SA’s quest for environmental and social sustainability is giving rise to some innovative financing. Agrarius Sustainability Engineered, an investment company focused on sustainable agriculture, proved this when it issued a Shariah-compliant sustainability-linked sukuk – the first of its kind listed on the JSE, and also a first for Africa.

A sukuk is a bond-like instrument used in Islamic finance. Therefore Agrarius’ inaugural sustainability-linked sukuk is listed among the bonds on the JSE’s Sustainability Segment. Being listed in the ‘sustainability-linked’ category meant that the money raised under this programme had to be invested in projects with pre-defined green or socially sustainable key performance indicators (KPIs) in the agriculture value chain.

According to Agrarius, the firm’s goal is to make a meaningful impact on new and existing agri-businesses, for example through increasing production capacities, job creation, ensuring food security and assisting businesses in transitioning to more sustainable practices. The uniqueness of this particular sustainability-linked financial instrument is that, in line with Islamic law, a sukuk note indicates ownership in an asset, whereas bonds indicate a debt obligation.

‘The JSE encourages product innovation, and this issuance in late 2022 showcased an investment approach that differs from traditional models,’ according to Refilwe Rakale, Primary Market Associate – Fixed Income at the JSE. ‘We welcome the mechanisms to enable access to funding to grow pivotal sectors within the South African economy.’

She explains that the country is faced with myriad social and environmental issues, and sustainability bonds present an opportunity to tap into the capital market to solve these issues.

‘By nature, sustainability bonds are designed to finance socially responsible or environmentally friendly initiatives or projects, such as employment creation, building low-cost housing, providing accessible education and training opportunities, supporting sustainable agriculture and reducing greenhouse emissions – all of which would propel South Africa’s various growth and development agendas,’ says Rakale.

With this in mind, financing solutions should be innovative and affordable in order to really shift the dial on sustainability, state Deloitte Africa experts Jayne Mammatt and Lindy Schmaman. ‘Sustainability-themed bonds are important for South Africa, because they can create a genuine opportunity for sustainable development by giving cheaper finance to the borrower while holding them accountable to use on specific projects and/or track, monitor and improve performance in whatever area is linked to the instrument.’

It’s worthwhile noting the subtle yet vital differences between a sustainability bond and a sustainability-linked bond, and acknowledge that all the bonds on the Sustainability Segment fall – as the name suggests – under the broader umbrella of ‘sustainability’.

Industry insiders sometimes use the acronym GSSS or GSS+ to describe the suite of green, social and sustainability (GSS) bonds, which now increasingly also features sustainability-linked (the additional ‘S’ in GSSS) and other emerging bonds.

Examples are climate bonds (raising finance for climate-change mitigation and adaptation), blue bonds (relating to ocean-based projects), orange bonds (promoting gender equality), and transition bonds (supporting companies, often in high-polluting industries, in their transition to net zero carbon). At the start of the GSS+ trend were green bonds, which still account for the bulk (R31 billion) of the total market cap (R48 billion) of all bonds on the JSE Sustainability Segment. At the end of 2023, sustainability-linked bonds made up R9 billion of this total, followed by social impact bonds at R6 billion and sustainability bonds at R2 billion.

SA’s sustainable bond landscape is continuously evolving. The Deloitte team describes it as ‘initially very focused in the renewable energy area, and other environmental performance, but definitely expanding to broader areas of sustainable development and beyond “use of proceeds” to a specific project but to improved performance in the specific aspects. For instance, we are seeing a number of these instruments linked to gender and diversity issues’.

The JSE’s Sustainably Segment has four categories with a total of 76 bond listings (end-2023). Green bonds are designed to raise money for environmental or climate-related projects. In SA, there’s still a strong focus on renewable energy (accounting for 23 of the 49 green bonds on the Sustainability Segment) and green buildings (15 bonds), as well as climate-change adaptation, sustainable water and wastewater management, pollution prevention and control, and energy efficiency. Social bonds intend to finance socially responsible initiatives such as creating employment, building low-cost housing and improving access to essential services (such as public transport). Sustainability bonds are essentially a combination of green and social bonds, as they raise money for projects that combine social and environmental benefits, such as the UN Sustainable Development Goals or socially responsible investments.

FirstRand Bank listed the first (and to date only) two bonds in this category on the JSE in April 2022. The two bonds (valued at a total of R2 billion) are part of a long-term programme to raise R72 billion to finance and refinance investments in green buildings and affordable housing projects. The social impact affects 2 659 applicants, who will access affordable and sustainable housing, with 2 403 mortgages and 842 newly built affordable and sustainable houses. The green impact sees three certified green buildings (65 031 m²) being built, and the equivalent of 3 140 tons of carbon emissions avoided per year.

Sustainability-linked bonds are issued to fund sustainability-related initiatives. Unlike the other three bond categories, they don’t require a ring-fencing of the use of proceeds, giving the issuer flexibility on disbursing the funds raised – as long as the agreed sustainability-related goals and targets are met. In other words, they are forward-looking, performance-based instruments, measured against predefined KPIs.

This focus on sustainability KPIs allows issuers greater flexibility in using mobilised funds over the term, according to international sustainable finance consultant Barry Panulo, who started his career in innovative finance research and transaction advisory at UCT’s Graduate School of Business. ‘Sustainability-linked bonds offer issuers incentives, such as a lower cost of debt, in exchange for commitments to deliver on pre-defined sustainability targets before maturity,’ he says. ‘This is attractive to investors as it has a clear focus on improving issuers’ accountability for results while improving the visibility of their own sustainability return of investment.’

To achieve meaningful change and prevent greenwashing, all these bonds need to meet certain criteria and standards. Rakale highlights the role of the International Capital Market Association (ICMA), which promotes standardisation through its sustainability bond guidelines and green/social/sustainability-linked bond principles. She says the ICMA ensures quality and integrity in the sustainable bond market.

Panulo agrees that the ICMA guidelines are essential for the development of this market segment. However, he says issuers must also remain proactive and strive for a robust correlation between the level of financial benefits that accrue to them and their actual sustainability value creation.

‘Crucially, issuers and arrangers should meticulously and credibly design incentives to ensure materiality, accountability and additionality when developing performance-linked instruments,’ he says. ‘Poorly designed instruments – including those perceived to set targets with limited potential for results beyond business-as-usual or that can be easily manipulated – have the potential to erode confidence in both the issuers involved and the broader sustainability segment.’

When designed effectively, these bonds have the power to complement and accelerate the long-standing economic transformation and equity goals of SA’s corporates, says Panulo. He provides the example of Barloworld’s 2022 R1.1 billion gender-focused sustainability-linked bond issuance, which tied potential reductions in the cost of debt to improved female representation in organisational leadership structures and the share of procurement spending benefiting black women-owned businesses.

Mammatt and Schmaman mention Anglo American’s 2022 sustainability-linked bond as a unique way to support livelihoods by providing a performance target to drive employment by creating five jobs offsite for every job onsite by 2030. ‘The finance sector has become an agent of change by influencing the type of solutions available,’ say the Deloitte experts. ‘Direct returns on the instrument still give a competitive return on risk, which is what investors need – this is not philanthropy – but the expanded socio-economic impact and upliftment has further-reaching positives that can only be good for the investors and the business community.’

Panulo calls sustainability-linked bonds ‘an exciting tool’ as they have the potential to grant access to sustainable debt capital markets for issuers. ‘This is particularly true for those seeking access to sustainable pools of capital but are concerned about the suitability of sustainable debt products with a more restrictive use of proceeds,’ he says.

In line with international trends, the sustainability bond market with all its emerging themes is expected to see improved growth, according to the JSE’s Rakale. ‘This would largely be supported by an improved interest rate environment globally, which is expected in the second-half of 2024,’ she says.

‘Coupled with the accelerated energy transition, independent power producers, state-owned enterprise unbundling and overall increasing pressure to meet ESG targets, this should all prove supportive for the sustainability finance universe.’

Looking ahead, Rakale believes that all the issues often cited in SA present capital markets with an opportunity, and the bourse is anticipating healthy growth in bonds listed on the Sustainability Segment.

By Silke Colquhoun
Image: iStock