amazon sustainability-linked bond, which could allow for a more effective mechanism to incentivize policy efforts. The paper also introduces the feasibility and ambitiousness matrix to set sustainability performance targets. The matrix is used to define the terms low-hanging fruits and long shots and to discuss why such targets are subject to the risk of greenwashing.

Suggested Citation

  • Wang,Dieter & O'Reilly Gurhy,Bryan & Hanusch,Marek & Kollenda,Philipp, 2023. "Could Sustainability-Linked Bonds Incentivize Lower Deforestation in Brazil’s Legal Amazon ?," Policy Research Working Paper Series 10558, The World Bank.
  • Handle: RePEc:wbk:wbrwps:10558
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    References listed on IDEAS

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