Green security and shoots of investment? Africa’s Green Bond Market (Part 2)

In Part 2 of our latest Global Vantage update on Africa’s Green Bond Market, we consider its developing and important international focus for construction, engineering and infrastructure projects. While Part 1 explored what green bonds are and their use in the region,  in this instalment we consider the potential challenges to their acceptance and use.

What are green bonds and why are they relevant?

Green bonds are not too dissimilar to traditional bonds; however, the raised capital is specifically for projects with positive environmental or climate benefits.[1] Green bonds may be issued by governments, corporations, municipalities and international organisations and appeal to investors since they are impact-driven and may contribute towards ESG commitments.

In our earlier update we noted that various international organisations have advocated for green bonds, including the Climate Bonds Initiative and the International Capital Market Association. We also touched on some of Africa’s Commitments, Frameworks and Successes. You can find Part 1 of this update on our website here.

Challenges

Notwithstanding the progress being made, there remain potential challenges to the overall uptake and use of green bonds in region, some of which are summarised below.

General

Environmental and sustainable practices are evolving quickly from a scientific and technical perspective. The same is true of the legal and regulatory regime. Since not all nations have well-defined green bond frameworks or regulations, there is the potential for ‘greenwashing’ and/or funds not being guaranteed to go towards or be allocated for environmental projects. Additionally, the current green bond market in Africa is concentrated in South Africa, Nigeria and Morocco.[2] For the best impact of green bonds on the negative impacts of climate change, this concentration must be dispersed.

It is estimated that Africa receives 3-4% of the global climate financing despite having a majority of the 10 world’s most vulnerable countries to climate change.[3] This may be due to lack of green bond frameworks on a national level but could also be due to the structure being less compatible with smaller economies. Since the benchmark for global indexes is around $250 million – $500 million, individual countries may struggle to pool enough projects to reach this value and access these markets.[4]

Issuers

While some guidelines and frameworks have been published, this is insufficient to unlock the overall potential of the African green bond market. This results in issuers being unclear as to the process and criteria of issuance. Additionally, the lack of guidelines results in issuers not understanding the green bond market.[5]

Investors

International investors could be hesitant to become involved with emerging economies when there is an exchange rate risk, specifically in the form of currency fluctuation/depreciation. However, a Columbia University report proposes a structure where a third party absorbs the local currency risk.[6] If this third-party suggestion is implemented, this could help investors feel more reassured when investing in emerging economies.

The lack of clear guidelines surrounding green bonds concerns investors since without them, there is less transparency regarding the reporting structure and use of proceeds. Similarly, the lack of issuance guidelines means that investors are relying on non-verified information providers which also presents risks.

The scale of projects may not be appealing to large institutional investors because at present, the market has not been established to the desired extent by sovereigns or municipal markets. Additionally, most green bonds currently do not have tax incentives attached to them which could hinder investor appetite.[7]

Conclusion

Although green bonds represent a welcome and significant development in helping nations to meet their Nationally Determined Contributions under the Paris Agreement to reduce emissions and adapt to climate change and in bridging the climate financing gap, their adoption and use appears to vary across nations in this region. Whilst those involved with projects with a climate or environmental, social or governance (ESG) element will likely be interested in the emergence of available funds and associated opportunities, it is necessary for nations to establish clear frameworks and guidelines to alleviate or manage stakeholder and investor’s concerns in practice.  In any event, it is certainly worth watching the continued evolution of green bonds and other green products in the context of financing and insuring international projects, as well as in the wider context of legal/regulatory reform linked to climate change and resilience and ESG more broadly.

For more information on international construction and engineering legal matters, including disputes or arbitration, please contact Antony Smith at A.Smith@beale-law.com.

[1] Easing Africa’s climate crisis: Can green bonds help close the climate finance gap? – Africa Policy Research Institute (APRI)

[2] Developing Africa’s Green Bond Market: Unlocking Investment and Economic Growth – ALN

[3] Climate Change Finance, Natural Capital Accounting by African Countries, Top African Development Bank Group’s Agenda at COP29 | African Development Bank Group

[4] A pathway for Africa to raise green financing

[5] Developing the green bond market in Africa

[6] A Potential Path for Alleviating Currency Risk in Emerging Market Green Bonds – Center on Global Energy Policy at Columbia University SIPA | CGEP

[7]  Developing the green bond market in Africa