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With the increased focus on environmental, social & governance (ESG) issues and the desire for clients to add such exposures to their portfolios, the market has finally responded — issuing more than R12bn of ESG bonds in 2021 (compared with less than R3bn in the previous year). ESG bonds now comprise 2.5% of all outstanding bonds on the JSE.

While the local market was already introduced to green bonds in 2014, sustainability-linked bonds and social bonds made their appearance in the SA market in 2021. Globally, sustainability-linked bonds are also a fairly new instrument, with the first such bond issued in the US market by Enel in September 2019.

While green bonds and social bonds have stringent requirements, sustainability-linked bonds have much more flexibility. Green and social bonds are “use of proceeds” bonds, which means the proceeds must be exclusively applied to eligible projects that promote progress on environmentally or socially sustainable activities.

The proceeds of sustainability-linked bonds are not ring-fenced to green or sustainable purposes. Instead, the issuer has certain predefined key performance indicators, which are assessed against certain sustainability performance targets.

In March 2021 the first social bond was listed on the JSE by TUHF through a securitisation vehicle, Urban Ubomi 1 (RF). TUHF is a specialised commercial property financing company that finances property investors exclusively in inner cities. The deployment of funds has a direct link to ESG: the creation of jobs, the empowerment of SMMEs, skills transfer and the supply of high-quality, affordable rental housing.

Earn a ‘greenium’

Green and social bonds are externally verified (called a “second-party opinion”), which can be costly. Much time is also required to plan, verify and launch such an issuance. Sustainability-linked bonds are not verified and are not tied to a specific project or plan. They are therefore much cheaper and easier to issue.

In both cases issuers expect to earn a “greenium” — the premium investors are willing to pay for an ESG bond. In exchange for the positive impact on the environment investors are willing to accept a slightly lower yield on an ESG bond than on a “non-ESG” bond (a typical “greenium” is about 10 basis points). Given the cost of external verification, the lengthy planning process and the clear link to change, a greenium can perhaps be justified in the case of a green or social bond. However, is this justified for a sustainability-linked bond?

To answer this question, what needs to be considered is whether the metric is relevant to the company and whether the chosen target is ambitious enough. How does the issuance of the bond enable the company to accelerate its existing plans to enhance its focus on ESG and facilitate real change?

Sanlam Investments reviews every issuance case by case. For each issuance, one (or more) of the following actions are taken:

  • Engage with originator and issuer to understand the rational of the issuance.
  • Review sustainability frameworks (if available).
  • Review second party opinion (if available).
  • Review metrics contained in the applicable pricing supplement to determine the materiality thereof.
  • Participation in the issuance, due to the belief that the issuance facilitates material change.
  • Participation in the issuance, but pricing the issuance as “vanilla” (not allowing for any pricing benefit for labelling the bond as ESG). Feedback to be provided to originator and issuer.
  • Non-participation in the issuance and provide feedback to the originator and issuer about why Sanlam did not deem the metrics, pricing, and other elements appropriate.

For Sanlam Investments it has become clear that some companies are applying “greenwashing” (creating a false impression that a product is more environmentally friendly than it actually is), especially in the issuance of sustainability-linked bonds. Issuers are using the opportunity to obtain cheaper funding (though not committing to ambitious ESG targets) while investors are still trying to understand the dynamics of this market.

However, as the market evolves and matures the risk of greenwashing will be diminished. This will largely be achieved by increased awareness and advocacy by investors; voluntary adoption of reporting guidelines (such as the proposed JSE sustainability disclosure guidance) that increase transparency; the growing sentiment that second-party opinions should also accompany sustainability-linked bonds (as is the case in developed markets); and increased regulatory oversight (for example there is growing momentum towards developing a global sustainability reporting standard by organisations such as the IFRS Foundation).

Ultimately, investors want to see how their investments are contributing to a positive environmental and social change. Are investors really getting what they asked for? Not always — not yet.

• Pretorius is portfolio manager at Sanlam Investments.

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