Policy and regulatory intervention can supercharge sustainable finance

Indian issuers have focussed on climate mitigation projects, with climate adaptation seeing limited traction.

Since it signed the Paris Agreement in 2016, India has spent about Rs 6.8 lakh crore on green projects until fiscal 2022, or less than Rs 1 lakh crore annually on average. If it is to meet its updated nationally determined contributions (NDCs) and get on to a low emissions pathway, India needs to invest a much larger Rs 28-30 lakh crore in the next seven years. And in the long run, investments will need to go into overdrive, at about 25 times the current levels, to reach Net Zero by 2070.

The new crop of sustainable finance instruments such as green, social, sustainable, sustainability-linked (GSSS+) and transition bonds/loans have sprung from this very need for financial innovation, to address the colossal ask of climate transition. As that requires a vast reallocation of capital, financial institutions, through their resource mobilisation, lending and investing decisions, are well-placed to influence sustainability outcomes in a big way.

In India, the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) have kept pace with these developments and come out with guidelines for green finance. The central government has also framed a sovereign green bond framework and issued India’s first green bonds this year. In short, an entire financial ecosystem around sustainability is falling into place.

Stumbling Blocks

So far, so good. But numerous stumbling blocks persist. For one, India still does not have a taxonomy for sustainable activities — only broad guidelines. The absence of specific reporting standards and guidelines for impact assessment methodologies remains a key concern for investors and lenders. They are also sceptical of claims by issuers, owing to a lack of measurement and verification standards that can detect greenwashing. Overall, both demand and supply side participants are still on a learning curve, on a relatively new and specialised subject such as climate finance with little precedent to rely on.

For another, the GSSS+ bond/loan market is not adequately developed yet. There are no mandates specified for asset management companies (AMCs), lenders and insurance firms. Moreover, though there is a great need, it is not as if profitable deployment opportunities of green proceeds are plentiful. Sectors other than renewable energy are constrained by unfavourable economics and/or scale. Finally, for an issuer, the cost of compliance to issue a sustainable finance instrument is relatively high, as it requires review and verification from third-party independent agencies at various stages. Other trends that highlight where sustainable finance stands in India vis-a-vis other countries are also worth noting.

Leading issuer in Asia, excluding China: India’s green bond issuances are estimated at $21 billion as of February 2023 (cumulatively, since 2015), higher than any other emerging market in Asia (excluding China). The private sector has driven these issuances, accounting for over four-fifth share of total funds raised. India’s GSSS+ bond issuances peaked at ~$9 billion in 2021 before dipping in 2022 in line with the global market which faced headwinds from tight monetary policies and macroeconomic uncertainties.

Green, the most popular label: In terms of labels, green bonds dominate the Indian market. They account for over three-fourths share of issuances in value terms. Renewable energy, with its large financing requirement, makes up more than four-fifths of the total use of proceeds. Indian issuers have focussed on climate mitigation projects, with climate adaptation seeing limited traction. In the global market too, green labelled bonds dominate (55 percent share) but social and sustainability-linked labelled issuances are seeing traction over the past three years, led by multilateral development institutions and issuers in Europe and the United States. India, unlike Japan, China and the EU, is yet to see interest in transition bonds issuances. In terms of currency, the US dollar remains the preferred currency for Indian issuers, considering the demand from offshore investors and India’s relatively underdeveloped debt market.

Greenium negligible, but likely to grow: The combined assets under management (AUM) of the 10 environmental, social and governance (ESG) funds in India has shown robust growth, too. It was over Rs 10,000 crore as of March 2023, or a four-fold increase over the past four years. As many as seven were formed only in fiscal 2021. SEBI’s recent regulations now permit mutual fund houses to launch more than one scheme based on ESG factors, providing more options to investors. Moreover, global markets have seen investors reward a premium — termed as ‘greenium’ — on sustainable bonds, especially green bonds. The premium, though thin, is an indicator of their favourable disposition towards such instruments. For instance, dollar- and euro-denominated bonds earned a premium of ~12 basis points (bps) and ~6 bps, respectively, between 2014 and 2021. India’s sovereign green bonds issued this year also saw a small greenium of 4-5 bps. This is expected to expand as the market matures with improved disclosures, and rising awareness and focus on sustainability.

Strong Policy Push Required

Developing the sustainable finance market in India requires many interventions at the policy and regulatory levels. Specifically, it would require spelling out a taxonomy which provides clarity to investors and lenders, standardises the use of proceeds, and ensures allocation of funds to economic activities are aligned with such a taxonomy. Stricter compliance requirements for bonds/loans to be certified would provide easier access to investors seeking these products. Higher disclosure requirements and improved access to data to reduce information asymmetry would help address investor and lender concerns regarding greenwashing. Introducing mandates for AMCs, lenders, insurance companies, and development institutions would boost domestic demand. Providing first-loss default guarantees by government and/or multilateral agencies would encourage issuances by entities with relatively lower credit ratings.

The government could also provide tax incentives to investors to improve the attractiveness of such instruments, and encourage the development of innovative financing instruments to cater to diverse market participants. Creating a demand pull and regulatory push through such policy interventions would ensure that investor and borrower interests are aligned with India’s energy transition goals — critical, as it cannot happen with intentions or statements of commitment alone.

Pranav Master is Senior Practice Director and Rathin Kukreja is Practice Director, Consulting, CRISIL Market Intelligence and Analytics (MI&A). Views are personal, and do not represent the stand of this publication.