BOND, GREEN BOND! : THE EMERGENCE OF GREEN BONDS IN INDIA

Aiyushi Mehrotra

Climate change is a threat to the environment and the financial system alike. India’s unique topography, geography, geology, and climatic diversity makes it particularly susceptible to the  current ‘pandemic’. Green finance is rapidly gaining prominence as a priority for public policy and is central to the broader discussion of sustainable economic growth. Green finance refers to financial arrangements that are tailored to the use of environmentally sustainable or climate-resilient initiatives. These projects may include energy generation from renewable sources such as wind, waste management, and efficient waste disposal and conversion to energy. To fund these types of projects, new financial instruments such as Green Bonds, carbon market instruments and new financial institutions (e.g. green banks and green credit unions) are being founded. They constitute green finance as a whole.

Inception of Green Finance in India

In 2015, India entered the green bond market when it issued the country’s first green bond for the purpose of financing renewable and clean energy projects, particularly wind and solar. The green bond market has subsequently spread to include a variety of public sector entities, state-owned commercial banks, government financial institutions, corporations, and the banking industry.

One of the earliest indications of attempts to connect finance, social, and environmental issues took place in 2008, when the Reserve Bank of India (RBI), issued a Notification titled ‘Corporate Social Responsibility, Sustainable Development and Non-Financial Reporting – Role of Banks’ (Notification no. RBI/2007-08/216). This was initiated in order to preserve the quality of environmental and social systems while pursuing economic development. In August 2016, the Reserve Bank of India introduced a series of packaged steps that aided in the development of the corporate bond market. Recently, RBI returned to the discourse on adhering to sustainable practice in its report on ‘Trends and Progress of Banking in India’ published on 24 December 2019 where it urged banks to be sensitive to the principles of the Financial Stability Board as well as Equator Principles.

Edifying on the global propulsion for corporate disclosure, in 2012, the Securities and Exchange Board of India (SEBI) mandated for the Top 100 Companies (by market capitalisation) to issue Business Responsibility Reporting (BRR). The Securities and Exchange Board of India published its official green bond requirements for Indian issuers in January 2016, making India the second country (after China) to do so. On May 30, 2017, SEBI issued a circular outlining the disclosure standards that would apply to the issuance and listing of ‘Green Bonds’ in India (Green Bond Guidelines), in addition to the existing SEBI (Issue and Listing of Debt Securities) Regulations, 2008). At the moment, compliance with the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (NCS Regulations) is required for issuances of listed green debt securities along with additional stipulations.

When there were no set guidelines defining the principles for issuance of Green Bonds, the International Capital Market Association (ICMA) came out with a document called Green Bond Principles (GBP). GBP outlined a set of principles that delineates good practices for the process of issuing a green bond which still holds great importance while issuing Green Bonds.

Current scenario

RBI’s renewed interest and growing demand for Green Bonds indicate potential for re-orienting finance in the country. India has committed to an ambitious Mission 2070 Net Zero goal. With this global commitment, India is now embarking on a five-decade-long, pan-economy, green transformation. New instruments in the switchover to net-zero energy include sustainability-linked bonds and climate transition finance. Sembcorp Industries, one of Asia’s largest energy producers, announced the introduction of Southeast Asia’s first sustainability-linked bond. With a $675 million offering, anchored with a $150 million IFC investment. More retail and institutional investors are changing their investment strategies toward net-zero goals, which could include making green and sustainability-linked bonds. This is because the new generation of socially conscious investors is more aware of the effects of climate change.

Indian Green Bonds are issued through banks and NBFCs. As of February 12, 2020, the outstanding amount of Green Bonds in India was US$16.3 billion. India has issued Green Bonds worth about US$8 billion since January 1, 2018, which constituted about 0.7 per cent of all the bonds issued in the Indian financial market. A number of government agencies have contributed to green bond issuance including Indian Railway Finance Corporation and State Bank of India.

Although, India stands second amongst emerging green bond markets after China (with $10.3 billion transactions) adopting a proactive position on issues affecting the sector is critical in view of the tumultuous economic and environmental situation. For example, Particle pollution from fossil fuel burning is one of India’s major environmental issues. This has major health implications, which are increasing with the economy’s rapid rise. At the same time, policymakers are concerned that the capital required for pollution control efforts could considerably slow economic growth or divert fundings from the annual budget.

Therefore, with advancements to these bonds, the ambitious goals of the Paris Agreement or the Sustainable Development Goals, which need a lot of capital funding, can be met.

Impediment to Progress and Suggestions

Despite the significant achievements accomplished by the Indian market, several limitations persist that prevent these bonds from reaching their full potential. Only a few businesses, like Yes Bank and CLP Wind Farms, issued Green Bonds. Large institutional investors such as LIC and EPFO favour longer-term securities. This may be due to the absence of a clear definition for a green bond; investors may not know exactly where their money is going, meaning it could be utilised for inappropriate purposes. For example,

Repsol, with its green bond issuance for an energy efficiency and carbon emission reduction programme, is the most well-known green bond villain. Repsol was the first fossil-fuel corporation to issue Green Bonds to fund energy efficiency and carbon reductions. The 2018 offering raised €500 million for energy efficiency and carbon reduction initiatives that are expected to save 1.2 metric tonnes of CO₂. Repsol acquired a second-party verification from Vigeo Eris that the bond was green before releasing it. Despite this certification, the bond was not included in most major green indices. The bond, according to critics, did not represent a fundamental shift in Repsol’s economic model, but rather an incremental one. Now this failure to deliver might lead to a contractual risk or simply a reputational  risk to larger institutional investors.

Local investors, in comparison to global investors, lack the concentrated finances necessary for sustainable investment. The government may have to provide resultant concessions in order to get institutions to subscribe to those securities. 

Existing literature and worldwide interactions indicate that a comprehensive policy approach to green finance is gaining traction, but high borrowing costs, false claims of environmental compliance, a lack of standardisation of green loan definitions, and maturity disparities between long-term green investment and investors’ relatively short-term interests act as a bump in the road. The  pre-requisite for the green bond issuing process involves technical understanding of established international standards in green transactions which make them unfavourable. Additionally, the small size, currency concerns, and high transaction costs have discouraged issuers and investors from using these instruments.

Another issue is that there are no Rating Guidelines. The fact that there are no Rating Guidelines is a problem. Credit rating firms give estimates of how safe it is to buy a bond. These help investors figure out the credibility and position of the issue. Since investors don’t know enough about the quality and credit risk of Green Bonds, the fact that they don’t have a rating guideline is a problem.

Unfortunately, Green Bonds also offer lesser returns. Green Bonds do not provide the same return on investment as conventional bonds. Green Bonds issued in India have a shorter maturity of 5-10 years, compared to foreign issuances, and thus take longer to generate profits. The lack of market infrastructure development, given the domestic market’s size and the far lower penetration of green instruments so far, significant prospects remain untapped. There is a need to build an active bond market that is systemically safe and adheres to stringent criteria for environmental, social, and governance integration.

A standard criteria is required to ensure a healthy Green Bond market and a cost-effective energy strategy to satisfy expanding demand. While the majority of Green Bonds, like standard government and corporate bonds, are taxable, a tiny subset of municipal Green Bonds are tax-free. Therefore, with no tax on interest earnings and no capital gains tax, if the bond is resold, it will help investors earn more. This is because the capital gains in case of normal bonds would have been deducted as tax to the government but here would go in the pockets of the investors. Bondholders are not required to pay income tax on the interest earned on their Green Bonds (so the issuer can get a lower interest rate). In the US market, this form of tax benefit is primarily given to municipal bonds. A case in point in the green bond arena is the tax-exempt bond issue for the financing of wind farms in Brazil. It’s worth noting that certain recognised long-term infrastructure bonds qualify for a blanket tax deduction under Section 80CCF of the Income Tax Act 1961. Regulatory incentives, such as rebates and other tax benefits, might incentivize local banks to invest in Green Bonds. Additionally, policymakers should consider creating frameworks that foster innovation and competition. Strategic public sector investments have the potential to attract private investors and increase their trust in the Green Bond market. Another possibility is to include these Green Bonds into ‘Smart City Projects’ to increase their vogue.

China has been consistently improving its policy and regulatory framework to promote Green Bonds as a means of financing environmental solutions since 2015. This has resulted in the fast expansion of China’s green bond market, as well as increased control of bond issuance. Local governments in China also contribute significantly to green bond issuance through a mix of legislative and regulatory assistance, as well as fiscal and financial measures. For example, Jiangsu’s province government offered a 30% interest subsidy on Green Bonds and asset-backed securities. Additionally, it offers a monetary reward (RMB 300,000, or US$43,400) for third-party guarantors of Green Bonds, as well as a risk compensation mechanism (covering 30% of actual loss) to third-party guarantors of aggregate green loans targeted at small and medium-sized firms. India has always imbibed her characteristic of being a decentralised nation with a strong Centre. State governments can also issue Green Bonds and make use of the proceeds in raising awareness and environmental standards. There have been instances where State governments have issued such innovative bonds and raised capital. On May 1, 2019, the Kerala Infrastructure Investment Fund Board (KIIFB) released the first sub-sovereign masala bond, which was listed on the London Stock Exchange. The finance provided by the sale of these bonds ensured the ability to repair important public infrastructure damaged by the devastating Kerala floods in August 2019. The liberalised external commercial borrowing (ECB) guidelines of the Reserve Bank of India have permitted renewable energy companies and other businesses to use the ECB channel to raise capital via Green Bonds and sustainable bonds.

Conclusion

Green finance has evolved over the last decade from a boutique business to one that is becoming increasingly mainstream. But green finance is yet to pick up in India. The RBI has constantly argued that financial institutions in India should assess and manage environmental and social risks when financing Projects. Having said that, the benefits of green finance, which include allocating the world’s wealth to the most productive uses and so providing the only plausible road to green global development and high employment, cannot be outweighed by the hazards. Without appropriate mitigation and preparedness, future crises can have a profound and long-lasting economic and social impact. COVID-19 has prompted governments in developing countries to allocate substantial funds to relief efforts, which have saved numerous lives and livelihoods. However, developing economic recovery plans must not upset the delicate balance between economic growth and natural capital in the region. Numerous worldwide thinkers advocate for the crucial role of green infrastructure in promoting economic growth and livelihoods while protecting the Paris Agreement’s objectives. Innovative financial structures can play a crucial role in mobilising private investments for a green and sustainable regional resurgence.

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The author is a student pursuing their degree in law from the Gujarat National Law University (GNLU), Gandhinagar.