Most of us know that bonds are issued by corporates, governments, or other organisations for raising funds. Investors buy these bonds as they get a regular stream of income in the form of coupon interest during the tenure and get back their principal on maturity.
We have heard of Bearer Bonds, Perpetual Bonds, Inflation indexed Bonds, Masala Bonds etc. In the last few years Green Bonds have caught the fancy of investors. What are these Green Bonds? Let us try and understand them.
What are Green Bonds?
Green bonds are issued by governments and corporates and proceeds are used for environmentally sustainable projects like production of renewable energy from wind, sun and biogas, clean transportation, sustainable water and waste management, energy efficiency and conservation of biodiversity.
Difference between green bonds and traditional bonds
Typically, traditional Bonds are issued by companies to meet long term requirements or for buying back shares or repayment of loans. Green Bonds on the other hand- apart from complying with the statutory regulations relating to issue & listing– must disclose additional information in the offer document about the utilisation of the issue money and demonstrate how they are benefitting the environment. The issuer also must comply with certain conditions which are globally known as Green Bond Framework.
Green bonds were first issued by the European Investment Bank in 2007 under the label “Climate awareness Bond”. The world Bank issued the first green bond in 2008 which had a maturity of 6 years. Subsequently, in 2013, corporates also started issuing Green Bonds.
The gamechanger was the Paris Agreement of December 2015 which seeks to mitigate greenhouse gas emissions and establish a low carbon economy. It resulted in the exponential growth of green bond market since 2015 and in December 2020 the total green finance market crossed the milestone of USD one trillion in cumulative issuance.
The United Nations has recognized the emergence of green bonds as “one of the most significant developments in financing low-carbon, climate-resilient investment opportunities”. Back home, in India SEBI has issued guidelines on Green Bonds in 2017 which among other things requires issuers to report on the progress of the projects on a half yearly basis.
What is in it for investors?
While green bonds globally have given the lesser returns compared to traditional bonds, they offer investors a better diversified portfolio and carry lower risks. It also lets investors contribute to the sustainable development goals. However as per the RBI report the average coupon rate for green bonds issued since 2015 with maturities between 5 to 10 years in India have generally remained higher than the corporate and government bonds with similar tenure.
For issuers, Green bonds increases their reputation and standing in the market, as it helps them in demonstrating their commitment towards sustainable development.
It also provides them access to global investors who invest only in green ventures. Over a period of time, this could help corporates in reducing the cost of capital.
Market for green bonds in India
Incidentally, Yes Bank was the first bank to issue Green Bonds worth Rs 1,000 crore in 2015 and other banks and corporates have jumped the bandwagon since then. As per RBI report, the outstanding amount of green bonds issued in India in February 2020 was $16.3 billion which constituted about 0.7% of all the bonds issued in the Indian financial market. Although the value of green bonds issued in India since 2018 constituted a very small portion of the total bond issuance, India was next only to China and was ahead of developed countries like the US and UK in issuing green bonds.
The challenges
The RBI report states that though many firms raise funds through green bonds stating that the projects will reduce greenhouse emission and enhance energy efficiency, etc., there are instances wherein companies have not adhered to the same in a strict sense. Further, green bonds offered in India have a shorter tenure of 10 years which is less compared to the international issuances. It further states that while there have been improvements in public awareness about Green bonds, the major challenges were high borrowing costs, false claims of environmental compliance, plurality of green loan definitions, maturity mismatches between long-term green investment and relatively short-term interests of investors.
(Vasant G Hegde is a Chartered Financial Analyst & a former banker and currently teaches at Manipal Academy of BFSI in Bengaluru)