JEANETTE CLARK: According to the Global Sustainable Investment Alliance, sustainable investing – including investments going towards a green economy and net-zero emissions – has grown from US$30.7 trillion in 2018 to $35.3 trillion in 2020. A recent report by McKinsey says more than one quarter of assets under management globally is now being invested according to the premise that environmental, social and governance factors can materially affect a company’s performance and market value. If we just look at green bonds, for example, the World Economic Forum says annual issuances are expected to exceed $1 trillion in 2023, double the amount issued in the previous year.
Today we are joined by Louis Dirker, head of debt capital markets at Investec Bank, to talk about the local green-bond market and the growth that the bank has seen. Louis, thank you for joining us. Can you firstly tell us more about what green bonds are, and what the market looks like in South Africa?
LOUIS DIRKER: Good afternoon Jeanette, and thank you for the opportunity to share some of our views on the green-bond market in South Africa. Just as some background, in your introduction you mentioned ESG [environmental, social and governance factors]. I’d just like to give some context on where green bonds fit into the ESG theme.
The term ESG refers to an evaluation of environmental, social and governance factors which are factors beyond traditional financial metrics for investment purposes. This dates back to the 1960s, when socially [responsible] investment was originally introduced; and since then the industry has evolved and branched out, incorporating concepts such as impact investing and corporate social responsibility.
But the industry is joining around the concept of ESG as a way of expressing, measuring and implementing considerations beyond traditional finance metrics. Currently green bonds dominate the sustainable debt market and constitute more than half of all outstanding sustainable bonds.
But to get your question: What is a green bond?
Just some history, the very first green-bond was issued in 2007 by the European Investment Bank under the label ‘Climate Awareness Bond’, with proceeds dedicated to renewable-energy and energy-efficiency projects.
So a green-bond is a fixed-income instrument designed specifically to raise money for specific climate-related and environmental projects. More specifically, green-bond finance projects are aimed at energy efficiency, pollution prevention, sustainable agriculture, clean transportation, clean water, sustainable water management, and numerous other [projects] for the cultivation of environmentally friendly technologies and the mitigation of climate change.
Just to note, the phrase ‘green bonds’ sometimes is used interchangeably with ‘climate bonds’ or ‘sustainable bonds’.
These bonds are typically asset-linked and backed by the issuing entity’s balance sheet, so they usually carry the same credit rating as their issuers’ other debt obligations.
Now, just to go into the green-bond market in South Africa, given South Africa’s well-developed and deep capital market, it is not surprising that South Africa is leading the way in Africa in respect of green bonds. We do expect wide adoption across the continent as governments and companies respond to the need for social advancement and delivery on ESG mandates. Several issuers have accessed the market, starting with the first green-bond being issued by the City of Johannesburg in 2014 to fund green initiatives like the installation of over 42 000 solar water heaters by City Power.
Now some of the issuers in the market – and obviously while we’re having this discussion, Investec recently launched its first green-bond – [are] Investec Bank and other issuers that have accessed the market in South Africa, Investec Property Fund, Redefine Properties, the City of Cape Town, the Development Bank of Southern Africa, Growthpoint, Nedbank, Standard Bank, and SA Taxi.
JEANETTE CLARK: Can green bonds grow as a sector within the fixed-income asset class? You’ve mentioned that they already constitute quite a percentage of sustainable bonds, but what does the growth look like in the South African market?
LOUIS DIRKER: You have correctly stated that it is a sector within the fixed-income asset class. The question has been asked if green bonds can be considered an asset class by itself. Now, typically investors use asset-class allocations to navigate around risk-diversification and returns, and in a particular market environment. Allocations vary dependent on the investor’s assessment of the environment now and in the future over different time horizons.
There has been significant growth in the sustainable-bond market globally and the expectation is for issuance to surpass $1.5 trillion in 2022. Just to provide some context, sustainable bonds – which [are] made up of green, social and sustainability-linked bonds – still make up a relatively small part of global bond issuance, but it [has been] increasing to around 11% of global issuance in 2021 from less than 5% three years earlier. So in 2022 we expect this share will grow to approximately 17% of total 2022 issuances, according to S&P Global Ratings.
We expect sustainable bonds to continue to grow, despite the stagnating global bond-issuance market due to the inflation outlook and the situation in the Ukraine.
Green bonds are still the dominant sector of sustainable bonds, and green-label bond issuance will set another record in 2022, driven by the momentum from the UN COP26 Summit that happened last year November
JEANETTE CLARK: A lot of articles and analyses of green bonds and the green economy refer to ‘greeniums’ rather than ‘premiums’. I just wanted to ask you what exactly does that mean and how does it fit into the importance of, when you’re looking at green bonds, finding bankable projects and the need for a fully supported ecosystem?
LOUIS DIRKER: I make the assumption that the listeners will know a little about [how] bonds get issued. So what is a greenium?
A ‘greenium’ is the difference in yield between green bonds and ordinary bonds of a similar maturity issued by the same issuer.
So the greenium can be hard to analyse. The reason for that is because issuers typically do not sell green and conventional bonds with the same characteristics at the same time, so the accurate measurement of a greenium is difficult.
Just a note, it’s not a question of lower financial risk. The risk of green bonds typically matches that of non-green bonds. So why the difference in pricing?
In our view, the biggest reason for a greenium is excess investor demand relative to the volume issued.
Investec’s recent green bond attracted total bids of R3.9 billion and we only placed R1 billion of bonds in the market, so a significant oversubscription.
By our own calculation, the greenium was between three and seven basis points.
When pricing a bond in the primary market, a lot is happening that can have a material influence on the price, like the setting of price guidance and follow-on discussions with investors before an auction, and market sentiment at the time of launching the bond. But that’s not going to change our general view that greeniums still currently exist.
The sources of green-bond demand [are] increasing more rapidly than the sources of supply, making pricing more competitive and hence the greenium.
Currently it is hard to analyse this excess demand given the lack of investment transparency, as demand could come from dedicated green-bond funds, regular investors looking to green their bond fund, or investors genuinely looking to finance green activities.
Also note that there is a difference between greenium experienced in the primary versus the secondary market. Green bonds are likely to be stickier than the vanilla bonds and, given their relative scarcity, they’re not among the first assets to be sold.
Secondly, some bond investors also believe that green debt, which tends to change hands less often than more conventional debt will hold up better in a market downturn
So governments and companies raising funds through green debt are benefiting from lower borrowing costs, so-called greeniums, and therefore supporting bankable projects, specifically given the low interest-rate environment that we are coming out of.
JEANETTE CLARK: Is it important to look for existing return-generating projects rather than future projects? And what does the pipeline look like?
LOUIS DIRKER: It’s an interesting question and also one we were asked during our engagement with investors. There are pros and cons to each of these, meaning existing return-generating projects versus future projects. We decided to go with existing projects, given that some of the issuers have also come to market on that basis, and given that it was our first green-bond issue.
It is important to note that construction risks also need to be taken into account for funding future projects. I’m talking specifically here of renewable energy projects …typically in South Africa the banks have had an appetite to take on this risk. So the debate about existing versus future projects could be expanded to satisfy the need of investors to invest in sustainable bonds they regard as furthering the net-zero principle.
So, according to the International Capital Market Association, sustainable bonds can be divided into two categories: the use of proceeds bonds, which are mostly currently the green bonds, social bonds and sustainability bonds, and then the second one is sustainability-linked bonds.
Now this is where the difference comes in. A sustainability-linked bond is any type of instrument for which the financial and/or structural characteristics can vary, depending on whether the issuer achieves predefined sustainability objectives.
So the alternative to the current green bonds is so-called sustainability-linked bonds. These bonds do not have the proceeds set aside for any specific purpose. Instead, they penalise the issuer by requiring higher interest rate payments to investors if the issuer fails to reach certain sustainability targets such as cutting carbon emissions. The market for sustainability-linked debt is much younger and smaller than that for use-of-proceeds bonds. But, according to S&P Global, sustainability-linked bonds will grow faster.
JEANETTE CLARK: So we’re talking from the investment side and why green bonds are something that you should be looking at. But in South Africa, considering our severe energy challenges, are green bonds truly helpful? Can they help create a cleaner energy future for South Africa?
LOUIS DIRKER: There are two points I want to touch on, and I’ll come to our answer once I’ve touched on these.
First is the Green Finance Taxonomy. On April 1 2022, South Africa launched its first National Green Finance Taxonomy, an official classification that defines a minimum set of assets, projects and sectors that are eligible to be defined as ‘green’ or ‘environmentally friendly’. So investors, issuers like ourselves, lenders and other financial sector participants can use the taxonomy to track and monitor credentials of their green activities in a more confident and efficient manner, thereby unlocking green finance. That’s the first one.
Then the second word that’s being used in the market is ‘JET’ – or the ‘Just Energy Transition’.
Last year in November, France, Germany, the UK, the US and the EU – [in what is] called the Just Energy Transition Partnership – raised the hopes that the country will embark on a comprehensive path towards renewable energy. The partnership aims to disburse $8.5 billion for the first phase of financing through various mechanisms – including grants, concessional loans and investments to support South Africa in reducing carbon emissions.
Now, just to explain a bit about the Just Energy Transition – ‘transition’ describes a gradual movement towards lower carbon technologies, while ‘just’ qualifies that the transition will not negatively impact society, jobs and livelihoods. So it’s not, if you can call it, ‘green at all costs’.
Ultimately South Africa’s transition to renewables will depend on its ability to attract sustained energy investment.
The international community will view the Just Energy Transition Partnership as a test for South Africa’s aptitude [on] transition to renewables, and government’s commitment in delivering the objectives of the Just Energy Transition Partnership.
The impact on dealing with issues such as climate change will become even clearer in years to come, but for the moment it’s possible to take a positive view about the policy and about its impact on what are essential projects – like cleaner transport, more renewable energy and improved energy efficiency.
So what we can tell you is that, yes, we believe that green bonds are helping to create a cleaner energy future for South Africa.
JEANETTE CLARK: So it’s clear that we are moving towards policy changes that are supporting South Africa moving towards a cleaner energy future, and we can also see that the growth in the green bond market can deliver good returns for investors, while also contributing to moving the economy towards that greener future.
That was Louis Dirker, head of debt capital markets at Investec Bank.
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