Validus Wealth

Green Bonds are fixed-income instruments issued for the specific purpose of funding projects that have constructive environmental and or climate benefits.

Green bonds are a growing avenue to raise fund: Should investors allocate their portfolio?

ETMarkets, 4th June, 2022 Rajesh Cheruvu

Green Bonds are fixed-income instruments issued for the specific purpose of funding projects that have constructive environmental and or climate benefits.

Like any typical coupon-bearing debt instrument, they have a specified end objective for using the funds raised.

The bond issuer is bound to exclusively utilise the proceeds to finance eco-friendly ventures or assets such as renewable energy, clean transportation, sustainable waste and water management systems, energy efficient and green buildings, and biodiversity conservation.

Green bonds usually have the same credit ratings and bondholder recourse as conventional bonds of the same issuer (all else being equal).

These bonds tend to have higher reporting and monitoring costs than traditional bonds, thus potentially resulting in higher costs for the issuer.

But they could have a lower cost of capital due to the green bond premium (“greenium”), leading to lesser interest expense.

Policies are being framed with a focus on reducing carbon emissions, as nations and citizens have become aware of the negative repercussions of climate change.

Many countries have explicitly announced net-zero emission targets by a specific year. In addition, the global green initiatives such as Paris Accord and the UN Sustainable Developments Goals have helped spur these programmes even further.

Such clear guidance calls for massive infrastructural developments involving enormous capital outlays. As a result, the governments, financial lending institutions and corporates would plan debt issuances worth trillions of dollars over the coming years.

Green bonds garnered a lot of traction in the past decade post the first issue in 2007. According to the Climate Bonds Initiative, the annual funds raised could hit USD 1 trillion in 2023.

It would be a significant achievement, though it would be just a fraction of the USD 130 trillion of the world bond market. Though USA is the largest source of green bonds, the European market is also growing very fast, with the issuance of USD 300 billion coming up in the next five years.

In its endeavour to make India a low-carbon economy and achieve the ambitious target of 175GW of renewable energy capacity, the FY22-23 Union Budget announced that sovereign green bonds would be a part of the Government’s overall borrowing program.

The resources thus mobilised would be deployed towards public sector projects earmarked as ‘green’. SEBI has also laid down a legal framework (SEBI Green Framework) and principles and guidelines around reporting and disclosure requirements for issuers of green debt securities.

Though green bonds could offer the same or slightly lower yield/return as other conventional bonds, there could be other benefits associated with sustainable investing:

a)- Investors get to showcase social responsibility and support climate action through investing in green bonds as the investment qualifies for SRI or ESG classification

b)- It could provide a way to earn interest income that is not taxable as applicable in some countries. A few federal/local Governments have offered a tax-free status to the Green bonds either in the form of a tax credit, direct subsidy or tax-exemption

c)- An allocation to Green bonds can aid in diversification and moderate climate risk at an aggregate portfolio level. This investment can act as a hedge against the other carbon-emitting and polluting sector exposures which could be at risk to evolving policy frameworks across the globe

d)- Investors with a broader stakeholder or societal view can feel assured that their money is being utilised for a good cause and in a way that is not harmful to the ecosystem.

e)- As per a 2021 research study, there is some evidence which shows that green bonds trade at a premium to conventional bonds of the same issuer. The sustainable angle has created positive market sentiment, driving up investor demand even as supply has not increased at the same pace. The other factors could be expected favourable policy and regulatory action going ahead.

But, as with any investment, this investing category is also prone to risks and fraud.

a)- A unique risk related to green bonds is “greenwashing”, which is the risk that the bond’s proceeds are not used for the stated beneficial climate-related project.

b)- Another risk could be a lack of liquidity as the bonds are held by long-term buy-and-hold investors and asset managers like insurance firms and pension funds.

Thus, the best approach for investors is to consider their risk-reward profile and build portfolios that are aligned to the strategic asset allocation required to meet stated investment objectives and goals.

Given the unavailability of time and lack of knowledge around the most productive method to have a valuable impact on Planet Earth, a need to do something for Mother Nature can be fulfilled indirectly through Green Bonds.

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