Sustainability bonds and the future bond market: Are you ready?

Green bonds, on the other hand, are fixed-rate financial instruments that allow project entities to secure ring-fenced proceeds funding to achieve clearly defined ESG goals in environment-based projects such as solar farms, wind farms, and energy-efficient building retrofits. These products are growing in popularity globally, with green bond or SLB issuance expected to exceed USD 1.4 trillion by the end of 2023. The importance of green bonds and SLBs is not only to allow companies to access new sources of funding, but also to improve their reputation and meet expectations for stricter ESG disclosures from both regulators and investors.

South African market: an evolving market

In the South African bond market, interest in ESG-friendly bonds (green bonds and SLBs) is steadily increasing, albeit from a low base. The City of Cape Town pioneered the domestic green bond market in 2017, issuing a R1 billion green bond to finance water resilience projects. Since then, financial institutions have steadily launched a range of green and sustainability-related bonds and financing products, with a notable example being Nedbank’s issuance of South Africa’s first certified green bond on the Johannesburg Stock Exchange (JSE) in 2019, raising R1.7 billion for renewable energy projects. However, having said that, the overall adoption of ESG-compliant fixed income products in the South African bond market has been somewhat slower than in developed markets, due to two main reasons.

The first is the slow development and uptake of the green bond and SLB market in South Africa. According to a case study by the Institute for Development and Sustainability (Discussion Paper 15/2023), the slow adoption can be attributed to several factors. Factors include the lack of a uniform taxonomy for defining “green” or “sustainable” assets, inconsistent issuance, reporting and verification practices, and a general lack of regulatory and legal certainty in the face of all new developments in the SLB market.

The second reason is that while the primary objective of SLBs is typically for issuers to derive positive publicity and social benefits from ESG disclosure, since the introduction of ESG-aligned bonds in South Africa, issuers of ESG-aligned bonds have faced challenges in sourcing reliable third-party valuers to verify their ESG claims, increasing the risk of ‘greenwashing’ and undermining investor confidence in the integrity of the bonds. Equipment with ESG label.

regulatory framework

The introduction of the Fixed Income and Specialized Securities Listing Requirements (DSSLR) by the JSE in early 2024 marked an important regulatory milestone in the formalization of South Africa’s ESG bond market. DSSLR provides a dedicated framework for listing green, social and sustainability-related debt products.

In particular, Section 4 of the DSSLR sets out specific disclosure requirements for issuers, including the identification of a bond’s sustainability goals, the selection of KPIs, methodologies for measuring progress, and mechanisms for third-party verification. These requirements are aligned with international best practices, in particular the International Capital Market Association’s (ICMA) Green Bond Principles (GBP) and Sustainability Linked Bond Principles (SLBP). DSSLR also encourages collaboration with broader multilateral frameworks, such as the United Nations Sustainable Development Goals (SDGs) and the Task Force on Climate-related Financial Disclosures.

Importantly, DSSLR imposes a stricter compliance burden on issuers. Paragraph 4 of the DSSLR provides that, in addition to the information required for the issuance of ordinary corporate bonds, an SLB will require the following information to be provided in order to qualify under the DSSLR: A report from an independent external assessor on ESG compliance, a disclosure to the JSE that the Sustainability Linked Bond incorporates future ESG results in accordance with the Sustainability Linked Standards, and a disclosure to the JSE regarding the alignment of the Sustainability Linked Bond with the Sustainability Linked Bond. Core components compliant with sustainability-related standards.

Additionally, issuers are now expected to issue post-issue reports disclosing progress against established ESG targets and details of any underperformance or KPI revisions. In section 6, the DSSLR requires issuers of sustainability-related debt securities listed on the JSE to:

In connection with our ongoing obligations, we will continue to comply with sustainability-related standards and DSSRs. Sustainability Linked Bond issuers provide evidence to the JSE of their compliance with the Sustainability Linked Standards, including verification reports from independent external auditors. If the sustainability-related standards have been updated/revised, a new third-party opinion reflecting the updates/revised sustainability-related standards.

From a legal perspective, this has created a landscape where ESG terms and obligations are evolving and need to be carefully drafted to ensure enforceability. The challenge is to balance flexibility with the need for legal certainty and investor protection, taking into account that sustainability goals may evolve. For example, in the event of a default or “sustainability breach,” bond documentation should make clear the financial or reputational consequences.

In particular, JSE SLB issuers that do not consistently comply with sustainability-related standards must report such non-compliance in writing to the JSE and correct the non-compliance within 25 business days. If the issuer fails to correct non-compliance, the sustainability-related bond will no longer appear on the JSE.

Country classification and institutional roles

While the DSSLR has been successful in providing a foundational framework, South Africa needs broader regulatory alignment around green bonds, SLBs and ESG targets. South Africa did not have a national green finance classification. A classification system that defines which economic activities qualify as environmentally sustainable. This has created a legal gray area that could call into question the enforceability of ESG-related covenants and investor redress mechanisms should issuers default. However, National Treasury, in collaboration with the Financial Sector Conduct Authority (FSCA), the South African Reserve Bank (SARB) and other stakeholders, launched a consultation process to develop such a taxonomy, publishing a draft for public comment in June 2021. The taxonomy is expected to draw on models such as the EU’s Green Taxonomy and the International Platform on Sustainable Finance. The final taxonomy will finally be launched on April 1, 2022 and will provide a uniform taxonomy related to green bonds, SLBs and ESG objectives, thereby increasing market transparency, preventing “greenwashing” and facilitating cross-border investments.

The FSCA has also indicated its intention to introduce ESG-specific disclosure rules that could be made mandatory for listed companies and large institutional investors. This may include alignment with International Financial Reporting Standards and sustainability disclosure standards recently developed by the International Sustainability Standards Board. Similarly, the SARB, through its prudential authorities, is considering incorporating climate risks into its supervisory framework, such as capital adequacy assessments and climate stress tests. The SARB’s recent Financial Stability Review identified climate change as a systemic risk, and future regulatory actions could directly impact the construction of ESG-linked financial products.

Next steps for the market and future participants

From a practical perspective, those wishing to issue ESG bonds must go through several regulatory and compliance steps. These include identifying eligible green or social projects; Comply with internationally recognized principles (such as ICMA GBP and SLBP). Appoint a third-party reviewer or verifier. Draft delivery documentation that complies with DSSLR and JSE requirements. Establish a robust impact reporting framework. Our dedicated legal team plays a key role in this process, from structuring bond terms and ESG terms to reviewing validation reports and ensuring regulatory compliance for issuers and projects.

Looking ahead, the regulatory environment for green bonds and SLBs is poised for transformation. National Treasury’s Sustainable Finance Working Group is currently refining the Green Finance Roadmap to ensure it remains a globally competitive framework for sustainable finance, while the JSE is expected to further update its ESG disclosure rules in line with regional and global developments.

Although South Africa’s regulatory framework for SLBs and green bonds is rapidly improving, much remains to be done. Establishing national taxonomies, harmonized reporting standards, and legally enforceable verification protocols are critical to building trust and attracting sustained investor interest. Legal advisors play a central role in ensuring that ESG measures are not only legally sound, but also strategically aligned with the client’s sustainability goals. As South Africa embarks on a just energy transition, ESG bonds are a powerful tool to free up capital, promote accountability and finance a greener and more inclusive economic future.