Green Bonds – The Greener Way of Financing

UNDERSTANDING GREEN BONDS AND GREENER WAY OF FINANCING

• Yes Bank and Export-Import Bank of India (Exim Bank) recently tasted success launching what are called ‘Green Bonds’- a relatively new way to finance renewable energy projects.

What are green bonds?

• A bond is a debt instrument with which an entity raises money from investors.
  • The bond issuer gets capital while the investors receive fixed income in the form of interest.
  • When the bond matures, the money is repaid.
• A green bond is very similar.
  • The only difference is that the issuer of a green bond publicly states that capital is being raised to fund ‘green’ projects, which typically include those relating to renewable energy, emission reductions and so on.
  • There is no standard definition of green bonds as of now.
• Indian firms like Indian Renewable Energy Development Agency Ltd and Greenko have in the past issued bonds that have been used for financing renewable energy, however, without the tag of green bonds.
• Green bonds are issued by multilateral agencies such as the World Bank, corporations, government agencies and municipalities.
• Institutional investors and pension funds also have appetite for such bonds.
• The issuer provides periodic reports about the project.

Why are they in the news?

• In March, the Exim Bank of India issued a 5-year $500 million green bond, which is India’s first dollar-denominated green bond.
• The bank has said it would use the net proceeds to fund eligible green projects in countries including Bangladesh and Sri Lanka.
• Earlier, in February, Yes Bank raised Rs 1,000 crore via a 10-year bond.

Why are green bonds important for India?

• India has embarked on an ambitious target of building 175 gigawatt of renewable energy capacity by 2022, from just over 30 gigawatt now.
• This requires a massive $200 billion in funding. This isn’t easy.
• Higher interest rates and unattractive terms under which debt is available in India raise the cost of renewable energy by 24-32% compared to the U.S. and Europe.
• India has big goals in terms of renewable energy installations, but a bighurdle has been financing and the cost of financing.
• “Budget allocations have been insufficient.
• Renewable energy is still part of the larger power/infrastructure funding basket in most banks, and with most financing going towards coal power projects, there is very little funding left for renewable energy.
• Currently, options for raising funds and investing in the “renewable energy” in the public markets in India is very limited.
• That’s why green bonds seem like a good option.

Still, why are green bonds an attractive option?

• Green bonds typically carry a lower interest rate than the loans offered by the commercial banks.
• Hence, when compared to other forms of debt, green bonds offer better returns for an independent power producers.

Why should an investor get excited with lower interest?

• Because, it inherently carries lower risk than other bonds.
• In case of a green bond, “proceeds are raised for specific green projects, but repayment is tied to the issuer, not the success of the projects.”
• This means the risk of the project not performing stays with the issuer rather than investor.

How well have green bonds performed globally?

• A record $38.8 billion in green bonds were issued in 2014, 2.6 times the $15 billion issued in 2013.
• Most issuances of international green bonds have been oversubscribed suggesting a strong appetite for them especially when done by a strong issuer like a large corporate or a government agency.

Who have been the issuers of these bonds?

• In the period between 2007 and 2012, supranational organisations such as the European Investment Bank and the World Bank, as also governments, accounted for most of the green bond issue.
• Since then, corporate interest has risen sharply.
• In 2014, bonds issued by corporations in the energy and utilities, consumer goods, and real estate sectors accounted for a third of the market.

What are the risks and challenges?

• Globally, there have been serious debates about whether the projects targeted by green bond issuers are green enough.
• There have been controversies too.
• Activists were claiming that the proceeds of the French utility GDF Suez’s $3.4 billion green bond issue were being used to fund a dam project that hurts the Amazon rainforest in Brazil.

There could also be a currency risk.

• From an Indian perspective, the downside is that green bonds in India have a shorter tenor period of about 10 years in India whereas a typical loan would be for minimum 13 years.
• This is less when compared to many international issuances.
• Many target buyers of Indian green bonds may not invest in any bonds that are rated lower than the AAA.

BACKGROUND:

• Green Bonds are short-hand for Qualified Green Building and Sustainable Design Project Bonds.
• These bonds are created to encourage sustainability and the development of brownfield sites.
• The tax-exempt status makes purchasing a green bond a more attractive investment when compared to a comparable taxable bond.
• To qualify for green bond status the development must take the form of any of the following:
  1. At least 75% of the building is registered for LEED certification;
  2. The development project will receive at least $5 million from the municipality or State; and
  3. The building is at least 1 million square feet in size, or 20 acres in size.
• The World Bank Green Bond raises funds from fixed income investors to support World Bank lending for eligible projects that seek to mitigate climate change or help affected people adapt to it.
• The product was designed in partnership with Skandinaviska Enskilda Banken (SEB) to respond to specific investor demand for a triple-A rated fixed income product that supports projects that address the climate challenge.
• Since 2008, the World Bank has now issued nearlyUS$ 8 billion equivalent in Green Bonds through over 80 transactions in 18 currencies.
• World Bank Green Bonds are an opportunity to invest in climate solutions through a high quality credit fixed income product.
• The triple-A credit quality of the Green Bonds is the same as for any other World Bank bonds.
• Green bonds were created to fund projects that have positive environmental and /or climate benefits.
• The majority of the green bonds issued are green “use of proceeds” or asset-linked bonds.
• Proceeds from these bonds are earmarked  for green projects but are backed by the issuer’s entire balance sheet.