International Capital Markets Newsletter: The ESG Edition - June 2021 – Issue 4: The Past, Present and Potential Future of ESG Investments in Africa

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Environmental, social and governance issues are expected to have a significant impact on the investment landscape in Africa in the short- to medium-term. While the UN has predicted that Africa is particularly vulnerable to the impacts of climate change, it is well documented that the African private and public sectors have lagged behind other emerging markets in their issuance of green and sustainable bonds. Some commentators and ratings agencies anticipate longer-term capital inflows into the continent will be influenced by sustainability-oriented strategies, addressing risks such as changing climate and weather conditions, the vulnerability of electricity infrastructure and the transition from fossil fuel dependence. This expectation draws on the link between environmental sustainability and economic development in Africa and would mark a notable shift from the historic dominance of commodity sectors in the region.

Green bond issuances across the continent have gained clear traction in recent years. In November 2016, the Moroccan Agency for Sustainable Energy issued the Kingdom’s first green bond. This MAD1.15 billion (approximately US$104 million) domestic issue was uniquely placed as both the first Certified Climate Bond in Africa and the first to meet the Climate Bonds Standard. In 2017, Nigeria became the first African country to issue a sovereign green bond with the issuance of a ₦10.69 billion (approximately US$29 million) green bond to fund green electricity to rural communities, energise education and support a government afforestation initiative. In September 2020, Dechert advised the Arab Republic of Egypt on its US$750 million green bond issuance, the first sovereign green bond from the Middle East and North Africa region and the first U.S. Dollar-denominated green bond from Africa. In January 2021, Dechert also advised Banque Ouest Africaine de Développement (BOAD, or the West African Development Bank) on its €750 million sustainability bond, the first sustainable bond issued by an African issuer.

Despite recent transactions, the market perception remains that the volume of sustainability and green bonds issued by African sovereigns, sub-sovereigns and corporates lags behind other regions. According to statistics published by Fitch Ratings, as at April 2021, only 19 green bonds have been offered by sub-Saharan African issuers, and the six priced in foreign currencies were all issued by regional development banks.

The relatively few green and sustainable issuances, as compared to other regions, have to date been linked to, among other factors, deficiencies or underdevelopment of legal and regulatory frameworks, a low appetite for venture capitalism, a lack of awareness of the potential of capital markets and macroeconomic factors, including instability and uncertainty as a result of the impact of the COVID-19 pandemic.

The African market poses a significant opportunity for growth in ESG investments, and recent and ongoing initiatives suggest that increased activity can be expected in the coming months and years.

Planned developments

Looking ahead, the implementation of various programmes and frameworks to attract sustainability-focused investors to the region is expected, including:

  • In March 2021, FSD Africa, a UK government-backed financial sector development programme, signed a co-operation agreement with the Committee of SADC Stock Exchanges (which overseas securities exchanges in Botswana, Malawi, Mauritius, Mozambique, Namibia, South Africa, Eswatini (Swaziland), Tanzania, Zambia, and Zimbabwe) to support the development of a green bond market. According to FSD Africa, the agreement is expected to facilitate the establishment of green bond programmes across both public and private sectors in its member countries.
  • Certain African governments have indicated plans to establish sovereign green bond and sustainability bond frameworks in 2021, with a range of environmental and social use of proceeds targeted.
  • Instruments, such as the World Bank-sponsored, wildlife conservation bonds, which are intended to raise funds in connection with various wildlife conservation projects, are also expected to have an impact in certain African countries.
  • The Finance for Biodiversity Initiative, managed by the UN Development Programme, is developing a new form of sustainability-linked bond, Nature Performance Bonds (“NPBs”). NPBs have been designed to enable emerging market sovereigns to align their financing needs with positive environmental outcomes. The COVID-19 pandemic, the subsequent economic downturn and the resulting pressures on sovereign debt amongst many developing and emerging markets have driven the development of this instrument. NPBs aim to generate short-term liquidity and provide a mechanism for “natural capital” to participate in the international debt markets. They would be tied to measurable targets for restoring wetlands, protecting forests and reducing threats to wildlife and plant species, although they would also allow for more general uses of proceeds. The Finance for Biodiversity Initiatives envisages that NPBs would build on current green finance products by ensuring that they are scalable, standardised and capable of extension beyond project-specific green finance initiatives in order to attract private sector investment. The Finance for Biodiversity Initiative has published a series of technical and policy papers to test the concept of NPBs and to help build and shape the market.

The ongoing trend towards the increased use of sustainable development frameworks as a means of raising capital, and the growing support from international organisations for green and sustainable bond programmes in emerging markets, have been well documented. As a result, an expansion of ESG-focused instruments issued from Africa is expected. Some sources consider sovereigns, state-owned enterprises and commercial banks to be best placed to further expand into this market in the short to medium term. Use of proceeds or targets for these bonds would be likely to address either development-oriented infrastructure investments (such as electrification or transportation) or projects aligned with international biodiversity and natural capital initiatives.

Anticipated challenges

Although there is proven investor interest in ESG finance, the pursuit of such initiatives in Africa does have certain challenges. The dominance of extractive industries poses a clear obstacle to the rise of “green” investment strategies on the continent. Sub-Saharan Africa is the world’s most commodity-dependent region, and much of its income is a product of the export of petroleum products, coal, metals and minerals. While investors in developed economies are increasingly excluding or reducing future investments in fossil fuels, these sectors remain undeniably significant contributors to GDP and export earnings. According to statistics published by the UN (from the UN Conference on trade and Development), sub-Saharan Africa is the most commodity-dependent part of the world, with 89 percent of countries in the region being commodity-dependent. Overall, commodities are reported by the UN to account for more than 60 percent by value of its total merchandise exports.

Several African governments have announced their intention to issue green or sustainability bonds in the coming year. However, while, as noted above, previous green bond issuances in the region have attracted positive and significant investor attention, it is unclear how the market will continue to perceive green investments in the context of largely commodity-dependent economies. In other markets, such as Europe, the use of social bonds has boomed since the COVID-19 pandemic began, and investors have been reported by commentators to “flock to ethical assets”. However, Africa’s economic dependence on fossil fuels and the mining sector could, at some point, become an issue for ESG-oriented investors.

An additional layer of complexity arises from the general lack of coherence on what constitutes a “green” investment across Africa. There is no convergence in frameworks, guidelines or rules, alongside inconsistent procedures and criteria for the issuance of green bonds on the continent. Ultimately, what constitutes a “green” instrument in one African market may not pass the relevant threshold in another. In any event, even where guidelines exist, many are not aligned with – or fail to meet – international standards. This lack of consistency within the developing African green bond market, coupled with insufficient supporting regulation to enable the market to grow effectively, could deter certain potential investors and issuers from entering the market. The adoption of internationally accepted standards, such as the International Capital Markets Association Green Bond Principles and Sustainability Bond Principles, by issuers (such as Egypt and BOAD did), would help to standardise and support the market.

A further potential challenge is presented by a recent investor base shift in the region. The influence of traditional development finance institutions on investment priorities – such as ESG finance – may decline as the composition of external debt moves towards private investors and alternate sources of capital. According to Fitch Ratings, in 2009, 75 percent of government debt in sub-Saharan Africa was attributable to public sources. However, by 2019 this had dropped to 56 percent, while the amount of debt from bond issuances had risen to 30 percent of the total, according to the same source. If this trend continues, the varied priorities of private investors may have a greater impact than the priorities of lenders with sustainable development and ESG goals.

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