Step Towards Sustainability: Green Bonds; How Do They Work?

Green bonds were brought into the main market issuances for companies as more and more investors look for products by companies raising capital for environmentally friendly ventures, or towards sustainable development initiatives.

While companies as well as governments issuing green bonds have globally increased, market penetration in comparison to the overall size of the bond markets remains meagre. According to a report by the Institute for Energy Economics and Financial Analysis (IEEFA), cumulative issuances of green bonds surpassed $3 trillion, with the annual issuance at $ 577 billion last year globally. This accounted for a mere 3 per cent of the total size of the global bond market.

What Are Green Bonds?

Green bonds are fixed-income debt assets which are raised by companies and governments to raise capital for green projects specifically. The proceeds of these bonds can be used in projects such as the development of renewable energy, sustainable land usage, clean and green transport, reducing carbon footprint, etc. Funds raised through these bonds must be used for environmentally friendly projects and sustainable development, unlike in the case of regular bonds. These bonds offer investors a way to support environmental sustainability goals while providing competitive returns.

Due to their indication towards environmental sustainability, green bonds have a relatively lower cost of capital compared to regular bonds and require credibility and commitments for the process of raising bonds through these issuances.

India has an existing framework for green bonds, called the Sovereign Green Bonds framework, as per which the Green Finance Working Committee (GFWC) was constituted to validate major decisions on the issuance of Sovereign Green Bonds (SGrBs). During the current financial year, the central government had planned to raise Rs. 1.1 lakh crore through SGrBs.

Why Green Bonds Are Seeing Low Traction In India

While the green bond principles are applicable in India, there is no requirement or mandate for institutions to invest in green bonds. Typically, raising money through green bonds also bears additional costs for companies and governments as they are required to go through additional checks and declarations to separate the proceeds from these bonds from other regular bonds. For this, both the government and companies desire a premium, called ‘greenium’, from investors. There have been instances where investors were not willing to pay a greenium for green bonds, leading to the cancellation of bond raises through SGrBs.

“The absence of robust monitoring and reporting mechanisms exacerbates greenwashing, and addressing this is important to ensure that green bonds achieve their intended purpose of financing genuinely sustainable projects,” Labanya Prakash Jena, consultant for sustainable finance at IEEFA, had said in a note.

How Investors Can Buy Green Bonds

Green bonds can be bought like regular bonds through exchanges or through the Reserve Bank of India’s retail direct platform. Several online bond platforms also offer green bonds. Additionally, some mutual funds and exchange-traded funds also specialise in green bonds. Insurance companies also invest in green bonds. It is, however, encouraged that investors conduct due diligence and look for third-party verification to choose legitimate projects, and conduct a risk analysis before investing in green bonds.