Green Deposits: Existing Framework and the Path Ahead

The use of green deposits in infrastructure banking and finance is a growing challenge, with a lack of awareness among individuals and institutions about its availability and benefits. Additionally, there is a need for more product offerings to be made available to investors and for the Indian government to commit to sustainable development. Green deposits can provide an avenue for investors to invest in these projects and help to promote sustainable development in India.

Introduction

Infrastructure is the backbone of any economy. In India, the need for infrastructure development is necessary due to the country’s large population and fast-paced urbanization. However, infrastructure development projects require large amounts of capital, which is always challenging. This is where infrastructure banking and finance come into play. Infrastructure banking and finance refer to the financial services provided to fund large infrastructure projects. In this context, green deposits serve a crucial purpose as a new source of capital for sustainable infrastructure projects. 

SEBI Circular

The Business Responsibility and Sustainability Reporting (BRSR) framework released by the Securities Exchange Board of India (SEBI) through a circular dated May 10, 2021, is expected to promote responsible business practices and encourage companies to invest in sustainable initiatives. The framework seeks to boost the demand for green bonds in India, which can provide a new source of capital for infrastructure projects and promote sustainable infrastructure development. However, it only applies to certain companies, such as listed companies and certain unlisted companies that meet specific criteria. The BRSR framework was voluntary in nature, and companies were not required to comply with it till FY 2021-22. However, it is made mandatory from FY 2022-2023 and hence, would have a positive impact on the environment, society, and the economy in the long run. By promoting transparency and accountability, the framework would improve their overall performance.  Financing energy-efficient projects through green deposits under public-private partnerships (PPPs) is an effective way to promote sustainable development and reduce the negative impact of energy consumption on the environment.

Green deposits can be utilized to finance the construction of energy-efficient buildings, including the installation of energy-efficient lighting, heating, and cooling systems, and the use of sustainable building materials thereby contributing to sustainable development as also envisaged by the Indian Government through a few of its projects. For example, the Centre’s Smart Cities Mission aims to develop 100 smart cities across the country, with a focus on sustainable development and the use of green technologies. Under this mission, several cities have launched projects to develop energy-efficient buildings, including green buildings, with support from the government and private sector partners.

The Hyderabad Metro Rail Limited (HMRL) is a classic example where HMRL collaborated with a private sector developer (Larsen & Toubro) to construct energy-efficient buildings at the metro stations in Hyderabad. The project involved the installation of energy-efficient lighting systems, rainwater harvesting systems, and solar panels to generate electricity[1]. Green deposits were utilized to finance the project, with the government providing guarantees and incentives to attract private-sector investment.

RBI’s Framework on Green Deposits

In recent years, the Reserve Bank of India (RBI) has taken several steps to promote sustainable finance and energy. One such initiative is the introduction of the RBI’s framework on green deposits, which was issued in April 2023. This framework provides guidelines for banks to offer green deposits to investors, with the aim of promoting investment in environmentally sustainable projects.

The RBI framework provides a clear definition of what constitutes a green deposit. According to the framework, green deposits must be used to finance projects that positively impact the environment, such as renewable energy projects, energy efficiency projects, and projects related to sustainable water management[2]. This clarity helps investors in making informed decisions and ensures that funds raised through green deposits are used for environmentally sustainable purposes.

Further, it encourages banks to adopt best practices in environmental risk management. This includes conducting environmental due diligence on potential projects, monitoring and reporting on environmental risks associated with green deposits and integrating environmental risk considerations into the bank’s credit risk assessment process.

One of the limitations of the RBI’s framework on green deposits is that it does not provide any incentives for banks to offer green deposits. While the framework encourages banks to offer green deposits, there are no financial or regulatory incentives for doing so.

Suggestions

In order to make green deposits successful, some tax incentives can be offered to encourage individuals and businesses to invest in green deposits. Some examples of tax incentives that can be given for green deposits include tax deductions, tax deferrals, reduced capital gains tax rate and income tax rate, etc.

The RBI’s green deposit framework includes concessional treatment of liquidity coverage ratio (LCR) and priority sector lending (PSL) requirements for banks that mobilize green deposits, which could help reduce interest rates and capital gains. This can encourage investors to hold on to their investments for a longer period, which can be beneficial for green projects.

Carbon credits are a type of tradeable permit that allows the emission of a certain amount of greenhouse gases. They can be given to green deposits to incentivize investments in projects that reduce carbon emissions or sequester carbon from the atmosphere. Once the project has been certified, the credits can be issued based on the amount of carbon emissions sequestered. The investors may be granted a carbon credit per ton reduced if they invest in the project. Such credits could be sold or traded on the carbon market, providing an additional source of revenue to investors.

The National Clean Energy Fund (NCEF) and other schemes of the government could also be financed with the help of green deposits under public-private partnerships (PPP) in several ways, namely: –

  • Equity Investment

Green deposits can be used to provide equity investment in PPPs that are aimed at promoting clean energy and sustainable development. This type of investment can provide long-term financing for PPP projects and can help to attract additional private sector investment.

  • Debt Financing

Debt financing can be extended to PPP projects through green deposits. This can be done through loans or other financial instruments that offer lower interest rates and longer tenors than traditional commercial loans. This type of financing can help to reduce the cost of capital for PPP projects and make them more attractive to private sector investors.

  • Risk Mitigation

Green deposits may be utilised to provide risk mitigation instruments to PPP projects. For example, they can be used to provide guarantees or insurance products that protect investors from potential losses due to project delays, cost overruns, and other risks. These instruments can help to reduce the perceived risk of PPP projects and attract more private sector investment.

  • Green Bonds

Green bonds that are backed by PPP projects can be issued through green deposits, to be marketed to socially responsible investors. Such bonds can act as a long-term source of financing for such projects and the proceeds from these bonds could be used to finance clean energy infrastructure and other sustainable development initiatives.

  • Technical Assistance

Conferring technical assistance to PPP projects is possible with the help of green deposits and this includes support for project development, feasibility studies, and other activities that help to build the capacity of projects and attract private sector investment.

Therefore, these mechanisms can help to accelerate the development of clean energy infrastructure and support the transition towards a low-carbon economy, while also attracting private sector investment to support sustainable development initiatives in turn providing financial support and incentives for renewable energy and sustainable development projects. Companies could also choose to invest in such projects using their CSR funds, potentially indirectly incentivizing green deposits.

Conclusion

The RBI’s framework on green deposits is a positive step towards promoting sustainable finance and encouraging banks to adopt environmentally sustainable practices. The framework provides clear guidelines for banks to offer green deposits and encourages them to adopt best practices in environmental risk management. However, the lack of incentives for banks to offer green deposits may limit the framework’s effectiveness and the RBI may need to consider providing financial and regulatory incentives for the same.

References:

[1] Anil Nair, Green Bonds for Sustainable Urban Transport in India

Available at https://www.janaagraha.org/files/Green_Bonds_Sustainable_Urban_Transport_India_1217C1.pdf

[2] Ravi Meena, Green Banking: As Initiative for Sustainable Development

Available at – http://www.ripublication.com/gjmbs.htm

Image Credits:

Photo by DAPA Images: https://www.canva.com/photos/MADFHHnnRyY-money-and-investment-growth/

Green deposits can be utilized to finance the construction of energy-efficient buildings, including the installation of energy-efficient lighting, heating, and cooling systems, and the use of sustainable building materials thereby contributing to sustainable development as also envisaged by the Indian Government through a few of its projects. For example, the Centre’s Smart Cities Mission aims to develop 100 smart cities across the country, with a focus on sustainable development and the use of green technologies. Under this mission, several cities have launched projects to develop energy-efficient buildings, including green buildings, with support from the government and private sector partners.

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Financing Global Transition Through Green Bonds

Green bonds were first issued by the World Bank in 2008 to push for private sector participation in projects contributing to a better environment and mitigating the risks of climate change. The Intergovernmental Panel on Climate Change (IPCC), which includes more than 1,300 scientists from the United States and other countries, forecasts a temperature rise of 2.5 to 10 degrees Fahrenheit over the next century.

Hence, it was essential to have an alternative mode of financing that would attract investors and global institutions’ attention towards projects, specifically catering to environment friendly projects thereby also ensuring that governments globally achieve their commitments in the reduction of emissions of CO2 and greenhouse gases.

The Indian government, in particular, has introduced measures and brought out amendments to regulations to encourage the construction of renewable energy projects. However, the evolution and growth of environment focused projects is mostly dependent on the modes of financing available in the market. In this article, we shall review primarily the laws applicable to green financing.

Types of Green Bonds

Green bonds are regular bonds with the distinction that the money raised from the investors must only be used to finance projects that are environmentally friendly. More precisely, green bonds finance projects that are aimed at renewable energy infrastructure, energy-efficient buildings, clean transportation, and waste management.

There are primarily four types of green bonds, mainly distinguished based on the collateral or security being provided in the issuance of green bonds:[1]

  • Green ‘Use of Proceeds’ Revenue Bond: These types of green bonds are secured by the projects producing income.
  • Green ‘Use of Proceeds’ Bond: These types of bonds are secured by assets.
  • Green Securitized Bond: These types of green bonds are secured by large pools of assets.
  • Green Project Bond: These types of green bonds are secured by the balance sheet and assets of the project.

 

Green Bond Principles

The voluntary best practice guidelines called the Green Bond Principles (GBP) were established in 2014 by a consortium of global investment banks.[2]

The GBP accentuates the required transparency, accuracy and integrity of information that will be disclosed and reported by issuers to stakeholders. The GBP has four core components, which include:

  1. Proceeds must be used for green projects;
  2. Process adoption for project evaluation and selection;
  3. Maintaining transparency in the management of proceeds; and
  4. Reporting of information pertaining to the use of the proceeds.

The GBP is a framework devised with the goal of accentuating the role that global debt capital markets can play with respect to environmental and social sustainability.

In India, the Securities and Exchange Board of India (SEBI) notified a circular dated May 30, 2017, which provides for the Disclosure Requirements for Issuance and Listing of Green Debt Securities in India, and the definition of a green bond has been given under the circular, which is within the outline of the International Capital Market Association’s GBPs with certain deviations.

Evolution of  Green Bonds in India

India’s first green bond was issued in 2015 for renewable energy projects such as solar, wind, hydro, biomass and power by Yes Bank. In the same year, another leading banking institution, Exim Bank of India, issued a five-year, $500 million green bond, which is India’s first dollar-denominated green bond.

Subsequently, Axis Bank[3] launched India’s first internationally listed and certified green bond and raised $500 million to finance climate change projects and solutions around the globe and use the bond proceeds to promote green energy in urban and rural areas, transportation and what is called ‘green-blue infrastructure’ projects in India and abroad. KPMG provided third-party independent assurance as per the requirements of the GBP (established by the International Capital Market Association). [4]

Regulatory Framework Governing Green Bonds in India

In 2017, the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (NCS) defined a “green debt security” (GDS) as debt securities used for funding project(s) or asset(s) falling under any of the following broad categories:

Renewable Energy, Clean Transportation, Sustainable Water Management Systems, Climate Change Adaptation, Energy Efficient and Green Buildings, Sustainable Waste Management, Sustainable Land Use, including Sustainable Forestry and Agriculture, Afforestation, Biodiversity Conservation; and any other categories specified by SEBI.

Issuance of listed green debt securities in India must be in compliance with all the following regulations:

  1. Chapter IX of the SEBI operational circular covers the issue and listing of Non-Convertible Securities (SEBI Operational Circular).
  2. The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations).
  3. The SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021.

However, there are no specific guidelines mentioned for unlisted green debt securities other than the general requirements for the issuance of unlisted green debt securities.

In the month of February 2022, Finance Minister Nirmala Sitharaman announced in her budget speech that India will issue sovereign green bonds to fund green projects. In FY23, the government will issue sovereign green bonds as part of its borrowing programme. The funds will be used to fund public-sector projects.

In addition to the above, on August 4, 2022, SEBI issued a consultation paper on Green and Blue Bonds as a mode of Sustainable Finance aiming to align with the updated GBP by ICMA and seek public comments on the proposed regulatory framework.

The Ministry of Finance rolled out the Sovereign Green Bonds framework (“Framework”) [5] that has been rated “Medium Green”, with a “Good” governance score by a Norway-based independent second opinion provider, the Center for International Climate Research (CICERO). The issuance of sovereign green bonds will help the Government of India with much needed capital and deploy funds from investors in public sector projects. The investors shall not bear any project related risks. The Government of India shall use the proceeds to finance/refinance projects falling under eligible green projects.

The Framework has provided a list of excluded projects, which include nuclear power generation, landfill projects, hydropower plants larger than 25 MW etc. Any expenditure relating to fossil fuels is excluded. The Green Finance Working Committee, constituted by the Ministry of Finance, will assist in the selection and evaluation of projects. The Framework’s publication will provide much-needed clarity and direction to the government’s initiatives aimed at transforming India into a green economy.

Benefits of Investment in Green Bonds

Green bond investments may lead to sustainable development and achieve the climate change goal, benefitting the environment in the future. Green Bonds will lead to increased funding for emerging sectors such as renewable energy since the Reserve Bank of India has included the renewable energy sector as part of its priority sectors. As a result, banks will have to dedicate a specific portion of their lending book to the priority sector. This will help the credit flow in this sector.

As far as commercial viability is concerned, green bonds typically have a lower interest rate than the loans offered by a commercial bank, which helps to reduce the cost for the issuer or promoter.

Challenges Pertaining to Green Bonds

  1. Green Bonds, especially in the Indian context, are still not very popular as there is a lack of structure and framework and uncertainty about the return on investment.
  2. There are no proper rating guidelines for green bonds or green projects to help investors make their investment decisions and to verify companies’ improvements, which directly impacts the development of the green bond market.
  3. The funds that have diversified investments in various sectors may not find investments in the green sector valuable compared to returns in other non-green projects. There have also been instances where, during the running of the Project, the issuer or promoters have faced queries from the authorities about whether the project falls under the green category or not.

Green Finance

India announced at the COP26 Climate Summit that it will increase its efforts to achieve the goal of net zero carbon emissions by 2070, including doubling its non-fossil energy capacity to 500 gigatonnes. [6] However, there has been growth in green financing in India over the last few years in both the public and private sectors.

It appears that the banks and financial institutions in India are not ready for the green transition as the experience in factoring climate change as a risk factor is not there when undertaking credit appraisals.[7] Even the bond market in India is still evolving, which is confirmed by the fact that green bonds have constituted only 0.7% of the overall bond issuance in India since 2018. More initiatives will be needed from a regulatory perspective to make green bond issuance more attractive by bringing measures that make investments in green bonds attractive as compared to other debt securities in India and in international markets.

Furthermore, as the world’s nations, including the developed world, look to India to lead the global transition, India should take the lead in attracting investments in green finance, which will not only benefit individual investors looking for safe instruments with attractive returns, but will also benefit the country in generating investment.

Leveraging a Healthy Green Bond Market in India

To build a healthy green bond market, one of the most important criteria is to achieve international norms, rules and regulations for green bonds along with a reasonable return on investment. Green financing, as an additional source of funding, must be used by companies and investors to establish projects that reduce the risk of climate change. There is an unprecedented demand for green energy globally, and investments through green financing will become inevitable in the long run.

References:

[1] https://efinancemanagement.com/sources-of-finance/green-bonds

[2] https://www.climatebonds.net/market/best-practice-guidelines

[3] https://cdkn.org/story/feature-india-strengthens-credentials-green-bond-issue#:~:text=The%20Axis%20Bank%20bond%20issue,base%20being%20%27green%27%20investors.

[4] https://home.kpmg/xx/en/home/services/advisory/risk-consulting/internal-audit-risk/sustainability-services/first-green-bond-in-india.html

[5] https://dea.gov.in/sites/default/files/Framework%20for%20Sovereign%20Green%20Bonds.pdf

[6] https://www.outlookindia.com/website/story/india-will-achieve-net-zero-carbon-emissions-by-2070-pm-modis-bold-pledge-at-glasgow-un-climate-summit-cop26/399507

[7] https://www.financialexpress.com/opinion/how-to-get-green-financing-to-take-off/2753083/

 

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Photo by Towfiqu barbhuiya on Unsplash

Green bonds are regular bonds with the distinction that the money raised from the investors must only be used to finance projects that are environmentally friendly. More precisely, green bonds finance projects that are aimed at renewable energy infrastructure, energy-efficient buildings, clean transportation, and waste management.

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