Somewhere in 2006, Swedish pension funds concerned with global warming and environmental degradation were looking to diversify their portfolio to include investments in environment-friendly projects that would not carry additional risk. They could not find any such instruments. This led them to explore the possibility of creating an instrument like a regular investment product in terms of yield, security, risk and maturity, while addressing concerns related to the environment. After many discussions with stakeholders, the draft of an instrument was prepared. With this, investors approached the World Bank within a month of deliberations, the Bank accepted the concept and worked out the details and the first ‘green bond’ was born in 2008.

This bond created the blueprint for today’s green bond in terms of the criteria to be followed to be classified as one. While drafting the product, financial and environmental teams interacted, understanding and addressing their respective concerns, to ensure that the bond meets the objective with which it was designed. This included criteria like opinion from recognised climate research institutions, transparency and impact reporting.

This bond established that it is possible to raise funds at competitive rates for environmentally sustainable projects and that there is a large pool of investors willing to invest in such bonds.

Multilateral funding agencies like the World Bank and Asian Development Bank

Sovereign governments

Municipal authorities

Banks

Private companies

In general, any entity with a clear plan to use the proceeds from a green bond to finance environment-friendly projects and can demonstrate the environmental benefits of these projects may be able to issue green bonds.

Green bonds issuance: Past performance and future expectations

As seen from thechart above, beginning with a modest issuance in 2017, the issuance of green bonds in 2022 was estimated to be $ 1 trillion and is expected to touch $5 trillion by 2025. A recent analysis by McKinsey suggests a total of $ 9 trillion in green investment is needed each year to reach netzero by 2050. This figure is higher than some other estimates but provides a headline reference against which to compare current investment levels.Sean Kidney, CEO, Climate Bonds, has estimated an annual $ 5 trillion in green bond issuance by 2025 as the next global milestone that governments, policymakers and investors need to reach as the necessary contribution to achieve our climate goals.Together, with equity flows and sovereign outlays, the investment projected by McKinsey should be achievable.

Major issuers in 2021

In 2021,the US, Germany and China were the top three issuers with India ranked No. 17.

Use of Proceeds in 2021

As seen from the chart above, almost 90 percent of the investment was utilised for energy, buildings, transport and water projects.

Documented benefits

There are several benefits of green bonds:

Environmental impact: The proceeds from green bonds are used to fund projects with a positive environmental impact, such as renewable energy projects and sustainable infrastructure. This allows investors to support initiatives that contribute to a more sustainable future.

Financial return: Green bonds offer investors a fixed return on their investment, similar to traditional bonds. This makes them an attractive option for investorswhile helping them in portfolio diversification.

Increased transparency:Green bonds are subject to independent verification to ensure that the proceeds are being used for their intended purpose. This increased transparency can provide reassurance to investors that their money is being used effectively.

Improved reputation: Companies and governments that issue green bonds can benefit from an improved reputation and increased investor confidence.

The World Bank impact assessment report for 2019 has listed the following achievements owing to green bond funding:

The risks

There is a risk that green bonds may be misused or that the proceeds may not be used for their intended purpose. Here are a few potential misuses of green bonds:

Misrepresentation of projects: There have been instances where the projects funded by green bonds were not actually as environmentally beneficial as claimed.

Misuse of proceeds:There is a risk that the proceeds from green bonds may not be used for their intended purpose.

Lack of transparency: In some cases, the use of green bond proceeds may not be sufficiently transparent.

To mitigate these risks, it is important for issuers of green bonds to be transparent about the nature and impact of the funded projects and to provide regular updates on the use of the proceeds. Additionally, green bonds should be subject to independent verification to ensure that the proceeds are being used for their intended purpose.

The India scenario

On November 1, 2021, Prime Minister Narendra Modi announced at COP26 that India would be a net-zero nation by 2070.He also made a number of near-term pledges:

500 gw of installed non-fossil energy capacity by 2030

50 per cent of energy from renewables by 2030

A reduction in carbon emissions by 1 billion tonne by 2030

The emissions intensity of India’s economy to fall by 45 per cent by 2030.

It is estimated that developing nations including India will require $ 1 trillion funding to achieve climate objectives.Everyone agrees that this is a tough target to achieve. To do so, all the stakeholders, Indian and state governments, financial institutions and industry will have to work in unison. The role of financial institutions will be critical as they will play a key role in arranging and providing the capital to transform India and achieve this tough target. The beginning was made by the Export-Import Bank of India in March 2015 by raising $ 500million five-year Reg S Green Bonds. Since then, some progress has been made but it is not enough. The following chart shows the progress made by India over the past four years.

To encourage issuance ofgreen bonds and attract investors,the Government can consider limited period income-tax incentives. The tax concessions may result in some revenue loss to the Government; however, the direct and indirect benefits will far outweigh the concessions.The transformation of the energy sector requiring huge investments opens up a huge business opportunity for construction companies, both in India and globally.

In conclusion Green bonds are a valuable tool to finance environment-friendly projects and supporting the transition to a more sustainable future. By providing a way for investors to align their financial and environmental interests, they are playing an increasingly important role in the fight against climate change and the promotion of sustainable development.

About the author: Vardhan V Dharkar is an Ex-Director of Finance and CFO with 30+ years of experience in successfully providing vision and leadership to high-performance financial organisations of civil EPC and Pharma players.