Mainstreaming ESG frameworks in African Financial Systems – the case of Governance (G)

Introduction

Sustainable finance has moved from a niche concept to a mainstream financial strategy, particularly since the Paris Agreement placed the financial sector at the forefront of combating climate change. Sustainable finance is the provision of financial investments that consider Environmental, social, and Governance (ESG) factors.

Initially, sustainable finance focused primarily on the Environmental (E) component. This initial focus on the Environment is explained by the urgency of climate change, the “defining threat of our time,” as emphasized by UN Secretary-General Antonio Guterres's statement.

In Africa as well, sustainable finance emerged with a strong focus on Green and climate change mitigation: from the pioneering issuance of green bonds (such as Nigeria's Sovereign green bond in 2017) to the development of green taxonomies (such as South Africa’s national Green finance taxonomy in 2022).

However, as the sustainable finance market evolves in Africa, there has been an increasing shift toward social and adaptation-related concerns. Since Africa contributes the least to global carbon emissions but suffers disproportionately from climate change, a consensus is emerging that sustainable finance must address environmental and social issues. Thus, the landscape of sustainable finance in Africa has gradually filled up with social bonds (ex. Standard Bank social Bond in 2021) sustainable or sustainable-linked bonds including social and environmental objectives (ex EBID GSS bond in 2024). The social momentum is also apparent in regulatory advancements such as WAEMU’s 2023 taxonomy, which includes broader sustainability objectives including social aspects[1]. The African Development Bank and various partners, under the African Financial Alliance on Climate Change (AFAC) are developing a sustainable finance taxonomy for the African financial sector with an equal balance between Environmental and Social objectives.[2]

But what about Governance (G)? Shouldn’t sustainable finance also tackle persistent governance challenges across the continent?

Governance issues in Africa and consequences on access to finance

Governance refers to the system by which an organization is directed, controlled, and held accountable to achieve its purpose over the long term[3].

Strong governance ensures transparency, accountability, and ethical decision-making, which are crucial for maintaining investor confidence and financial stability. Governance is therefore the cornerstone of finance.

Africa has long faced severe governance issues, which significantly limit access to financial resources in both the public and private sectors. A recent initiative highlighting this challenge is the African School of Governance (ASG) Home - ASG, launched in October 2024 by H.E. Paul Kagame, President of Rwanda, and H.E. Hailemariam Desalegn, former Prime Minister of Ethiopia. Under this initiative, key African leaders (including Makhtar Diop, Managing Director of IFC, and Donald Kaberuka, former President of the African Development Bank), acknowledge the continent’s pressing governance challenges and come together to create a sustainable governance model rooted in African realities[4].

While such initiatives are crucial, they must be complemented by financial incentives that encourage the implementation of robust governance frameworks. This is where sustainable finance can play a transformative role.

The Governance aspects of ESG include Corporate governance and Corporate Behaviors issues[5]:

• Corporate governance: is the system of rules, practices, and processes by which a firm is directed and controlled. Key corporate governance issues include Board, Pay, ownership and accounting.
• Corporate behavior is how the company’s employees interact with each other, as well as the interactions with external stakeholders. Key corporate behaviour issues include business ethics, anti-competitive practices, tax transparency, corruption & instability, and financial system instability.

Integrating a strong(er) Governance Component in sustainable financial products

In the landscape of sustainable finance products—Green, Social, Sustainability, and Sustainability-Linked Bonds (GSSS)—two instruments mainly focus on the Environment or Social Factors: Green and social bonds. These two instruments are also the most issued ones globally.

However, given Africa’s governance challenges, there is an opportunity to develop financial instruments specifically designed to improve governance.

Recently, such innovative instruments emerged in other parts of the world, facing similar challenges in Africa. In December 2024, Sri Lanka initiated a significant restructuring of its $12.55 billion international bond debt by introducing innovative Governance-Linked Bonds (GLBs). The mechanism is quite simple: if the country met two (Key Performance Indicators) KPIs related to the governance of the country, then the bond's coupon rate will be reduced by 75 basis points starting in late 2028, potentially saving the country approximately $80 million in interest payments over the bond's lifespan, which matures in 2035[6]. The two KPIs are as follows:

• Sri Lanka must exceed the Revenue-to-GDP Ratio thresholds set by the International Monetary Fund (IMF) for 2026 and 2027.
• The Ministry of Finance must publish a Fiscal Strategy Statement for 2026 and 2027.

Applying Governance-Linked Bonds in Africa

While the success of Sri Lanka’s GLBs remains to be seen, Africa could explore similar financial mechanisms: Governance prevents many African institutions from accessing finance at a reasonable cost, so let’s revert the narrative and make finance work for Governance. Potential applications include:

• Public Sector Debt: Many African countries face debt sustainability challenges and seek innovative financing solutions. Gabon, for example, used a Debt-for-Nature Swap in 2023, restructuring $500 million into a blue bond. Governance-linked bonds could serve as a similar tool, allowing countries to secure more favorable financial terms in exchange for governance reforms.
• Strengthening Development Financial Institutions (DFIs): African DFIs play a crucial role in mobilizing funds for sustainable development. However, issues such as weak corporate governance, inadequate risk management, and inefficient credit delivery can hinder their effectiveness. To address these challenges, the Association of African Development Finance Institutions (AADFI) and the African Development Bank (AfDB), developed the AADFI Prudential Standards, Guidelines, and Rating System (PSGRS)[7]. These guidelines are set to assist African DFIs in self-rating themselves in the three areas of governance, prudential, and operational guidelines. By linking financing incentives to PSGRS rating, governance-linked bonds could improve governance within DFIs.
• Enhancing SME Access to Finance: African SMEs face a significant financing gap, largely due to governance deficiencies such as poor financial reporting and inadequate corporate structures. Although sustainability-linked loans exist (e.g., those offered by some local banks), their impact is limited as only a limited number of entities have the reporting capabilities to access such financings. Redesigning these loans to incorporate governance-focused KPIs could enhance accessibility for SMEs, incentivizing improved business practices.

Mainstreaming Governance targets in Sustainability-Linked bonds

Governance considerations can also be (more) integrated into sustainability-linked bonds (SLBs), which are gaining popularity in Africa. So far, the sustainability performance targets and KPIs in these instruments have primarily focused on environmental and social factors. In 2022, the International Capital Market Association (ICMA) published high-level recommendations and illustrative examples for selecting KPIs for SLBs[8]. The registry already includes five governance-related KPIs, specifically focused on corporate behavior.  Africa representatives at ICMA should push to include Corporate Governance KPIs as well and increase their integration in sustainability-linked bonds.

Conclusion

Sustainable finance is gaining momentum in Africa, presenting a valuable opportunity to close financing gaps and drive development. However, without tackling governance challenges, environmental and social finance efforts will be undermined. It is time to bring governance—the “G” factor—into the center of ESG finance discussions and leverage financial innovation to promote transparency, accountability, and sustainable economic growth.