"The financial crisis of 2008, through its detrimental long term effects, has brought finance into a negative limelight and exposed it to strict regulatory scrutiny. Despite setback, evangelists of financial markets continue to believe in its potential to benefit society. Robert Shiller, Nobel laureate and Professor of Economics at the Yale University, terms finance as a ’technology that can make things happen’. The invention of Green Bonds gives proponents another good reason to promote finance as a tool to create long lasting benefit.
Green Bonds are instruments whose proceeds are exclusively applied towards new and existing projects and activities that promote climate or other environmental sustainability purposes. Designed by the World Bank in partnership with the Nordic Bank, Skandinaviska Enskilda Banken (SEB), the first such instrument, the World Bank Green Bond raises funds from fixed income investors to support World Bank lending for eligible projects that seek to mitigate climate change or help affected people adapt to it. Since 2008, the World Bank has issued approximately US$4 billion in Green Bonds.
The concept of Green Bonds is garnering wide popularity. According to Dealogic, a market information firm, global green bond issuance totalled $7.4 billion via 21 deals in the first quarter of 2014, around two-third the amount issued in the entire 2013. SEB forecasts that Green Bonds will account for 10-15 percent of the corporate bond markets by 2020. However, until recently, the issuance of Green Bonds had largely been limited to International Financial Institutions (IFIs).
That changed in February 2013 when the International Finance Corporation (IFC), the World Bank’s private-sector arm, raised a US$1 billion bond creating interest among financial companies and corporations alike. In November 2013, a French energy group, EDF, raised $1.9 billion, the first euro-denominated green bond from a large company. EDF’s issuance was twice oversubscribed and prompted many other large businesses to dive into the market for Green Bonds. On March 19, 2014, Unilever issued a $415m bond targeted at reducing waste, water use and greenhouse-gas emissions. Toyota is also raising $1.75 billion to help finance car loans for hybrid and electric vehicles.
To set common standards in the rapidly growing market for Green Bonds, a consortium of banks, including Bank of America, Citigroup, Credit Agricole and JP Morgan, published a set of voluntary guidelines called the Green Bond Principles (GBP). This will facilitate a robust and liquid market by launching credible debt instruments and ensuring transparency. The same group of banks has also released a governance framework, which will allow diverse stakeholder input from members ranging from green bond issuers to other green finance observers.
India and Green Bonds
India’s 12th five-year plan has an overarching theme of low carbon growth. The main initiative under this theme is the National Action Plan on Climate Change (NAPCC) that aims to reduce greenhouse gas (GHG) emissions by 20-25 per cent by 2020 with respect to 2005 levels. Eight focused national missions in the areas of solar energy, enhanced energy efficiency, sustainable agriculture, sustainable habitat, water, Himalayan eco-system, increasing the forest cover and strategic knowledge for climate change form the core of NAPCC. Besides, there are several initiatives envisaged in the sectors pertaining to energy generation, transport, renewable, disaster management and capacity building that tie in with India’s overall development strategy.
According to the Finance Ministry, India spends over 2.6 per cent of its GDP to deal with challenges of climate change. However, despite the Government’s commitment towards climate change policies, resource scarcity and other competing priorities make it a challenge to find matching financial resources for mitigating climate change. The Expert Group on Low Carbon Strategies has also stated that mitigation cannot be achieved without significant international financial support.
There are two main ways in which Green Bonds have the potential to significantly change the climate change landscape of India.
First, Green Bonds issued by multilateral organisations like the World Bank and the IFC can use the proceeds from issuance towards investing in new and existing renewable energy projects in India. India’s abundant renewable energy potential and relatively low labour costs are offset by its prohibiting financial environment, and specifically the high cost of debt. A joint Climate Policy Initiative-Indian School of Business study found that high interest rates and relatively short-term loans for renewable energy projects in India add 24-32 per cent to the cost of financing renewable energy in India compared with similar projects in the US and Europe. By providing an additional avenue of direct financial access and by ensuring the funded projects adhere to the internationally standardised regulations and guidelines, investment from Green Bonds would ensure the long term viability of such projects in India.
Second, the successful launch of Green Bonds by corporations around the world can incentivise larger Indian companies to offer such market instruments to improve the environmental impact of their own products and services, enhance their brand image as well as to offer a chance to participate in India’s long term growth strategy.
However, the adoption of Green Bonds in India is unlikely to be smooth sailing. For private sector banks and corporates, Green Bond issues involve specific undertakings that need to be clearly understood by all parties in the transaction. For example, the GBP recommend disclosures like the use and management of proceeds, the investment decision making process, project evaluation and reporting in order to understand characteristics of a Green Bond. A number of key issuers and intermediaries are thus waiting for further guidance on good practice and standardisation. The Government agencies will have to step-in to provide these requisite assurances and ensure transparency.
Lack of a vibrant corporate bond market itself is likely to pose the biggest obstacle in assimilating Green Bonds in India. Although the primary market for corporate bonds has increased 7.6 times in the last 10 years, India’s corporate debt market is just 14 percent of total GDP compared with a range of 40-70 percent for developed countries. Private placements account for 95 percent of overall issuances, largely because of the ease, efficiency and lower cost compared to public issuances. This limits participation by retail investors and FIIs, resulting in a less liquid market. Moreover, due to differential provisioning norms, corporates have predominantly favoured bank loans versus bonds.
The Government has been implementing several measures to improve India’s corporate debt market. The cap on foreign investments in corporate bond markets was raised from US$40 billion to 51 billion in June 2013. Other steps include simplification of issuance procedures, an enabling regulatory environment and innovative products such as infrastructure debt funds and inflation-indexed bonds. Public issuances grew 11 times from 2009 to 2013, primarily due to tax incentives on infrastructure bonds. Similar incentives for Green Bonds can create a crucial new stream of finance for climate change initiatives and move climate finance from traditional fossil fuel investments into the projects that can mould India’s low-carbon growth.
(The writer is a Research Assistant at Observer Research Foundation, Delhi)
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