African states prepare sustainability-linked debt to win investors

Public sector issuers in seven African countries are working with the World Bank to prepare sustainability-linked bonds or loans, as a way to attract new investors.

Kenya and several other sub-Saharan African nations, as well as a couple of state development banks, are interested in following the example of Côte d’Ivoire and the Development Bank of Rwanda.

Three deals are well advanced and likely to come to market in the next 12 months —whether as loans or bonds will depend on market pricing.

In sustainability-linked (SL) debt the borrower commits to pay lenders a financial compensation, usually a higher interest payment, if it misses certain sustainability targets.

Mostly used by companies, especially in Europe, SLLs and SLBs have also attracted

emerging market governments. Chile, Uruguay, Thailand and Slovenia have all issued SLBs.

“Sustainability-linked financing has a few advantages, especially for emerging countries,” said Gianleo Frisari, a senior financial sector specialist in the World Bank’s finance, competitiveness and investments group in Washington.

“It’s important because it can get commercial investors involved — typically it can mobilise investors who would not look at these countries otherwise,” said Frisari, who is leading engagement on SL finance with public sector clients. “With a sovereign SLB or SLL, we make these countries investable for a pension fund that needs a sustainability angle.”

Finding that angle can be easier for a country with an SL deal than a green bond or loan.

Unlike those, the issuer does not have to use the proceeds for green investments. Developing countries often do not have large volumes of green projects, and what they have may already have been financed by development banks.

Government measures to reduce deforestation, for example, may not involve hundreds of millions of dollars’ worth of spending. What matters is the government setting rules and enforcing them. Most of the cost is not outlays but forgone opportunities to farm or mine in the forest — and these cannot be used to back a bond.

For countries working on goals like that, SL debt can be very suitable. Governments are coming to the World Bank asking for its help to explore and issue sustainability-linked debt.

After issuing sustainable use of proceeds bonds in 2021 and 2023 Côte d’Ivoire approached the Bank, wanting to expand its toolkit.

“They had commitments on energy, education, that they were looking to put under a [key performance indicator] structure but the data was not ready,” said Frisari. “Forestry was an important issue — they had seen the example of Uruguay.”

Forestry and energy together produce 92% of Côte d’Ivoire’s greenhouse gas emissions.

In its Sustainability-Linked Financing Framework, published in July, Côte d’Ivoire defined targets to raise renewable energy, excluding hydroelectric, from 1% of generation capacity in 2023 to 11% by 2030.

It will also try to limit forest cover loss to 300,000 hectares across the period 2025-30, and reforest 1m hectares between 2021 and 2030.

The latter is vital for Côte d’Ivoire. Under EU deforestation rules it could lose up to $2bn of cocoa export income by 2050 if it does not get control of the problem. Worse, deforestation disrupts rainfall patterns, threatening to make half the country’s cocoa-growing areas unsuitable by 2050.

In September Standard Chartered arranged a €433m SLL under the Framework, with the World Bank guaranteeing the first loss and MIGA the second loss. The interest rate will go down if Côte d’Ivoire hits its targets, and up if it does not.

“We are trying to keep structures symmetrical as much as possible,” said Frisari. “Especially in sub-Saharan Africa, countries are dealing with extremely high costs of financing. Anything that can reduce it is super-important, especially for a debt management office. When you look at the trade-off between green bonds and SLBs, in this case you have the ability to control your own cost reduction — if you deliver the target you get it.

“Now we have successful pilots,” Frisari added. “The ones we have now are requests for replication of Côte d’Ivoire.”

The popularity of SLBs among companies has ebbed, for several reasons, the chief probably being that most investors are indifferent to them.

For emerging market sovereigns, it’s different, Frisari said. “Uruguay got 188 investors, and 20% of them were new,” he said.

Although flexible for the issuer, SL debt “comes with tangible commitments and policies that we [and investors] can measure, track and follow,” said Frisari.

On Côte d’Ivoire’s loan, a lot of banks participated in the request for proposals, although only Standard Chartered was chosen. It then syndicated the deal itself. On the roadshow there was interest from a dozen banks.

This investor appetite creates a genuine, pragmatic reason for developing countries to use the structure.

Dieter Wang, who works with Frisari, leading the Bank’s methodological work on SL finance, said a breakthrough for investors had been when JP Morgan clarified that SLBs could be included in the EM Bond Index.

“The difference between corporates and sovereigns is crucial,” Wang said. “What I’ve heard repeatedly [from investors] is that on sovereign SLBs the data quality and monitoring are much better.”

He said signs of investor enthusiasm were a bulge bracket bank and a UK asset manager, both constructing EM impact funds, which included explicit allocations for SLBs.

What the sustainability-linked finance market has lacked so far is central control or standards on how targets are set.

The Green Bond Principles organisation has published qualitative SLB Principles, but they do not enable investors to know how ambitious a target is.

Investment banks structuring deals say they try to maintain standards, but their ultimate incentive is to please the issuer.

Since it works with multiple clients as a non-commercial adviser, the World Bank is in the unusual position of being able to try and support the development of standards.

“The big question is always ‘what’s a good target?’” said Wang. “We are not standard setters, but we can provide the data, the methodology, and provide an option for standardisation and scalability.”

In June the Bank launched an innovative online tool called the FAB Dashboard. It uses the World Bank’s stores of information from its Sovereign ESG Data Portal, which covers 213 economies and 171 indicators.

The tool enables users to grade a country’s ESG targets on two axes — feasibility and ambitiousness. Targets that are too easy can thus be avoided — but so can those that are too difficult to implement, and therefore unlikely to be achieved.

For example, the Bank considered one target of reaching 100% rural electrification. Its data showed not a single country had been able to achieve that within seven years. That suggested the country might deserve an extra level of reward for achieving it.

Even with lots of data, evaluating a target’s ambition is difficult and subjective. Other countries may have achieved a certain degree of progress in reducing carbon emissions over five years, for example — but each country’s circumstances are unique. Moreover, those gains were made in the past, when technology, politics and economic conditions were different from what will face the country setting its target and trying to achieve it in the future.

“Our approach is to take the best comparators that we think are most applicable,” said Wang. “We have a preference for similar regions, levels of economic development and income categories. The more peers we can find, the more confident we can be about the distribution [of pathways].”

Crucially, users of FAB can choose their own comparators. “It’s a decision support system,” said Wang. “We provide all the data. We don’t want to prescribe which peers you use.”

But the data gives issuers a fact-based way to demonstrate their ambition to investors.

The World Bank tries to help countries identify targets that have financial benefits for their economies, as well as environmental and social ones. Improving education or access to electricity should raise GDP, and “that will make the country a much better borrower” said Frisari.

Many investors, used to green bonds, do not regard SL debt as having ESG ‘impact’ because the money is not spent on green purposes.

Others see impact differently. “The investors that get SLBs are really buying into the systemic impact,” said Frisari, “the idea that they are supporting the country or development bank in delivering something that goes beyond the transaction itself — making sure the government is incentivised to meet its forestry policy.”

In Wang’s view, “The impact is direct — measuring targets.” But “much bigger, in my opinion, is that through the consistent measurement targets, the country will have much better data afterwards”.

A common problem, for example in forestry, is that an EM country will start a monitoring system and then after a few years the funding runs out and it stops. SLF creates a hard reason to keep it going.

But Wang also said: “The investors we talk to which understand the issue and want to go beyond green bonds ask ‘what is the counterfactual?’” In other words, how would the country evolve if it did not take the sustainable transition path set out in the SL financing.

“They look very carefully at what we define as what would happen anyway,” Wang said. “What they like about the structure is to hold countries responsible for targets that go beyond the election cycle.”

At the moment in the world, said Frisari, “there is a lot of volatility on policies and priorities. With SLBs, investors have a way to give an issuer a financial incentive to keep to its policy objectives. There are investors who can see the forest and not just the trees.”