Issuance of Green Bonds in India: Protecting the Environment at the Expense of Commercial Prudence?
[Siddharth and Tanay are students at National Law University Odisha.]
In November 2022, the Government of India granted approval for the Sovereign Green Bond Framework, which outlines the utilization of proceeds generated from the issuance of sovereign green bonds to fund projects that align with India's objectives for decarbonization.
Despite this recent proactiveness shown by the government, due to the current state of India’s sustainable bond market, it is likely that it will fail to meet its updated Nationally Determined Contributions (NDCs) target by 2030 which will require around USD 2.5 trillion of investment. The lack of green financing can be attributed mainly to three characteristics of the Indian green bond market. First, there is a lack of incentives for both the issuers and the investors. Second, in contrast to other markets, there is a dearth of diverse investment opportunities in India. Last, an effective legal framework to regulate the green bonds market is lacking.
This article assesses the measures taken by the Indian government to promote green financing, and highlights that the government’s efforts, at present, fall short in achieving the desired environmental targets. The article also delves into the commercial and legal challenges faced by the green bond market and proposes possible solutions to unlock its growth potential in India. In order to provide a comprehensive analysis, the article characterizes green bonds into two types based on the issuer(s) - sovereign green bonds (SGrBs) issued by governments, and corporate green bonds (CGrBs) issued by companies to fund their environmentally sustainable projects.
Sovereign Green Bonds
The government, in the Union Budget 2022-23, unveiled its plans to issue SGrBs as part of its market borrowings to raise funds for green infrastructure, and the proceeds will be invested in public sector projects aimed at reducing the carbon emissions of the economy. The Green Bond Framework is in line with the globally recognized International Capital Market Association’s (ICMA) Green Bond Principles which are a set of voluntary procedural guidelines that suggest for transparency and disclosure.
The Reserve Bank of India (RBI) in its maiden auction in January 2023 of SGrBs worth INR 8,000 crores attracted an oversubscription of more than four times. The second auction was as successful as the first one. Interestingly, the success of these auctions was despite the fact that the yields of these bonds were a few basis points lower than other government securities of the same tenure. This indicates the strong demand and potential for growth of the green bond market in India which has not been tapped yet.
The introduction of SGrBs in India is a welcome step, but it is insufficient to deal with the problem at hand for two reasons. First, SGrBs are limited to raising funds for public-sector green infrastructure projects, entirely neglecting the requirement for green financing in the private sector. Second, SGrBs solely will neither be able to fund India’s panchamrit targets nor meet the demands of the growing green bonds market. Thus, the promotion and success of CGrBs are quintessential to resolving these issues in green financing in India.
Corporate Green Bonds in India: Opportunities and Obstacles
As of January 2023, Fitch Ratings reports that the green bonds market represented a mere 3.8% of the total CGrB market in the country. Also, India’s contribution to the global green bond market was $8.6 billion, which amounted to only a meagre 1.7% of the total issued green bonds. CGrBs in India have failed to reach its full potential in the Indian green bonds market because of two reasons. First, issuances are largely limited to the renewable energy sector, with a focus on solar projects. Second, sufficient incentives are neither provided to the issuer nor investor. Third, absence of an effective legal framework to regulate the CGrB market in particular. The detailed description of these problems is discussed further.
Lack of Incentives
A major concern which makes CGrBs detrimental to investor interest is ‘greenium’ which is the yield difference resulting from the increased demand for a green bond that leads to a lower yield compared to a similar conventional bond. Relying solely on investors' environmental conservation willingness to accept lower yields will not be sustainable in the long term. Lower yields owing to lower rates of interest must be supplemented by tax incentives by the government. Despite there being such provision under Income Tax Act 1961 for possible tax exemptions, the same has not been made applicable for income generated out of green bond investments.
In addition, green bond investors are not permitted to contribute funds for issuance intended to support ongoing projects. Developers must therefore obtain domestic loans to finance their projects before refinancing them using bond revenues. Again, the issuer needs to have a price advantage for this, which may not always be the case, thus discouraging issuance.
As opposed to this, the United States, for example, has a structured incentive system under the Clean Renewable Energy Bonds (CREBs) and Qualified Energy Conservation Bonds (QECBs) program that provides for three types of green bonds - Tax Credit Bonds, Direct Subsidy Bonds and Tax-Exempt Bonds, all of which provide distinct forms of monetary incentives for the investor, the issuer, or both.
There are also various structural problems with green bond market in India which are detrimental to the commercial interests of the issuers. Issuers have no pricing advantage as more than 80% of total issuance is done by renewable energy developer companies. A critical problem with wind and solar companies is the financial health of their main customers, the electricity distribution companies or discoms run by various states. Poor financial health of the customer leads to lower rating of the issuers, thus increasing the interest rates that can be charged by the investors, defeating the commercial viability of the issuance for the developers.
Another concern is that green bonds are denominated in rupees and primarily held by domestic banks, insurers, and the RBI. Meanwhile, a significant majority of issuers, up to 90%, prefer issuing green bonds in dollars. Thus, resulting in reduced issuer interest. Issuance in INR has also prevented foreign investment from flowing into the Indian green bond market.
Lack of Effective Legal Framework
Until very recently, India did not have an effective compliance framework in relation to issuance of CGrBs. However, in February 2023, SEBI released the “Revised Disclosure Requirements for Issuance and Listing of Green Debt Securities” that overhaul the required compliances and ensures transparency in relation to the use of proceeds. The requirements mandate publishing a statement on due diligence policies regarding the major negative implications of investment decisions. It also requires that specific information be disclosed by the issuers of these bonds in annual periodic reports which would be subject to examination by a third-party certifier/reviewer. However, rules regarding standardisation and certification of CGrBs are absent in India’s legal framework. Such standardization not only acts as a mark of credibility of the bond, but any attached benefits for compliance under the standard can incentivise issuance of green bonds with better specifications.
In the European Union, for example, there is an additional framework for issuance of green bonds called the European Green Bond Standard which gives the designation of European Green Bond (EuGrB) to those bonds that meet its specific requirements. The principal requirement is that the use of the proceeds of the EuGrB shall be allocated to the economic activities that are aligned with the EU taxonomy requirements. Additionally, the Corporate Sustainability Reporting Directive (CSRD) compel issuers of EuGrBs subject to the requirement to prepare transition plans, which are audited plans for carbon emission reductions. Effectively, small and medium sized enterprises are not covered by the CSRD, therefore the requirement to create a transition plan only applies to large businesses. The benefit of complying with these stricter requirements and being characterised as a EuGrB is the notably lower issuance costs.
When it comes to the structural problems in the green bond market because of the poor health of the discoms, the government can help by changing the “guarantee mechanism,” that gives the creditor assurance that, in the event that the borrower fails to make payments (because its client, the discom, has not paid its dues), a third party will act as a “guarantor”. The more practical approach is to offer a “partial guarantee,” as blanket guarantees are very expensive, and thus rare. However, partial guarantee methods, such as those provided by government-owned NBFCs like IIFCL and IREDA, have not gained popularity in India because of the exorbitant fees they impose on developers.
Additionally, the introduction of a diverse range of incentivized green bonds in the Indian market, similar to that available in the well-established bond market in the US, would be a positive development. This would create a level playing field for green bonds to compete with other investment options, fostering increased investment and supporting the growth of the green bond market in India. The implementation of tax incentives under the Income Tax Act for income derived from green bond issuance would further be a highly favourable step by the government. This would encourage and incentivize businesses to invest in green bonds and thus environmentally responsible initiatives, promoting sustainable development and environmental conservation.
India, not having any effective standardisation for CGrBs, should also adopt a similar incentivised standardisation as that of the European Green Bond Standard that can help first, the issuers to lower issuance costs; second, instil confidence in the investors about the prospective use of the bond proceeds; and third, help the government to meet its NDC goals as a consequence of issuance of healthier bonds in general due to the stricter compliance requirements in order to be certified under the standard. Also, India must adopt a similar mandate for transition plans as provided by the CSRD in the EU for the largest polluter industries.
The government and regulatory bodies in India have implemented multiple measures to promote green financing, including the introduction of SGrBs and continuous enhancements to the framework that regulates the green bond market. Despite these efforts, it must be acknowledged that they may not be adequate to achieve India's NDC targets. The lack of incentives for both issuers and investors, the dearth of diverse investment opportunities, and the absence of an effective legal framework are key hindrances to the growth of the green bond market in India. To unlock the full potential of India’s green bond market, there is a need for promotion of CGrBs by offering greater incentives such as tax exemptions, and addressing structural problems such as pricing disadvantages and financial health of issuers' customers. Apart from this, efforts to promote and regulate CGrBs through standardization and certification are crucial for India to achieve its environmental targets and contribute significantly to the global green bond market.