Climate finance is the new buzz word these days and climate change was the major theme during the recent G20 summit, where India stood firm on the Paris Agreement. Green bonds, blue bonds, green corridors and green initiatives are gaining traction across the country. Investments of $2.5 trillion are required between 2016 and 2030 to meet climate change targets. To arrange for such massive sums of capital, it is important to look beyond conventional financing sources such as banks and non-banking financial companies (NBFCs). Environmental financing must be mainstreamed as soon as possible. Though the expanding green bond market is sending a positive signal to market participants about the country’s commitment towards low-carbon infrastructure, the lack of depth and volume of the capital market is an impediment.
Green bond market
The Indian green bond market grew gradually from $1 billion in 2015 to over $7 billion at present. While this constitutes a meagre share of the over $100 billion global green bond market, the country is progressing fast and is ranked at eighth place globally in terms of green bond issuances. The green bond market is strengthening with participation from public and private sector corporations alike that are opting to raise funds, especially for renewable energy projects. Other than renewable energy, the proceeds of green bonds are also being deployed in the low-carbon transport sector and for construction of low carbon buildings. Most Indian firms turn to the London Stock Exchange (LSE) to raise funds through green bonds. Renewable energy firms such as Azure Power, NTPC Limited, Greenko and ReNew Power and banks such as YES Bank, Exim Bank, L&T Finance, Axis Bank and IDBI Bank have issued green bonds on the LSE. Besides, green masala bonds (rupee-denominated bonds) have also been listed on international exchanges since 2015 such as those issued by the Indian Renewable Energy Development Agency (IREDA) and NTPC.
There has been ample regulatory support for the green bond market. In January 2016, the Securities and Exchange Board of India (SEBI) published the Green Bonds Requirements for Indian Issuers. The guidelines have listed a broad category of projects that are considered green. Further, in May 2017, SEBI finalised norms for issuing and listing of green bonds and other environment-focused bonds. The launch of the country’s own green bond trading platform, the Global Securities Market [GSM] Green, by India International Exchange (India INX) has further signalled regulatory commitment towards sustainable finance. In fact, Adani Green Energy became the first to issue green bonds (worth $500 million) on GSM Green.
Going a step further, the Indian Railway Finance Corporation (IRFC) has set up a Green Bond Framework for fundraising. The proceeds are proposed to be used for financing the dedicated freight corridor and electrification of railways. The IRFC had raised $500 million in 2017 from the 10-year green bond through India INX. Recently, India, through the Hyderabad-based Greenko Group’s $950 million green bond, made its biggest contribution to the global green bond market. Further, the Kerala Industrial Infrastructure Fund Board (KIIFB), a special purpose investment vehicle of the state government, is raising $250 million through the country’s first green bond issue by a government entity.
The interest in green bonds is not only visible in terms of the growth of the Indian green bond market, but is also reflected in the oversubscriptions of some of the bonds. This shows that not only are the issuers showing active interest but that investors are also attracted to the instrument. This is corroborated by the fact that the tax-free bond issued by IREDA in 2016 was oversubscribed by more than 5.1 times.
Other green financing options
Given the huge scale of investments required for financing green infrastructure, the country needs to explore alternative green financing mechanisms. This need is further accentuated due to a fragile banking sector, regulatory restrictions on insurance and pension funds, and an underdeveloped corporate bond market.
- Blended finance: This refers to the merging of public and private funds to maximise developmental impact. The extent to which blended finance is used by multilateral agencies varies. The World Bank’s Multilateral Investment Guarantee Agency (MIGA) is focused on using blended finance, while the International Finance Corporation has established a blended climate finance team to undertake pioneering projects that directly combat climate change. Other multilateral banks make limited use of this mechanism.
- Green securitisation: A mechanism that has proved to be successful globally but has not as yet been explored in Indian green bonds is securitisation. In green securitisation, the cash flows backing the issuance could be from green or non-green assets, but the proceeds raised from the bond issuance are to be allocated to green assets. While most transactions in the Indian securitisation market have involved mortgages and vehicle loans, there is great potential for refinancing loans backed by green assets such as renewable energy and energy efficiency projects. Green securitisation can help diversify the green bond market to cover sectors such as electric vehicles, green housing and agriculture.
- Alternative investment funds (AIFs): Through participation of institutional investors, an AIF allows investment in debt securities issued by renewable energy project developers that are backed by cash flows from stable operational projects. The proceeds from bond issuances can then be used to retire loans that the dev-elopers would have taken from banks/NBFCs. AIFs, by regulation, cannot invest more than 25 per cent in a single security. With an anchor sponsor (for example, IREDA), however, a project may be able to attract more institutional investors, create better credit enhancement structures and increase the scale of placement relative to an individual project.
Key deterrents
The major challenges facing India’s green bond market include high currency hedging costs, lack of a pricing advantage, a poor sovereign rating, lower tenors, lack of standardised reporting, exposure to credit risks, and limitations of foreign investors to invest in sub-investment-grade assets. The cost of issuing a green bond (5-6 per cent per annum post underwriting), coupled with a hedging cost of 3-4 per cent, has rendered the net cost of a bond issue in the similar range as domestic interest rates (of 8-10 per cent) charged by commercial banks. As a result, some public entities, such as NTPC and KIIFB, have issued green masala bonds at the rate of around 7.5 per cent, wherein hedging costs are saved.
Large independent power producers such as the Greenko Group and Adani Power Limited were successful in raising huge sums from the market due to strong promoter backing. However, that is not the case with other developers. Also, partial guarantee mechanisms, such as those offered by India Infrastructure Finance Company Limited and IREDA, have not taken off because of the high fee charged from the developer.
A key factor impacting the rating of bond issues by renewable energy developers is the poor financial health of discoms. “The potential for green bonds is huge. With an ambitious renewable capacity addition target, India is poised for an eventful journey. However, instability and unpredictable counterparty/offtaker behaviour deters players from tapping this market. So far, large players with deep pockets have made these transactions with some partial guarantee. Improvement in the financial health of discoms will steer more developers towards green bonds,” says Vishal Kotecha, Associate Director, India Ratings.
Another key challenge which impacts the credit rating of green projects is the small scale of standalone projects such as rooftop solar, and household or building energy efficiency. In most bond markets, institutional investors seek issuance sizes of at least $100 million, and this makes it difficult to raise financing for smaller projects.
India’s banking sector faced losses of almost $2.5 billion in 2018 due to bank frauds and scams. The lack of accountability and stability has an impact on foreign direct investment, including investments in green bonds.
Future outlook
India is executing the National Action Plan on Climate Change to reduce emissions by 33-35 per cent by 2030, and this highlights the importance of renewable and sustainable energy projects. Investments in renewables have primarily been driven by the government’s ambitious renewable energy target of 175 GW by 2022. Besides, there are opportunities aplenty to finance projects via green bonds in segments such as waste-to-energy, water treatment and urban transportation.
Due to challenges with the partial guarantee mechanism, the government can opt for sovereign green bonds, as per the Climate Bonds Initiative. The country has a sound track record of honouring international debt, adequate foreign exchange reserves and low international debt to GDP ratio. Thus, a sovereign green bond issue can get a better rating and, in turn, a better price, the benefit of which can be passed on to the developer.
Currently, there are a few funds such as GEF Capital Partners, Eversource Capital, etc. which are dedicated to financing green projects. Avendus Capital recently launched the country’s first environment-, social- and governance-focused fund. While these funds are not as well known among the general public, awareness needs to be created to encourage retail participation in such instruments. Mutual fund industry players can create dedicated green funds in their portfolio to help move retail savings to green investment. They can also channel them to platforms such as green AIFs.
In order to create a sound green finance ecosystem, funding instruments and mechanisms holding potential such as sustainability-linked bonds, municipal bonds and philanthropic funding must be encouraged. The country needs to formulate a national green financing strategy to ensure coordination among various stakeholders and design financial pathways to catalyse impact investments. While India has been a strong proponent of green infrastructure and climate finance at various global forums, it is time for the country to walk the talk. w
Ishita Gupta