The myopia that is inherent in the conventional approaches to growth and development has many dimensions. Conventional development pathways have been concerned with allocating scarce resources in a manner that perpetuates the fixation on propelling economic growth and chasing ever-increasing GDP numbers. Unbridled depletion of nature and environmental degradation, worsening economic inequalities, multidimensional poverty and social exclusion, stagnation of economic and social upward mobility, the lack of decent work, unfair pay and dismal working conditions inter alia have entailed growth fetishism. Clearly, this approach has failed in optimising the allocation of scarce resources. The calculus of conventional economic growth and development is misplaced to such an extent that it has exacerbated the existing scarcity of resources and violated existential boundaries that need to be respected for preserving stability and resilience.
The calculus of conventional economic growth and development is misplaced to such an extent that it has exacerbated the existing scarcity of resources and violated existential boundaries that need to be respected for preserving stability and resilience.
The world has to now cope with the environmental debt accumulated over time and socio-economic fault-lines that threaten the world order. Owing to the urgency of mitigating the impact of these negative consequences, the world has been embracing concepts such as sustainable development and green growth among others. The global economy has been making remarkable strides in accelerating its trajectory of sustainable development and green transition. In 2015, the world came together to adopt the 2030 Agenda for Sustainable Development and the Paris Agreement.
An important dimension of resource allocation is the disbursement of financial capital. Finance is the lifeline of the economy and lubricates it. As such, the principles that govern the financial system align with those that govern the real economy. The pursuit of self-interest and short-termism that have characterised conventional economic approaches towards consumption and production have also been seen in the allocation of financial capital. While sustainable development and green growth are replacing conventional notions of economic growth and development, conventional finance is being replaced by sustainable finance.
Efficient allocation of finance is anchored in optimising the risk-return trade-off. Sustainable finance follows from altering the calculus of conventional finance in two ways: Broadening the notion of risk and accounting for the impact of finance in optimising the risk-return trade-off. In the context of sustainable finance, the allocation of resources is expected to entail screening of risks on environmental, social and governance (ESG) dimensions: risks associated with carbon-intensive production, pollution, excess water consumption, destruction of forests, biodiversity and natural ecosystems; risks associated with widening of disparities in access and availability of essential services such as health, education, sanitation and housing, failure to create shared value for communities; risks associated with unfair employment and remuneration practices, lack of transparent governance, dismal working conditions. In an alternative yet complementary approach, returns are mapped to the impact generated by the use of allocated finance. Generating a positive impact includes the use of sustainable finance for accelerating the installation of renewable energy, encouraging the adoption of green technologies, augmenting human capital formation, investing in efficient water management, building affordable housing and ensuring universal access to basic amenities, shifting away from shareholder welfare to stakeholder welfare and adhering to international standards of employment, employee welfare and working conditions.
The challenge in mobilising sustainable finance has been in designing a new class of financial instruments which are highly liquid and viable both in terms of financial and non-financial returns. A wide range of bonds which satisfy these properties have emerged in the recent past. These bonds have displayed their mettle and future potential as debt securities that can mobilise sustainable finance efficiently. These bond markets have been developing in terms of credibility, robustness, transparency, and scalability. Bond instruments mobilising sustainable finance include green bonds, social bonds, sustainability bonds, transition bonds, and sustainability-linked bonds.
The challenge in mobilising sustainable finance has been in designing a new class of financial instruments which are highly liquid and viable both in terms of financial and non-financial returns.
Unlike conventional bonds whose use of proceeds is fungible, the above-mentioned thematic bonds are defined by the use of their proceeds. Green bonds are dedicated to projects related to climate change and other environmental issues. Green bonds can be further classified into climate bonds that fund climate change mitigation and adaptation, blue bonds that finance sustainable water management and conservation of marine ecosystems, and yellow bonds that support solar energy-related projects. Social bonds are concerned with projects focused on addressing access and affordability of basic infrastructure and essential services among other things. Sustainability bonds finance projects that address a combination of social and environmental purposes. Unlike Green, Social, Sustainability (GSS) bonds, the use of proceeds from the issuance of sustainability-linked bonds is neither predefined nor tied to any particular project(s) so long as the key performance indicators and the sustainability performance targets, which are pre-determined at the outset of the issuance, are achieved. Transition bonds can either belong to the class of GSS bonds or take the form of a sustainability-linked bond. Proceeds from these bonds are intended to be utilised to support the decarbonisation, and green and/or just transition initiatives.
From the above-mentioned fundamental difference between conventional and thematic bonds emerge other differences between them. These differences increase compliance and transaction costs associated with thematic bonds. Projects which are eligible for the use of proceeds from these bonds need to be identified. Their eligibility is dictated by objectives and outcomes sought to be achieved by them. The issuance of these bonds involves communicating unambiguously the sustainability objectives and intended outcomes which make projects eligible for sustainable finance as well as the process by which this eligibility is determined along with the standards and benchmarks that define eligibility. The issuance process is also required to delineate the risks material to the intended project and measures that circumvent them. Monitoring and verifying how the resources generated from the issuance are being used and reporting the same to maintain transparency are essential for the enterprise of sustainable finance.
The appetite for GSS bonds is growing exponentially and will continue to do so as is mirrored by the explosive growth experienced by these bond markets. Globally, the GSSSB issuance stood at US$ 980 billion in 2023. In India, as of the end of December 2021, the GSSB issuance stood at US$ 19.5 billion of which US$ 18.3 billion comprised green bonds while the issuance of social and sustainability bonds stood at US$ 500 million each, and of sustainability-linked bonds stood at US$ 200 million.
The appetite for GSS bonds is growing exponentially and will continue to do so as is mirrored by the explosive growth experienced by these bond markets.
The failure to ensure transparency in measuring, verifying, and reporting the intended impact of their issuance as well as in complying with required standards and guidelines leads to greenwashing. The prevalence of greenwashing discourages investment in instruments of sustainable finance. Formulating guidelines and setting up regulatory regimes which intend to curtail greenwashing have occupied the focus of the global financial system. India has also been engaged in these tasks.
The Securities and Exchange Board of India (SEBI) has put in place various protocols that elucidate the mechanism for regulating the issuance and servicing of green debt securities in the country, dos and don’ts underpinning the mechanism of green debt securities to avert instances of greenwashing. and the review process to be followed in evaluating the pertinent project, its eligibility and the issuance of green debt securities. These circulars bolster the intended objectives of the Business Responsibility and Sustainability Reporting (BRSR) which has been made a mandatory disclosure mechanism for the top 1,000 listed companies.
Measures undertaken by the government that can encourage firms to embark on the trajectory of greening their production process and embrace social imperatives for prioritising shared value creation include clear and well-defined benchmarks, norms and regulations governing the pursuit of ESG goals; policy tools to incentivise sustainable business practices; and mechanisms that make firms accountable for their obligations towards sustainability and penalise them in case they violate these obligations. Policy incentives and regulatory mechanisms which make GSS bonds attractive can boost domestic demand for them, for example, making investments in these bonds tax deductible. Creating a predictable pipeline of sustainability-related projects can increase the liquidity of these markets and boost investor confidence. Innovative financial instruments can be created, the expertise of existing institutions can be leveraged and interoperable taxonomies can be formulated to accelerate the mobilisation of sustainable finance. There is a need to invest in capacity building that creates and fosters the ecosystem underlying the mobilisation of sustainable finance.
Renita D’souza was a Fellow at the Observer Research Foundation.
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