The announcement of green sovereign bonds (GSBs) in the Budget speech of finance minister (FM) Nirmala Sitharaman on 1 February 2022 is a breakthrough in promoting clean and sustainable investments. India’s ambitious commitment to become a net-zero carbon emitter needs dedicated investments to finance clean infrastructures. It is a praiseworthy step, especially after the recently held Glasgow COP 26, where India has committed to becoming a net-zero carbon emitter.
India needs to execute strategic transitioning of its carbon-centred energy infrastructures, which needs devoted investments to finance climate-friendly projects. Indian capital markets are growing in terms of their volumes and have the potential to fund India’s ambitious commitments. But some regulatory concerns and challenges need to be tackled to ensure a credible and robust market of the green sovereign bonds (GSBs).
GSBs are fixed-income debt security, that raises funds from investors who are willing to invest in environmentally benign projects, and have already turned into a mature market in different countries. It has attracted diversified investors like corporate, multinationals, and sovereign wealth funds. In India, GSBs is a new financial experiment and, considering the global experiences, there are regulatory challenges that need addressing.
The Four-pronged Green Bond Principles
International Capital Market Association (ICMA) has put down a set of four-pronged principles that outline the governance of GSBs.
1. The proceeds from the bonds need to be used to finance or refinance eligible green projects.
2. Criteria to be framed to evaluate and select the eligible green projects. It includes third-party opinions regarding the greenness of the concerned projects.
3. Proper management of the proceeds to ensure that it remains invested in green projects or activities.
4. Project monitoring to be done using a third party or independent entity to ensure transparency and accountability.
Key Regulatory Challenges
Ensuring GSBs Remain Green – There are no uniform guidelines to determine activities that qualify for eligible green projects. Therefore, the issuer relies on the opinions of third parties to assess the greenness of projects. The third-party opinion may vary or can create uncertainties about the eligible green projects. This leads to a lack of clarity over the eligible green projects, which generates the scope for diverting the proceeds in non-green projects.
The proceeds remain with the issuers for prolonged durations and therefore, the issuer may divert them in non-green activities. This constitutes a breach of investment criteria and can hamper the credibility of the GSB market.
Ineffective Contractual Protections to the Bondholders Against ‘Defaults’ – In the case of GSBs, the use of proceeds in eligible green projects is an essential investment criterion that the issuer needs to abide by. The investment contract governing the GSBs issuance does not treat the use of proceeds in non-green projects as default, as per the OECD policy report on green bonds titled “
Green Bonds Mobilizing the capital market to low carbon transition”. As long the investors get timely payment of interest, they have no right to protest against the issuer.
The Problem of Rampant Greenwashing – This is one major problem in the issuance of GSBs, where the issuer spreads a fake impression that the proceeds will be invested in environment-friendly activities. It happens because there are no uniform global definitions or market criteria to identify green sovereign bonds or to measure the extent of the greenness of a bond. Greenwashing leads to scepticism in investors’ minds about the credibility of GSBs.
Suggestions
Incorporate ‘Green Use of Proceeds’ as a Contractual Obligation – To ensure the credible and robust GSBs market, proceeds from it must be invested in environmentally benign activities. To ensure this, one possible solution is to incorporate ‘green use of proceeds’ as an obligation under an investment contract. This will trigger the contractual protection in case of a breach and give remedies to investors.
Frame Guidelines on ‘Eligible Green Projects’ – As there are no uniform guidelines or market standards to determine which projects or activities qualify for eligible green projects, the Indian regulators should formulate guidelines for identifying the eligible green projects.
Introducing Penalties for ‘Defaults’ – It is important to clearly define the incidents of contractual ‘defaults’. I strongly argue for treating noncompliance with the green use of proceeds as contractual default and attaching corresponding penalties. It will ensure that the proceeds from the issuance of GSBs remain invested in green projects throughout the life of the investment.
Incentivise Accomplishment of Green Actionable Goals – Lastly, the issuers should properly define their respective green actionable goals for which they are issuing GSBs. This will bring clarity among investors and help in investment decision-making. In addition, incentivising accomplishing the respective green actionable goals will help a lot. The incentivisation could be in terms of tax exemptions. This will encourage the issuers to accomplish their individual actionable goals.
(Saksham Misra is an Assistant Professor of Law at Indore Institute of Law. He is an LLM from the National Law School of India University Bengaluru.)
