Sangeeta Lakhi | Sanjana Somani
Banks and non-banking finance companies have been the primary source of funding for renewable energy. However, banks have limited appetite for a major role as providers of long term debt for renewable energy projects as they are weighed down by the risk of an asset-liability mismatch. The long-term funds available with insurance and pension funds in India are not adequately channelised to meet the debt requirement of the renewable energy sector due to regulatory restrictions.
Thus, the existing traditional financing sources are not sufficient to support capacity addition, and given the huge financial requirement of the renewable energy sector, there is a dire need to identify alternate sources to supplement and widen the channels of renewable sector funding.
The introduction of Green Bonds will resolve the issue of funding, which is the reason for delay in these 'green' projects, in the evolving renewable energy sector. Green bonds are debt instruments that raise money to fund clean energy projects. Companies that raise money through these bonds have to invest it only in areas that are environment-friendly such as renewable energy, waste management, clean transport or sustainable land use.
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 US$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 per cent, compared to the US and Europe. India has big goals in terms of renewable energy installations, but a big hurdle 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 story in the public markets in India is very limited. That’s why green bonds seem like a good option.
Benefits and risks associated with Green Bonds
Green Bonds help the issuer amplify funding sources and limit dependency on specific markets. Particularly, Green bonds have been quite popular with investors focused on sustainable and responsible investing and investors that come under the ESG criteria (Environmental, Social and Governance).The proceeds are raised for specific green projects, but repayment is tied to the issuer and not to success of the projects. This means the risk of the project not performing stays with the issuer rather than an investor. There is also a pricing advantage, inasmuch as, the green bonds bring domestic and foreign capital for renewable energy on better financing terms, including lower interest rates, and longer repayment schedules.
Globally, there have been debates about whether the projects targeted by green bond issuers are green enough. There have been controversies too. Reuters reported how activists were claiming that the proceeds of the French utility GDF Suez’s US$3.4 billion green bond issue were being used to fund a dam project that hurts the Amazon rainforest in Brazil.
India’s Green Bond market
India is emerging as a significant Green Bond market and was among the top issuers in the debut year (2015) itself. Green bond issues from India was to the tune of US$1.95 billion in the September quarter of 2017, making it the fifth largest issuer in terms of size in the world for the quarter. The proceeds of these bonds are allocated to renewable energy projects, low carbon transportation, and to energy efficient projects and green buildings.
Recent transactions have demonstrated the demand for and growth of Green Bonds in India. The first Green Bond issue in India was by Yes Bank Limited in 2015 for Rs.1000 crores followed by the Green Bond issue by CLP India for Rs.600 crores for its wind portfolio. Hero Future Energies raised Rs.300 crores, being India’s first certified climate bond issue and Axis Bank Limited raised US$500 million, being the first internationally certified green bond issue.
Positive green sentiment
With the issue of Green Bonds by Indian corporate, there has been a positive effect on account of investor diversification, increased capital inflow from global investors who would invest in green ventures and access to finance at various stages of the project lifecycle. It also enhances issuer's reputation as it helps showcasing their commitment towards sustainable development. At the same time, the drawback of Green Bonds is that the risk of project performance stays on the issuer rather than the investor and investors are at times hesitant to buy bonds with rating lesser than AAA.
The Reserve Bank of India (“RBI”) has included the renewable energy sector as part of the priority sector. As a result, banks must dedicate a certain portion of their overall lending book towards the priority sector, which will in turn help credit flow in this sector.
Formal push to the renewable sector
In 2015, the Securities and Exchange Board of India ("SEBI") endorsed the Green Bond principles which provided a strong signaling impact to the market, when it was in its infancy in India. The Green Bond principles are internationally recognized standards, and SEBI endorsing it, was an important step by a regulator. SEBI has also issued guidelines on Green Bonds (“Green Bond Guidelines”), including listing of Green Bonds on the Indian stock exchanges, thereby codifying the issue of Green Bonds and affording comfort of regulation to an investor.
The Green Bond Guidelines formalise the regulatory framework for Green Bonds with the aim of addressing critical financing needs of India's rapidly expanding clean energy market. These guidelines provide a big boost to the renewables sector by making investment in Green Bonds more attractive to investors. The above measures are expected to facilitate investment decisions of investors who have a mandate to focus on green investments and will also provide uniformity in disclosure. The global Green Bond market is growing rapidly and India is garnering international attention in the form of foreign investment to finance various ongoing projects.
To keep green bonds sustainable, we need an "investor pull" factor rather than a "regulator push" factor. The regulators can kick-start the market, but to sustain it, we will eventually need investors to have a natural demand for the product. Currently, on the demand side, the bulk of investors in Green Bonds are still conventional investors who buy purely on credit fundamentals as opposed to green fundamentals.
Clearly, this would require more investors to reserve a portion of their portfolios for such climate-friendly bonds. As the market matures, perhaps a better RWA (risk-weighted assets) impact for green bonds versus conventional bonds for bank investors could also have the effect of incentivizing such investments.
Sangeeta Lakhi is partner and Sanjana Somani is associate with Rajani Associates. Views expressed are personal.