The Director of the Finance Institute of China’s Development Research Centre, Madam Zhang, was once asked whether it would be more productive for China to fervently pursue green finance once it had developed a sophisticated enough financial system. To my mind, this seems a fair question because green bonds (just like conventional bonds) require above all else: stable macroeconomic stewardship, transparent regulatory frameworks, and robust investor protection mechanisms. Nevertheless, Madam Zhang swiftly responded that green finance itself can “improve the efficiency and effectiveness of the financial system”.
Effective African sustainable development strategy demands an appreciation of how the development of the green bond market and the development of financial systems can be mutually reinforcing. Not only this, but of how green bonds present an opportunity for African countries to take on leadership roles in the discussion and deployment of sustainability-oriented financing instruments.
What Are Green Bonds?
Just like conventional bonds, Green Bonds represent a promise between an issuer and an investor where an investor lends money for an period of time, and in return, the issuer pays back the investor at an agreed rate of interest. What differentiates Green Bonds are the principles underpinning their application.
Although Green Bond Principles are not yet universally standardized, broadly speaking, a bond is Green when:
(1) It is used to finance projects with material environmental benefits;
(2) Issuers commit to the disclosure of identifiable use of proceeds and the management of those proceeds (via an independent auditor);
(3) Issuers regularly report on the impact of their green investments.
Who is Buying and Issuing Green Bonds?
The type of Green Bonds being issued and the financing terms particular to a green bond are infinitely diverse because it depends on who the issuer is. Issuers can be anyone from sovereigns, municipalities, energy utilities, electric cooperatives. Private energy companies can even issue Asset Backed Securities (ABS), these are typically smaller asset-focused green bonds which pay investors back using future cash flows from the sale of clean energy from power generation infrastructure.
It’s important to understand that the credit risk of green bonds and conventional bonds are the same, it’s based on the balance sheet of the issuer. What is markedly different about green bonds is how they attract financing from a broader spectrum of investors with a variety of risk appetites. Comparatively, conventional asset managers, pension funds, insurers and investment banks typically have a lower risk appetite. This is because Green Bonds form part of a specific sustainability strategy that adheres to a the internal yield requirements applicable to their broader investment portfolios. Recent research has even shown that the growing global demand for green bonds has raised the possibility of the market developing a premium over conventional debt.
Conversely, other investors with a greater risk appetite target Socially Responsible Investments (SRIs). These investors instead emphasize the environmental and social governance criteria of the bonds being issued. This group includes SRI asset managers, some faith-based investors and even foundations or endowments. Generally, SRI’s are smaller-scale deals as they do not require the degree of liquidity that institutional investors with designated sustainability portfolios demand.
What does this mean for Africa?
The problem for the African bond market is the savings constraint. Put simply, in African economies less people are saving their incomes than in more developed economies, this means investors with maturing liabilities (e.g pension funds, insurance companies) struggle to find longer-term securities that tally with the liability side of their balance sheet. Over time, this inhibits the development and participation of non-banking financial institutions which are (of-course) integral to the development of any bond market.
Sustainable development strategy challenges African leaders to look not only at how individual ministries can become more sustainable (e.g economy, energy, housing, natural resources and health), but also at the environmental implications of how these ministries’ policies intersect with one another. The practical application of sovereign green bond issuances requires the establishment of departmental synergies to deliver them, furthermore, they also engage both domestic and foreign capital markets, DFIs and multilaterals to participate in this process.
Nigeria’s issuance of the continent’s first sovereign green bond for NGN$10.69bn has paved the way in this respect. Moody’s Investor Service assigned a Green Bond Assessment of (GBA) of GB1 (Excellent). In achieving the highest possible accreditation, Nigeria will have codified reporting mechanisms and transparency guarantees to certify the use of the bond’s proceeds. This will undoubtedly instil a market discipline that will be conducive to the development of Nigerian debt capital markets more broadly.
At the very least, the symbolism of Nigeria’s maiden green bond issuance demonstrates to private international investors that Nigeria envisages private capital as playing a key role in its fulfilment of its Nationally Determined Contributions (NDCs) under the COP21 agreement. And from the other side, it does much to quell the deep distrust with which many Nigerians view globalised private finance.
Elsewhere, the Indian coal producer NTPC (National Thermo Power Corporation) which is majority owned by the Indian government issued the country’s first green Masala bond by a quasi-sovereign issuer. This is especially important as the balance sheet of a company engaged in carbon intensive commercial activity is being used to raise capital for the diversification of the country’s energy mix. As the basket case for the worlds most important natural resources, Africa is home to some of the world’s most profitable extractive industries. There is vast potential in Africa for green bond issuances by corporates and sovereigns alike, what is required is for legislators to compel these industries to participate in the creation of sustainable financing ecosystems.
About the Author
Tobia is an Energy Analyst based in the UK. LinkedIn profile can be viewed here. He can be contacted at tobia.charles@fizambia.com