Sovereign Green Bonds

India launched its first sovereign green bonds recently. It is believed that the Green Bonds will not only boost India’s efforts toward energy transition but will also make finances available for green infrastructure and renewable energy projects. Read here to learn more about green bonds.

In the Budget 2022, the finance minister stated that the government plans to issue sovereign green bonds to raise money for green infrastructure.

The funds raised are to be used to fund public projects that lower the economy’s carbon intensity. The declaration is consistent with India’s goal of having net-zero carbon emissions by 2070.

In line with the announcement, India’s first sovereign green bonds were launched recently.

Sovereign Green Bonds

Governments issue sovereign green bonds to raise money for projects that deal with the environment or the climate. Investors, however, could require clarification on issues like interest rates, liquidity, and trading.

According to the World Bank, a green bond is a debt security that is issued to raise money for initiatives that are relevant to the environment or the climate. Governments offer sovereign green bonds to raise money for these kinds of initiatives.

The first-ever Green Bond was issued by the World Bank in 2008. Ever since its issuance, the Green Bond Market experienced an insane spike.

• Green Bonds continue to be the most prevalent of the sustainability, social, and green bond-set among issuers worldwide.
• Social bonds were displaced by sustainability bonds as the second most common type of bond issued this year in terms of dollars.

Companies, nations, and international organizations all offer green bonds, which guarantee fixed-income payments to investors while only funding initiatives that benefit the environment or the climate.

• The initiatives could involve, among other things, green buildings, sustainable transportation, and renewable energy.
• These bonds’ earnings are designated for environmental projects. This is different from regular bonds, which allow the issuer to use the proceeds for a variety of things.

What distinguishes green bonds from conventional bonds?

• The revenues of regular bonds may be used for a variety of reasons at the issuer’s discretion, whereas the proceeds of green bonds may only be used for environmental projects.
• Green bond issuers are also required to provide details about the project they seek to fund, as well as any anticipated effects on the environment and the climate.

Also read: Electoral Bond Scheme

Sovereign Green Bonds Framework of India

The Framework closely follows India’s “Panchamrit” pledges at the Conference of Parties (COP) 26 in Glasgow in November 2021.

• Through this India’s dedication to its Nationally Determined Contribution (NDC) targets, set forth under the Paris Agreement, would be further strengthened.

To approve important choices for the issuing of Sovereign Green Bonds, the Green Finance Working Committee (GFWC) was established.

The framework has received a “Good” governance score and a “Medium Green” rating from the independent second opinion provider CICERO in Norway.

• The project or solution is given the “Medium Green” classification if it “represents important progress towards the long-term objective, but is not quite there yet.”

The government said the green bonds’ proceeds would be used for green projects that-

• Encourage energy efficiency
• Reduce carbon emissions and greenhouse gases
• Promote climate resilience and adaptation
• Improve natural ecosystems and biodiversity, especially by the principles of sustainable development goals.

The framework listed investments in solar, wind, biomass, and hydro energy projects, urban mass transportation projects such as metro rail, green buildings, pollution prevention, and control projects.

• All fossil fuel-related projects have been kept out of the framework, along with biomass-based renewable energy projects that rely on feedstock from protected areas.
• The government also excluded projects such as nuclear power generation, and direct waste incineration.

The eligible expenditure is limited to government spending that occurred not more than 12 months before issuance.

• The proceeds should be allocated to projects within 24 months of issuing the bonds.
• If an eligible green project is postponed or canceled, it will be replaced by another eligible green project.

Benefits of sovereign green bonds

Governments and authorities are sent a strong signal of intent about climate change and sustainable development by sovereign green issuance.

• It will spur the growth of the local market and provide institutional investors with a boost.
• It will facilitate the expansion of a local market by offering benchmark pricing, liquidity, and a demonstration effect for local issuers.
• Sovereign issuance can help jump-start these significant capital inflows, with the IEA’s World Energy Outlook 2021 projecting that 70% of the additional USD 4 trillion spending to reach net zero is necessary for emerging/developing nations.

Benefits for investors are also manifold:

• Depending on the issuer and the location, tax incentives may include tax credits and tax exemptions.
• Facilitating direct investment in initiatives to enhance society and greening brown industries
• Increased accountability and transparency regarding the use and management of income, which led to the creation of a new risk management instrument
• Comparable financial gains plus benefits to society or the environment
• Investors in Green Bonds would thereby gain additional tax advantages in addition to investment security.

Challenges

Maintaining liquidity and enabling trade in these bonds is the first challenge.

• According to the RBI, statutory liquidity ratio and repo transactions will be open to green bonds. These actions will support the preservation of liquidity and facilitate the trading of these bonds.
• To assure liquidity, twin bonds can also be issued, as Denmark did. Two comparable and interchangeable bonds are issued under this arrangement, allowing investors to move between them and promoting increased trade and liquidity.
• Based on the twin bond strategy, the government and RBI previously issued market stabilization bonds.

The interest rate on these bonds is the second issue.

• Will investors pay more or less for green bonds of comparable maturity compared to regular bonds?
• Market participants refer to the price differential between green bonds and regular bonds as “greenium.”
• Research by US Federal Reserve economists shows that corporate green bonds have a yield spread that is 8 basis points lower relative to conventional bonds.
• Before investing, investors will require additional details about the green projects.
• Given that investors will initially be unsure about factors like liquidity and tradability, there may initially be a “green discount.”

The third challenge is to make sure that green bonds continue to be a component of the budget and the broader borrowing program.

• Such thematic bonds are frequently employed by the government off the balance sheet, which causes the total borrowings and deficits to be underestimated.

Also, investors worry about greenwashing as well.

• Investors want to be sure that their resources are being allocated to projects that make a difference and have positive impacts.
• In addition, financial factors such as macroeconomic outlook, credit profile, and political risks are relevant for investors when evaluating thematic bonds.
• Sovereigns should take these factors into account when planning such green bond issuances.

Way forward

Interest in sovereign green bonds from countries and investors is growing. Considering the potential of this market, the World Bank surveyed emerging market trends and international investors to understand the prospects for such transactions which reiterated the trend.

Challenges related to establishing governance arrangements to manage and track proceeds, knowledge of international standards and investor expectations, and the limited pool of eligible projects constrain the supply of emerging market sovereign thematic bonds.

The need for sovereigns to issue green bonds remains because of significant funding needs to implement actions related to climate, environment, and SDGs, yet challenges must be addressed.

Unlocking the potential for sovereign thematic bonds in emerging and developing markets can only be achieved by clarifying market expectations and overcoming the knowledge gap.

Related article: Social Impact Bonds

-Article written by Swathi Satish