The path to net zero carbon emissions requires a collective effort from asset managers, asset consultants and asset owners. Fixed income mandates, particularly in the pension fund space, typically provide larger allowances for investment in listed credit as opposed to unlisted credit. This is primarily a function of Regulation 28 requirements, liquidity and credit quality (listed issuers carry agency credit ratings). As such, the listed credit markets have to play a vital role in facilitating the path to net zero.

Until recently, ESG bonds have not been a material segment of the listed credit market. The first JSE-listed green bond was issued in June 2014 by the City of Johannesburg for a total of R1.46 billion, which accounted for 1.3% of total term issuance that year for the market as a whole. Since that inaugural issuance until the end of 2020, green bonds were the only type of ESG bonds issued and the amounts issued ranged between R1 billion and R3 billion – never accounting for more than 2.5% of total term issuance in a particular year.

That all changed in 2021, when we saw a record amount of ESG bonds issued, totalling R13.8 billion and accounting for over 12.5% of total term issuance. Interestingly, most of this issuance was through two new types of ESG bonds: social bonds and sustainability-linked bonds.

The JSE requires that these ESG bonds meet certain criteria, as specified by globally recognised standards – like those published by the International Capital Market Association (ICMA’s) Green Bond Principles, Social Bond Principles and Sustainability Bond Guidelines. In addition, issuers must provide a disclosure of proceeds, an independent external review of the transaction, and commit to regular post-issuance reporting. A sustainability-linked bond (SLB) differs from green, social and sustainable bonds. These bonds are instruments for which the financial and/or structural characteristics (i.e. coupon, maturity, repayment amount) can vary depending on whether the issuer achieves predefined ESG objectives within a predefined timeline, and must be aligned with the core components of the Sustainability-linked Bond Principles published by the ICMA. A key differentiator is that the use of proceeds for SLBs is for general corporate purposes and does not have to be directed towards specific ESG projects. SLBs were the largest type of ESG bonds issued in 2021.

COMING CLEAN ON GREENWASHING

While the improvement in standards and increased issuance volumes in ESG bonds is encouraging, it is important to properly critique the ESG qualities of each investment to ensure that an investor’s impact expectation is aligned to that of the issuer. Given the buzz around ESG and responsible investing, greenwashing will be an inherent risk. Greenwashing is spending more time and money claiming to be “green” through advertising and marketing rather than implementing business practices that minimise environmental impact. Furthermore, there is an inherent expectation from issuers that ESG bonds should provide a pricing benefit to them (when compared with vanilla bonds), which has the potential to exacerbate this greenwashing risk.

Diving a little deeper into the ESG bonds issued on the JSE, we could argue that a green/social bond is a better investment from an impact perspective than an SLB – given that the use of proceeds must be directed towards green/social projects. However, the challenge is that in many cases, green/social bonds are used to refinance existing projects. One school of thought is that if these projects were going to go ahead anyway, by investing in this bond, are you really moving the needle towards a more sustainable world? Another challenge is the inability to provide tangible impact assessments in reporting, that is, objectively measure quantitative metrics to monitor improvement. Despite not requiring funding to be earmarked for specific ESG projects, SLBs address this requirement. If an issuer has linked the interest rate of a bond to their ability to reduce carbon emissions in a period, then come that measurement date, an independent, objective and a quantifiable amount of CO2 emissions will need to be provided to assess if that objective has been met. Reporting back to clients is more powerful and tangible if a manager can say, “Your R100 million investment has resulted in this company reducing their CO2 equivalent by 1 000 kg”.

While ESG investing in the listed market is not perfect, it is developing, standards are improving, and the conversation is well and truly underway. Encouragingly, the concept of ESG is no longer the unpopular, often overlooked part of an investment decision, but rather a critical part of an investment thesis where stakeholders are aligned to a common goal. The path to net zero is not an easy one but by working together, we can secure a sustainable environment for future generations.