This article has been written by Pranjal Sharma pursuing Diploma in US Corporate Law and Paralegal Studies.
This article has been published by Sneha Mahawar.
This article documents a brief introduction to green bonds financial instruments and the benefits it reaps to issuers and investors.
This article has been divided into six sections as stated below:
- What is a green bond instrument
- History and origin
- Different types of green bonds
- How it works
- Benefits of green bonds to the issuers
- Benefits of green bonds to the investors
The anticipated read time for this article is 25 minutes.
What is a green bond instrument
Green bond financial instruments fall under the category of fixed-income investments. It is specifically used for environmental and sustainable projects. These projects include wind, solar and hydro energy. Green bonds can be issued by companies, organizations and governments. These bonds are generally issued for raising capital for renewable energy and these bonds help nature by providing for a better recycling effort, and sustainable forestry.
These bonds are typically asset linked and backed by the issuing entity’s balance sheet. They carry the same credit rating as their issuer’s other debt obligations.
History and origin of green bonds
In the year 2007, an agency of the United Nations published a report surfacing the negative effects of human activities on the environment and how it is related to global warming. This report triggered the Swedish government and shortly afterwards, they undertook financial projects for the betterment of the environment.
In the very next year that is 2008, the World Bank issued the first green bond and thus green bonds originated. Since then, over the years more and more countries adopted this financial instrument and realized its usefulness towards the betterment of the environment.
Today, more than 50 countries have adopted this financial instrument to raise funds for the betterment of the environment and among these countries, the United States is the largest issuer of green bonds.
In the year 2020, the estimated worth of wealth generated by the issuance of green bonds stood at 350 billion dollars.
Different types of green bonds
There are majorly six types of green bonds. These are “Use of Proceeds” Bonds, “Use of Proceeds” revenue bonds or asset-backed securities (ABS), project bonds, securitization bonds, covered bonds and loans. Each of the aforementioned types is briefly explained below:
- “Use of Proceeds” Bonds: Needless to say, the money provided by the lender is used for green projects. In case of liquidation, the lender has recourse to the other assets owned by the issuer.
- “Use of Proceeds” Revenue Bonds or Asset-Backed Securities (ABS): Money provided by the lender is used to finance or to refinance green project initiatives. Unlike the case in “Use of Proceeds” bonds, in this case, the collateral for the debt comes from the revenue collected by the issuer which can be taxes or fees.
- Project Bonds: Capital financed in this type of green bond can only be invested in a specific green project and the scope of this type of green bond is limited to that particular green project only.
- Securitization Bonds: Capital financed by this type of green bond can only be invested in a set of green projects. It is similar to project bonds in a sense. Project Bonds have a scope limited to just one project but in this case instead of one green project there is a portfolio of multiple green projects.
- Covered Bonds: This type of green bond is used to finance a group of green projects. This group of green projects is called Covered Pool. In this type of green bond, if the issuer fails to repay the debt payments, then the bondholders gain recourse over the covered pool.
- Loans: In this type of green bond, the issuer takes a loan from the investors. This loan can either be backed by collateral or can be insecure and not backed by any collateral. In this case, if the issuer fails to make the repayment, then the lender gains control over collateral (if there was any). If there was no collateral, then the lender gains control over the personal assets of the issuer.
How green bonds work
In terms of functionality, green bonds work just like any other corporate or government bond. Borrowers or issuers of green bonds issue green bonds to the investors/lenders and raise capital. This capital is then used for running green projects. These green projects result in the betterment of the environment.
Types of green projects commonly financed by green bonds are energy efficiency projects, renewable energy projects, natural resource management projects, projects to prevent water pollution, projects that promote clean transportation, projects that promote green buildings, etc.
Investors or money lenders who invest in these green bonds expect to earn profits when their bond matures. Not just this, money lenders also receive tax benefits when they invest in green bonds. It is so because by simply purchasing green bonds, they become part of initiatives that work for the noble cause of betterment of the environment and mother earth. Since the government wants to promote green initiatives, it gives tax benefits to those who purchase green bonds. As per Section 80 CCF of the Income Tax Act, 1961, the government can provide a tax deduction of up to Rs. 20,000 on certain notified long-term infrastructure bonds.
This also makes green bonds unique in the sense that investors who purchase green bonds reap profits in multiple ways. Examples of these benefits are profits when the bond matures, tax benefits, and being part of initiatives that work towards the betterment of mother earth.
Indian government’s initiatives
By virtue of Article 48-A, the Government of India is under a constitutional obligation to work for the betterment of the environment. In the year 2015, the Securities and Exchange Board of India issued a concept paper for green bond issuance. The concept paper highlighted the need for green bonds to achieve clean energy goals. Green bonds help in maintaining positive relations with the public and also facilitate investor diversification. The paper further pointed out that the green bonds issued by the World Bank and European Investment Bank have gained much popularity and India must also aim for the issuance of green bonds.
Recently, the Government of India announced that it would issue green bonds for the purpose of raising capital for green investment projects and released the framework for sovereign green bonds. This will help in reducing the nation’s carbon intensity. The proceeds received from the issue of Sovereign Green Bonds would be used for public sector projects. It is pertinent to note that the investors who invest in sovereign green bonds will not bear any project-related risks and the payment of interest and principal would be made irrespective of the performance of the projects where the proceeds are deployed. Moreover, the Government of India has committed to provide transparent reporting on the use of the proceeds of Sovereign Green Bonds.
The government is also planning to introduce the Energy Conservation (Amendment) Bill, 2022 which aims at specifying a carbon credit trading scheme.
Benefits of green bonds to the issuers
Green bonds reap multiple benefits for their issuers or capital borrowers. Some benefits of issuing green bonds are:
- Diversification: By issuing green bonds the bond issuers can diversify their sources of raising capital. Green bonds provide the issuers with liquidity and a demonstration value.
- Reputation: Working towards the betterment of the environment and mother earth is a noble cause. Needless to say, the individual or group of individuals taking these initiatives earn the respect of those around them. Since capital raised by green bonds is used for the betterment of the environment, the issuers thus also gain the respect and admiration of those around them. This includes the government as well since the government wants to promote more and more environment-friendly initiatives.
- Sustainable financing: Green bonds provide a source of sustainable financing to the issuers and can raise sustainable capital by leveraging this financial instrument.
- Attract investors: Green bonds are not just issuer-friendly but are investor friendly as well. An investor who invests in green bonds reaps profits at its maturity, reaps tax benefits throughout the bond lifecycle and by simply investing in green bonds becomes part of the noble cause of betterment of the environment and thus mother earth. Because of these reasons, green bonds generally always have high demand among investors. This is beneficial for issuers, as green bonds by their very own nature attract investors and are comparatively easy to raise capital with.
Benefits of green bonds to the investors
Green bonds reap multiple for its investors or capital lenders. Some benefits of investing in green bonds are:
- Financial returns: Green bonds as a financial instrument are not lesser than any other corporate or government bond. Investors investing in green bonds can expect profits at maturity in the same manner as they do in the case of any other corporate or government bond.
- Tax and Social benefits: Since the capital provided by investors by purchasing green bonds is used for green projects, that is, for the betterment of the environment and thus mother earth, the investors willing to invest in green bonds also become contributors to this noble initiative. The government also gives tax benefits to those who invest in green bonds. It is so because the government wants to promote this initiative and wants to protect and improve the environment and mother earth.
- Resolve climate change-related risks in their portfolio: Investors can invest in green bonds to get rid of climate change-related risks present in their portfolio. These risks are associated with changing policies such as carbon taxation which can lead to stranded assets. By investing in green bonds, they can invest in environment-friendly initiatives such as green building, etc., and bear a lower credit risk over time.
The rapid growth of green bonds in the capital market has a vast area of discussion and attention of investors attracted towards its growth and the returns from this investment. As we are witnessing the awareness among people for environmental and sustainable activities, so this leads to a strategic investment that will turn into a profitable venture and at the same time, it will be considered an environment-friendly investment which ensures its productivity in various activities such as clean water, agriculture and biodegradable waste treatment. Any such progression in environmental upgradation will need proper capital to finance its purpose.
Investors become aware of the risks of climate change to their portfolios and it is evident by the mechanism of the task force on climate-related financial disclosures (TCFD). They are working to report on such risks.
Green bonds provide investors with a proper platform to involve in good practices and majorly influence the strategy for businesses to issue bonds. Green bonds enjoy a 49% growth rate in the five years before 2021. As per climate bonds whose study provides a rough estimate of the green bonds market, annual issuance of green bonds could exceed the $ 1 trillion mark by 2023.
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