India and Green Bonds: Where We Are
(Parveen Arora & Shloka Vaidialingam)
Earlier this year in February 2022, the Indian Finance Minister announced the prospective issue of ‘sovereign green bonds’, to finance infrastructure and meet clean energy goals. This type of government-backed measure recognizes the need for financial instruments to encourage investments in such areas, by providing investment opportunities to the public at large.
Green bonds are regular bonds/ debt instruments for raising investment to finance green projects. The earmarking of the funds raised is their distinguishing feature, with the issuing entity declaring publicly that the funds will be put to a specified use with an environmental benefit.
The initial issues of such instruments in India were by Indian financial institutions (Yes Bank Ltd., Exim Bank of India) and a corporate entity (CLP Wind Farms) in 2015. Since then, there have been a slew of green bond and sustainability-linked bond issues by Indian companies. However, at present most of the green bonds issued in India have been issued by non-financial corporate entities (almost 32% of the green bonds in 2021), mainly those engaged in renewable energy businesses. Indian financial institutions (such as banks) have of late been slower to issue such instruments.
Current regulatory framework:
Green bonds are a form of infrastructure financing and the Securities and Exchange Board of India (“SEBI”) had issued a concept paper on the same in 2015. Such instruments were covered within the ambit of general debt securities and were regulated by SEBI as such, along with the related compliances for general debt securities – i.e compliance with provisions of the Companies Act, 2013, mandatory listing as per SEBI regulations, disclosures etc. However, until a circular issued in May, 2017 by SEBI, what was to be considered a ‘green bond’ was mainly understood only in terms of market parlance.
In the 2017 circular, SEBI proposed a definition of ‘green debt securities’ as part of its regulations in relation to issue and listing of general debt securities. A debt security could be considered ‘green’ or a ‘green debt security’ if the funds raised through such issuance were to be utilized for projects/ assets categorized broadly as follows, which list could be added to / changed by SEBI from time to time:
Renewable and sustainable energy (including wind, solar, bioenergy and other energy sources using clean technology);
Clean transportation including public/ mass transportation;
Sustainable water management including clean water, drinking water and water recycling;
Climate change adaptation;
Energy efficiency including green buildings;
Sustainable waste management including recycling, waste disposal, waste to energy;
Sustainable land use; and
In addition to requirements such as listing, the primary obligation on the issuer of any green bond under the 2017 SEBI circular was to utilize the proceeds only for the intended purpose and make disclosures in relation to the same – for example, a statement of the environmental objectives of the issue, details of the project / assets in relation to which the issuer proposes to utilize the funds raised (including if any refinancing is proposed), summary of the decision-making process followed by the issuer to determine eligibility of the project / assets and details of the system which would track or monitor the deployment of funds. The issuer also had the option of appointing an independent third-party reviewer/ certifier to certify the processes, selection of green criteria and project evaluation. Regular and periodical disclosures were also to be provided along with the issuer’s annual report and financial results, including details of utilization of the funds, performance measures of the environmental impact of the project/ asset.
To summarise, in order to issue and list any ‘green bonds’ or ‘green debt securities’, an issuer had to comply with (i) Companies Act, 2013; (ii) SEBI (Issue and Listing of Debt Securities) Regulations, 2008; and (iii) the SEBI (Listing Obligations and Disclosure Requirements), 2015, all of which apply to debt securities in general, and there were no specific rules or regulations in relation to issuance of green bonds or green debt securities in particular.
What is now proposed:
India had previously identified and declared its intended Nationally Determined Contribution (“NDC") goals in October 2016, pursuant to its commitments under the Paris Agreement adopted in 2015 (a legally binding international treaty on climate change). These were reduction in carbon emissions, 40% electricity generation capacity from renewables or nuclear energy by 2030 and creation of a carbon sink. India has once again enhanced its climate commitments at the 2021 United Nations Climate Change Conference (the “Conference of Parties” or “COP 26”) held in Glasgow, Scotland in November 2021 under the aegis of United Nations Framework Convention on Climate Change. These include meeting 50% of India’s energy requirements from renewable sources, reducing carbon emissions to 45% (compared to 2005 levels) by 2030 and achieving net zero emissions by 2070. This stands alongside a domestic push on electrification of mobility and urban transport and exploration of alternate fuels such as green hydrogen and biofuels. It is estimated that least USD 1 trillion will be required to finance climate commitments and huge infrastructure deployment to meet these energy transition goals.
While green bonds may continue to be issued by the private sector (with tenures of 5-10 years typically), to encourage wider use of green bonds or green debt securities as a manner of financing such infrastructure requirements, the Indian Ministry of Finance is presently developing a comprehensive framework to issue ‘sovereign’ green bonds with sovereign-grade investment status. The Indian government is reportedly in the final stages of identifying projects in which proceeds of the bond issue may be utilized (such as renewable energy, automobiles, river restoration), while also announcing tax benefits to make the instruments attractive to investors. Proceeds from such bond issues will likely be earmarked to selected Indian public sector projects designated as ‘green’. At present, there is no indication of the interest rate at which such sovereign green bonds will be issued.
The framework for issue of the sovereign green bonds is also stated to be in line with principles of the International Capital Market Association, one of which is that such bonds should provide transparent green credentials alongside the investment opportunity to investors. A robust green bond framework will encourage investment in environmentally friendly and sustainable projects, diversify the investor base (as sustainability-focused and ESG-focused funds may participate) and be an opportunity for investors to demonstrate their social responsibility commitments.
Some green bonds may even trade at a premium, as compared to the non-green bonds of the same issuer, making such ‘green premium’ or ‘greenium’ attractive to investors. Investment agreements for subscription to such debt securities will likely have increasingly stricter representations on the green benefits of the projects, covenants with respect to proven environmental benefits, disclosures of hazards associated with the project, and penalties or liquidated damages in relation to any breach or misleading covenants made by the issuer. Such disclosures are in addition to those mandated with effect from April 1, 2022 under the business responsibility and sustainability reporting rules issued by SEBI, which are to be followed by the top 1000 listed companies (by market capitalization) on the Indian stock exchange.
As the policy framework develops and investor interest increases, so will risks become apparent, such as greenwashing and diversion of funds to non-green purposes. Such risks will likely be managed with strong periodic assessment and certification requirements on the part of the issuer (similar to what the 2017 SEBI circular already contemplates).
What are banks doing:
At present, since 2015, the Reserve Bank of India (“RBI”) allows the small-scale renewable sector to be a ‘priority sector’ for lending, i.e. all commercial lenders are required to earmark a certain proportion of their funds for such a sector to promote growth. Under such policy, bank loans of up to INR 30 crore are available to borrowers for purposes like solar based power generators, biomass-based power generators, windmills, micro-hydel plants and for non-conventional energy based public utilities, viz., street lighting systems and remote village electrification. This is clearly not sufficient to meet India’s climate change targets on a national level and hence, the need for instruments such as green bonds becomes more relevant as a fund-raising mechanism.
The RBI has also released a discussion paper on climate risk and sustainable finance in July, 2022, which may be a useful guide to a more detailed policy framework about to be introduced relating to climate disclosures and assessment of climate risks by financial institutions. Broadly, the RBI has acknowledged the need for climate-related disclosures for stakeholders of regulated financial entities, responsibilities of the boards of directors of the relevant entities to implement committees monitoring the same and clear disclosures in relation to the financial risk emanating from climate and environmental degradation.
What to look out for: The first sovereign-graded green bond issue is likely to come out by March 2023, in smaller tranches initially and investors looking for investment opportunities in green, social or sustainability-linked bonds in emerging markets should take note. Indian financial institutions may also expand priority sector lending in such sectors and allow a wider range of green projects eligible for such lending, as key financiers of the energy transition. The impending policy framework for green bonds is likely to be comprehensive, addressing what will constitute green finance, tax credits, establishment of regular statutory ‘green audits’ with penalties in case of misleading claims or disclosures by issuers etc. We also expect a rise in establishment of green certification councils or bodies to minimize risk of greenwashing (such as the Indian Green Building Council for buildings in India) for such investments.
As per Climate Bonds Taxonomy, internationally aligned green bonds are those where at least 95% of the proceeds are designated for green projects