Emenike Omeye
The need to bridge the huge infrastructure gap in Africa is increasingly a front-burner issue for financial policy makers across the continent. Whilst the lack of critical infrastructure in the continent is largely a mixed bag – with variant needs among various African countries, there is a collective lack of funding to establish and maintain productive infrastructure for power, water, and transportation within the continent. In 2018, the African Development Bank estimated that the continent’s infrastructure needs amounted to about $130–170 billion a year, with a financing gap in the range $68–$108 billion.
While governments, their agencies and multilateral organizations within the continent continue to explore viable financing options for tackling the infrastructure gap, they are, in the wake of exacerbating climate change concerns, additionally tasked with the responsibility of balancing such options with the long term environmental interests of the continent and the wider international community. It has been argued that Africa is more vulnerable than any other region to the world’s changing weather patterns , thus there appear to be some justification for the accelerating clamor for African leaders to recognize and prioritize sustainability in capital markets master plans.
In view of the above realities, capital raising opportunities through green bonds have been gaining considerable traction across the continent, with a few institutions and sovereigns seeking to raise critical debt finance that are earmarked for new and existing clean energy projects. In 2017, Nigeria issued a N10.69 billion sovereign Green Bond, the first sovereign green issuance in Africa and the fourth in the world. The Bond was oversubscribed at the close of offer. Globally, the Green Bond market is witnessing rapid growth from its pioneering days. The market which accounted for issuance of only $3 billion in 2012, reached over 1500 issuances in 2017 valued at $155.5 billion, a 78% increase compared to 2016. There were 239 different issuers, more than half of which were new issuers from 37 different countries across the globe. Between 2012 and 2018, there were about eight green bond issuers in the continent, across four countries, raising about $1.5 billion. Climate investment opportunity in the region has been deepened by increasing urbanization and the appurtenant need for essential climate-smart infrastructure to support emerging urban communities.
As such, green bond issuances have been growing in frequency, with progress driven primarily by the mutual benefits it provides to issuers and investors. Whilst corporate issuers (including large financial institutions) continue to participate actively in the green bond market, many government agencies and sovereign issuers are increasingly interested in issuing such bonds aggregately account for a notable portion of issuances in Africa and about 16 per cent of all issuances in the world.
A green bond is structurally identical to a traditional bond, save for an additional (distinguishing) commitment. In a regular bond, investors purchase the bonds and lend money to the issuer through the market in return for a commitment to repay the principal loan sum with interest (“coupon”) at a predetermined date(s). However, in a green bond, the issuer borrows money from the market in exchange for a commitment to repay, and an additional commitment to apply the proceeds only to projects with environmental benefits. Since traditional financial instruments are usually in the form of senior debt with recourse to the balance sheet of the issuer, green bonds fit appropriately into investors’ traditional fixed-income allocations.
They provide institutional investors relatively long-term maturities, in line with their liabilities, and relatively stable and predictable returns for their risk exposure. Additionally, they enable institutional investors to direct financial flows to specific projects and assets earmarked as green. Essentially, green bonds benefit issuers in two primary respects: (1) developing corporate branding that sends a strong signal to the market on their commitment to climate change and (2) attracting new investor class and tapping a wider investor base.
However, given the relative restriction imposed on an issuer of green bonds, such bonds would only exist if they confer some additional economic or commercial benefit on the issuer, beyond regular bonds. Put simply, from an issuer’s perspective, green bonds limits its discretion to apply the proceeds of an issuance to projects as it pleases, so an issuer should not issue a green bond unless it can extract some additional commercial benefit from same.
Investors in green bonds are typically attracted by ethical considerations, thus such investors are driven not only by the need to gain financial returns in the form of coupons, but also some principle-motivated interest in promoting a cleaner planet.
For most ethical investors, the latter interest is prioritized, such that the investors are motivated to accept lower financial returns than would ordinarily be applicable. Poor liquidity, however, pose an increasing challenge for green bonds, especially such bonds issued by small sovereign issuers (a category that includes most African countries). This is largely attributable to the fact that green bonds presently represent a significantly smaller market than conventional bonds – a scenario which should pose no surprise as most issuers are presently interested in raising funding for more projects that are not necessarily “green”.
Given the compact market for such bonds, due primarily to infrequent issuance of same, the bonds risk (and indeed, suffer) illiquidity which consequently encumbers their ease of trading in the secondary market. The liquidity of bonds is a key consideration for investors and most primary/secondary market investors would typically abstain from or grossly underprice instruments with some prospects of illiquidity.
To be concluded tomorrow
Omeye is an LL.M Student and a Research Assistant in International Finance at the Harvard Law School