An inconvenient truth

Humour me for a moment and allow the image of an income statement to enter your mind. It starts at the top with revenue, the lifeblood of any business. For every extra rand generated in revenue, there are variable costs incurred. By the time those costs are paid, there’s probably only 15c-25c left, unless the company is a global tech giant with mouth-watering operating margins of 60% and higher.

Selling more products or services is the hardest way to make more money for shareholders. It’s also the most sustainable way for a business to grow. That doesn’t mean corporate management teams don’t find other ways to improve returns to shareholders and bump up their bonuses.

Everything that happens below the operating profit line has a larger relative impact on net profit than the benefit of an additional unit of revenue. Any savings in interest or tax drop straight to the bottom line and assist greatly in driving shareholder returns. Thus, corporates dedicate significant time and energy to optimising the balance sheet and finding ways to save on tax.

Even a few basis points can make a difference. If you’ve borrowed R100bn and you can save 0.03% on your interest bill, that’s R30m a year available for shareholders (and the SA Revenue Service) instead of being paid to the bank.

The environmental, social and governance (ESG) space has exploded recently and is now a significant focus area for corporates and investors alike.

In news that should shock absolutely nobody, investment bankers have found innovative ways to make money from this phenomenon. Ten years ago, the green finance industry was focused on green bonds, debt structures built around specific projects. This is known as the use of proceeds market, as the finance raised through the bond issuance must be used for a predetermined purpose the investors feel has appropriate green credentials. A perfect example would be renewable energy projects. I imagine their environmental benefit can withstand a robust audit.

Naturally, this doesn’t work for most corporates that don’t have major renewable projects in their pipelines.

Building solar farms is great, but corporates like to be rewarded for fitting water-efficient taps in bathrooms, not littering in the reception area and sticking up signs reminding people not to steal food from the fridge. Welcome to a world of sustainability-linked loans, opportunistic bankers and the evergrowing threat of greenwashing.

In a revelation that may be as traumatic as learning the truth about the supply chain behind the presents under the Christmas tree, I regret to inform you that corporates are not altruistic entities. After all, only a tiny proportion of humanity is altruistic, and corporates are no different.

Governments and regulators provide financial incentives for the behaviours they desire because humans (and thus corporates) tend to respond to incentives. We are donkeys walking across a field to eat a carrot. In this case, the carrot is sustainability-linked financing.

Let’s put some numbers to this industry. In a recent report, Bloomberg reported $1.5-trillion in sustainabilityrelated debt sales in 2021. A decade earlier, it was just $34bn. Reuters reports green bond issuances of

$480bn in 2021. This is the traditional use of proceeds model already discussed. Social bonds have exploded from nowhere, with issuances in 2021 of $190bn for companies that can demonstrate projects to improve health or provide affordable housing.

Again, these projects sound to me like they can be audited. Beyond the use of proceeds model, we have the murky world of sustainability-linked loans.

This is where the nonsense starts.

There is no restriction on the use of the funds. The only differentiator compared to normal debt is that the rate varies unless certain key performance

We are donkeys walking across a field to eat a carrot. In this case, sustainabilitylinked financing

indicators (KPIs) are achieved.

Ironically, this rewards socially conscious investors if the corporate fails in its quest to tick more ESG boxes. In other words, investors in these bonds will earn a higher return because corporates who don’t meet all their ESG goals will pay a higher coupon on the money they’ve borrowed.

Some may call this an inconvenient truth. Google it in case you’re too young to understand the reference.

S&P Global reports that about 58% of the KPIs for sustainability-linked bonds are related to emissions reductions. Thankfully, this is measurable: 13% of KPIs relate to waste reduction and 8% to renewable energy, both of which seem reasonable. Beyond that, companies clutch at straws and choose metrics that are easy to manipulate.

This is the ugly side of ESG, which chooses a convenient label to help it rise to prominence. Governmentbacked investment agencies happily invest in “sustainable” companies, giving them favourable terms on their debt.

The biggest winners of all, as usual, are probably the investment bankers.