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What Is a Green Bond & How Does It Work?

Writer # Indiabonds | November 3, 2022

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The concern for the environment is growing and the government and corporates are taking active steps to reduce the activities that have a hazardous impact on the environment. Apart from that, active steps are being taken to create and develop projects that are more environmentally friendly or create a positive environmental impact.

This is where green bonds come into the picture. It creates a win-win situation for all its stakeholders i.e., a good investment avenue for investors like us, a source of financing and a positive impact on the environment. So, what are these green bonds and why should we be concerned about them as investors? Find out here!

What is Green Bond?

Green bonds are like regular corporate or government bonds that are issued to investors. One key difference that sets apart green bonds from their peers is that the funds raised through green bonds are exclusively used for financing the project that creates a positive environmental impact. This can include renewable and sustainable energy projects, clean transportation, biodiversity conservation, green buildings etc.

How do Green Bonds Work? 

As we are clear about what is green bond, let’s proceed to understand how green bonds work. Suppose the government wants to set up environmental friendly projects across the nation. However, to fund these projects, the government is aiming to raise funding from the public at large. Therefore, the government will issue green bonds to the people against which it will be paying a certain amount of interest on the same. Investors can buy these green bonds from any of the stock brokerage platforms that provide this facility.

Process of Issuing Green Bonds

Green bonds are essentially debt securities. In India, SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (also known as ILDS regulations) governs the public issue and listing of such debt securities on a recognized stock exchange. Thus, the issuer of green bonds is also covered under the ILDS regulations. As the issue of green bonds is under the governance of the stock market regulator i.e., SEBI, this makes green bonds a relatively safe instrument to invest in.

While there are no set principles for the issuance of green bonds, The International Capital Market Association (ICMA) has released a document called Green Bond Principles that outlines the good practices necessary for the process of issuing green bonds. These include:

  • Use of Proceeds: Issuers need to define what is considered ‘green’ for them. Disclosure should be made for which projects, activities or assets will the proceeds be used.
  • Project Evaluation and Selection: What will be the process that will be used to determine whether a particular project or asset falls under the ‘green’ criteria?
  • Management of proceeds: What controls or processes are put in place to ensure that the funds are only used in the ‘green’ projects and there is no misutilization of funds?
  • Reporting: How the green projects will be evaluated and their progress is reported. Reporting should be both in terms of financial results and environmental impact.

Benefits of Green Bonds

As stated earlier, green bonds create a win-win situation for all stakeholders. Following are the benefits of green bonds that make them an ideal investing instrument:

  • Green bonds are an excellent way to finance a cost-intensive investment project.
  • Green bonds are a great source of earning passive income that is exempt from tax.
  • The funds are utilized in projects that are environmentally friendly thereby working towards the cause of saving the environment.
  • The green angle in the bond works great in spreading awareness among people about environmental problems. Further, it also shows that corporates and governments are taking active steps towards preserving the environment by initiating environmentally friendly projects.
  • Higher demand for green bonds means lower spending from the pockets of the corporates. This money is then channelised as dividends to the investors.
  • Issuers issuing green bonds earn goodwill and reputation as society perceives them as an environmentally friendly entity.
  • The interest cost in issuing green bonds is lower than that charged on loans by banks and financial institutions. Therefore, they directly reduce the cost of initiating environmentally friendly projects. This acts as a motivation for other entities to undertake such projects and go green.

What are the Risks of Greenwashing?

While green bonds are issued specifically for environmentally friendly projects, there might be certain entities that can convey a false impression of initiating environmentally friendly projects and use the funds for other purposes. These could be done to overshadow their activities that are actually damaging the environment or to exaggerate positive image of the brand. This is known as greenwashing. The following are the risks associated with greenwashing:

  • The Securities and Exchange Board of India (SEBI) has already set up an advisory committee on Environmental, Social and Governance (ESG) related matters. This committee works towards the enhancement of disclosures that are specific to ESG schemes. Further, it specifically focuses on the mitigation of risks associated with mis-selling and greenwashing.
  • Greenwashing can attract stringent penalties for the issuers and entities who are conveying such false impressions.
  • The investors of instruments like green bonds may lose faith in these schemes and financial instruments which will defy the very purpose for which these bonds were launched.
  • Greenwashing can slow down the positive environmental impact that otherwise would have been created if the greenwashing did not take place in the first place.
  • Certain entities with ill intentions can use greenwashing to hide their environmentally damaging practices. Further, creating portraying a false image of being environmentally friendly will create false impressions in the minds of the people who will then buy more products from these entities. It’s a vicious cycle that will directly damage the environment.

In a Nutshell

The above insights clarify green bonds’ meaning and all the other aspects relating to green bonds. If you want to generate passive income, then green bonds are a great investment instrument. It not only helps you invest in a secure avenue but also gives a sense of satisfaction that on having invested in a pro-environment avenue. According to Climate Board Initiative, the annual issuance of green bonds can hit the $1 trillion mark in 2023.

If you are looking to invest in green bonds, you can browse all Green Bonds issued in India through IndiaBonds’ Bond Directory and access detailed information of the Bond. It is India’s first bond directory providing access to 25000+ bonds. Get all the financial details of any of the bonds you wish to invest in and begin your investment journey toward earning a good passive income. Go Green with Green Bonds!

Frequently Asked Questions

1. When were the green bonds first issued in India?

India’s first green bonds were issued by Yes Bank in 2015. The banking giant was raising Rs. 5 billion for enhancing long-term resources to fund infrastructure projects in the clean energy and renewable energy sector.

2. Which is the first ever Municipal Green Bond issued? 

India’s first ever Municipal Green Bond was issued by Ghaziabad Municipal Corporation, Uttar Pradesh raising over 150 Crores for the construction of a tertiary sewage treatment plant.

3. What is the tenure of investment in green bonds? 

Tenure of investment in green bonds may range anywhere between 2 years to as long as 20 years depending upon the issuer and the type of project for which the funding is raised.

4. What is the return on investment in green bonds?

Green bonds can yield an interest of anywhere between 6.50% to 10.5% per annum. The return is quite lucrative as compared to other investment avenues. Further, being debt instruments, they are a relatively safer bet to other volatile investment options.