Green Bonds in South Africa, and How They Work

The Northern Cape is South Africa’s smallest province by population. But it’s home to big attractions like the Kgalagadi Transfrontier Park, the ‘Big Hole’ and Augrabies Falls.

Add the Kathu Solar Park to that list.

Should you visit, don’t expect to see any solar panels. Instead, don your sunglasses for a large array of curved mirrors. They track, reflect and concentrate the suns rays onto tubes filled with a salt solution that then turns molten; its heat is used to generate steam that drives electricity-generating turbines.

The neat part? Molten salt can retain its heat in insulated storage for up to four and a half hours. That means they can spin up their turbines as the sun is setting, dinners are cooking and geysers are warming.

The technology is called concentrated solar power (CSP). And it gives the Kathu Solar Park 100MW of generation capacity, enough to power 179,000 South African homes. The story of how it was funded provides an excellent case study and use case for an increasingly popular financing instrument: green bonds.

What is a green bond?

“Green bonds are structured in a very similar way to conventional bonds. They pay investors interest and return their principal borrowed at maturity. The difference comes in how the borrowers use the proceeds," says Melanie Jansen van Vuuren, Head of Group Sustainability at Investec.

The Kathu Solar Park – which is set to save six million tonnes of CO² over a 20-year period – falls neatly into her classification. Indeed, it was partly funded using green bonds.

In broad terms, a green bond is a financial instrument used to raise money for projects that will have a positive impact on the environment and/or help to combat climate change.

Why are companies keen on green?

The ‘greenium’ is the difference in the interest rate (read cost of funding) when raising capital for projects that will create positive environmental impact versus those that don’t – in other words, companies can theoretically borrow more cheaply when financing a green project.

There is evidence both in support of and in contradiction to the pervasiveness and sustainability (ahem) of the greenium. On home turf at least, it does seem to be a feature.

“Green bonds issued on the JSE so far have been anything between three and five times oversubscribed. In addition, issuers have been able to extend the duration of their loans into the 10- to 20-year range, as opposed to the five to seven years for traditional bonds.”

That is the corporate case for green bonds, explained succinctly by Shameela Ebrahim, Chief Sustainability Officer for the Johannesburg Stock Exchange

But with cheaper, longer-term financing at stake, regulatory oversight needs to be strong. As a result, issuing a green bond doesn’t come easy. According to Shameela, companies coming to market with green paper must do the following:

1.     Justify why their project qualifies as green using a local taxonomy or reference framework like that outlined by the International Capital Markets Association. 

2.     Facilitate an independent review of the bond to certify that the proceeds will create or are creating a positive environmental impact

3.     Deliver regular post-issue impact reporting that proves the bond proceeds are being used as originally stipulated by the issuer

Such measures are critical to uphold and strengthen the credibility of the green bond market in the eyes of investors – if the greenium does exist, they will want their slightly lower yields to be offset by tangible, legitimate impact they can confidently point to.

To be sure, green bonds offer investors more than just impact credentials.

The investment case for green bonds

Most investors want their capital to create positive impact, provided they can still achieve the returns they need at a palatable level of risk. Green bonds are fit for that purpose.

Cash flow certainty

Green bonds arguably come packaged with more certainty around future cash flows – and therefore interest and principal repayments – because the underlying assets are less likely to become ‘stranded’ by disapproving consumers or stricter regulations and policies implemented to combat climate change.

Engagement benefits

The additional transparency required around green bonds creates a platform for investors to engage with issuing companies, a right usually reserved for shareholders. That footing can be used to drive change that ultimately supports green bond returns.

Sticky investors

Just like their traditional counterparts, green bonds will be impacted by inflation and interest rate movements. However, investors that value impact in addition to return will, on average, be less likely to trade out of green bonds than might be the case with conventional bonds.

Key risks

As already alluded to, any corporate behaviour that undermines investor confidence in green bonds (‘greenwashing’ is the most common risk) has the potential to hurt demand and therefore returns. The green bond market is also less liquid, a risk that can be mitigated by holding the bonds to maturity.

In short, green bonds have characteristics that are attractive for both companies and investors before considering their ability to make an impact. But impact they do.

Green-tinted glasses

Movundlela believes the uptake in renewable energy will increase rapidly in the years ahead, particularly in the energy-intensive mining industry. For her, it’s not just about adding capacity to the grid – a saintly cause given our familiarity with load shedding schedules – but also building the capacity to manufacture the components and offer the services needed to support a thriving renewables sector.

It is the second-order effects of projects like the Kathu Solar Park, as much as their direct positive impact on the environment, that make green bonds such an important instrument for the future development of our country.

If you ever get to see that impressive array of mirrors in the Northern Cape, don’t be surprised if you see the slightest shade of green through your sunglasses.