Rand Merchant Bank (RMB) expects transition bonds, a new asset class targeted at industries with high greenhouse-gas emissions, to gain popularity in South Africa this year.

These bonds are designed to help “brown” companies – those with a high carbon footprint – transition to greener business activities.

RMB explains that many companies are increasingly being excluded from existing markets for sustainable finance and, therefore, the adoption of transition bonds can be transformative for corporates in South Africa.

Last year, the South African debt capital market saw the listing of its first social and sustainability-linked bonds (SLBs).

These follow the first green bond issued a few years prior, in a growing trend by businesses to align their financial and sustainability strategies.

“While it is clear there are differing levels of sophistication across the market, South African investors are increasingly proactively engaging with companies on improving their sustainability profile,” says RMB sustainable finance and environmental, social and governance (ESG) advisory head Nigel Beck.

Social bond proceeds aim to address or mitigate a specific social issue. Green bonds, in turn, are exclusively to finance or re-finance projects with clear environmental benefits.

Of the R15.7-billion worth of South Africa-listed ESG bonds issued last year, SLBs represented R8.7-billion, while green bonds and social bonds accounted for R3.5-billion each.

“The growing popularity in South Africa was against an international backdrop of rapidly growing SLB issuance that doubled in 2021 when compared to 2020, reaching a total of just over $1.1-trillion, or R15-trillion,” Beck notes.

The issuances took place across all the key credit sectors – banks, corporates, State-owned entities and securitisation.

About half of last year’s ESG issuances were placed in the market through auctions.

Notably, only one SLB auction took place. All of the social bonds were issued through public auctions, with green bonds a mix of both private placements and public auctions.”

RMB Market Research conducted a survey to better understand South African investors’ perceptions towards this fast-developing part of the market and found that, when it comes to investor popularity, green bonds are currently the most represented (61.9%) with respect to bids, followed by SLBs (42.9%).

“But ESG bond adoption is still slow in South Africa,” Beck states.

He explains that their issuance has been hampered by South African issuers’ understanding of their benefits and also concerns about costs.

“Offshore service providers are often used to provide pre-issuance verification or second party opinions which is a cost borne by the issuer. Despite this, there is a very large appetite for green bonds from South African investors. On balance it makes issuing green bonds worthwhile.”

RMB’s research shows that credit quality matters. When investors who bid for ESG paper were asked to substantiate their rationale for participation, fundamental credit quality of the name superseded other motivations.

“Notably, ESG mandates did not inform their decision,” Beck notes.

Measuring returns and impact of sustainable funding is an important challenge. Reporting has been labelled as ‘extremely important’ by about 60% of respondents.

Investors believe that issuers should report the direct and indirect impact funding results, RMB reports.

Most investors agree that 100% of issuers are issuing ESG bonds to capitalise on market trends and only half of the issuers are putting consideration into making a difference.

“Issuers and arrangers need to be cognisant of these factors, but a way of rectifying this is by providing clear guidance of targets versus historical performance. Global trends and comparable numbers also form a good benchmark,” Beck concludes.