Green bonds to achieve green shoots?

As we grapple with the impacts of the current pandemic, we shouldn’t steer attention away from another critical and immediate challenge; climate change. Response to climate challenges is no longer the right thing to do but imperative in order to create a sustainable future. Enhanced investor focus on environmental, social and governance (ESG) factors, increased stakeholder activism and the need to remain competitive with peers who are leading the pack continues to create momentum for investments that can achieve both the necessary returns and a positive tangible impact. One such financing mechanism dedicated to funding climate positive or friendly investments and gaining traction in the South African landscape is the issuance of green bonds. At the recent Sustainable Infrastructure Development Symposium, the South African Government made mention of the issuance of green infrastructure bonds to finance much needed infrastructure projects that are key to revitalising the South African economy. Below we explore this financing instrument and some investor questions around aspects of green bonds.

What are green bonds?

A green bond is a fixed income instrument issued on either a listed or unlisted basis, the proceeds of which are specifically earmarked to address climate related challenges. It is important to stress that green bond proceeds are not available for general corporate purposes. Green bonds can be used to fund both new or existing operations with issuance not only limited to greenfield project finance transactions. A green bond issuance by an existing corporate could seek to improve their environmental impact by utilising proceeds to reduce greenhouse gas emissions, water pollution or improve energy efficiencies.

Is investing in a green bond riskier?

Our view is that participation in listed green bonds does not bring about additional credit risk. The fundamental risks and returns of the issuer will continue to be assessed on the same basis. Where the bonds are unlisted, investors should be compensated for illiquidity through an upward adjustment in the margin. There is, however, added operational complexity and costs borne by the issuer in respect of reporting requirements but assessment of the risks and returns remain the same as with traditional bonds. In fact, one could argue that there is a slight decrease in the credit risk due to the improved sustainability of the issuer’s operations as a result of the use of bond proceeds.

Do green bonds price differently to traditional bonds?

The City of Johannesburg was the first to pioneer the issuance of green bonds in 2014. More recently, we have seen issuances from South African financial institutions. 

In 2019, Nedbank led the South African banks with two issuances. A R1.7 billion first issuance in April and a second R1 billion issuance in October were both oversubscribed by 3x and 4x respectively. The proceeds from both issuances were used to fund solar and wind energy projects. The below table compares Nedbank’s green bond issuance spreads to other Big Four South African bank issuances in the same month.

Green bonds table 1_
Source: Nedbank CIB Fixed Income DCM Trends Publication April – 09 May 2019

Green bonds table 2

Source: Nedbank CIB Fixed Income DCM Weekly Issuances -29 October 2019

From the above, it can be seen that Nedbank’s green bond saw a marginal improvement in spreads. This could be driven by various investor bid considerations. It is, however, unlikely that a lower return will be accepted for the same counterparty’s green vs traditional bond unless there is a specific mandate target for sustainable investments. 

Why should an investor consider green bonds if a traditional bond provides similar returns?

Investor mandates and the increased appetite for socially responsible investing will drive demand for green bonds over conventional fixed income bonds as they place a specific requirement on the issuer in terms of the use of the proceeds, reporting principles and audit requirements. Earlier this year, Standard Bank issued its maiden USD200 million listed ten-year green bond. The entire issuance was taken up on a private placement basis by the International Finance Corporation. The proceeds of the bond would be applied towards financing of eligible green assets including renewable energy, green buildings, water and energy efficient projects. [1]

Last week, African Development Bank invested R2.05 billion in Nedbank’s ten-year non call five Tier 2 Sustainable Development Goals linked bond. The investment is expected to create more than 6 000 new jobs in South Africa and promote financial inclusion through the provision of 20 000 Small Medium Enterprise loans, as well as catalyse further investment in renewable energy. The facility is aligned with the African Development Bank’s ten-year strategy emphasising green and inclusive growth. [2] 

The quantum of the two issuances evidences both lenders and investors commitment towards sustainable financing.

Through a green bond, investors will be able to access projects or investments that will unlock specific environmental and economic benefits.

Given limitations on use of proceeds and increased reporting requirements, how does an issuer benefit from issuing a green bond?

Green bonds enable an issuer to broaden its funding base attracting capital from a diverse and/or new funding base seeking to address climate challenges. It also enables the issuer to meet their sustainability objectives and provides brand or marketing equity, enhancing its reputation as a responsible corporate citizen that does not generally arise with raising of conventional debt.

Investors should, however, ensure that they are comfortable with the reporting principles or framework and the third-party verification so that the intended consequences of the financing are achieved.

Transparency with regards to selection of projects, use of proceeds and reporting will set further appetite for future green bond issuances.

What are typical green bond tenors?

Tenors vary and can match those of traditional bonds but are largely dependent on the underlying project or activity being funded. Green bonds are typically medium-term in nature but can range from short-term to much longer dated tenors providing a risk adjusted return for investors looking to match long-term liabilities with an added impact benefit.

Are green bonds suitable for retail investors?

This is really dependent on the green bond reporting framework. While retail appetite may be present, retail investors’ ability to assess the credibility of the reporting and impact assessment may require a further measure of oversight.

Outlook

In light of the current economic crisis brought about by COVID-19, companies are currently in survival mode with a focus on raising debt to manage operations and or create liquidity buffers. As the economy recovers and in further stimulation thereof, we expect increased appetite for green funding driven by ESG factors. To assure investors that the proceeds are being used as intended, transparency and requisite reporting is key.

Overall, participation in green bonds will achieve climate investment objectives but not at the expense of investors returns.

References:

[1] https://www.bloomberg.com/news/articles/2020-03-02/standard-bank-sells-200-million-10-year-green-bond

[2] https://www.afdb.org/en/news-and-events/press-releases/african-development-bank-concludes-r2-billion-investment-nedbank-sdg-linked-bonds-36712