CFI Newsletter #12: The Future of Green Bonds in India
+ We celebrate a friend's success, targeting CO2 super emitters, a 3 degree world, and bridging the adaptation financing gap
The Climate Finance Initiative Newsletter offers quick digests and insights around what is happening in climate finance. While the Climate Finance Initiative’s current focus of work is India-centric, we will capture a global perspective of climate finance in this newsletter on a fortnightly basis.
We want to start today with a shoutout to our friends at Snehakunja Trust who just won the very prestigious Equator Prize for 2021 - pretty much the Nobel Prize for biodiversity and conservation. Simmi has firsthand experience seeing the team in action, as a director on the board of IFHD, a sister concern of Snehakunja, and she has some impressive stories to tell. Whether it is supporting farmer producer organisations, preserving biodiversity in wetlands or creating cutting edge carbon offset and blue carbon projects, the folks at Snehakunja and IFHD are creating real, grassroots impact to combat climate change, and we celebrate the wonderful work they do.
Congratulations, team Snehakunja! We are honoured to count you among friends of CFI.
Climate Finance by the Numbers
By now we - you, me, policymakers, and even school-going kids - are mostly aware that fossil fuel combustion for electricity, primarily coal plants, is the single largest contributor to global carbon emissions.
Most of us are also aware that tackling this as a sector-wide transformation of pulling the plug on coal and oil plants en masse and shifting to renewables is not as simple as it sounds (ok, the school-going kids may not think this).
But we may not need a sectoral transformation to create big wins in reducing the energy sector’s carbon emissions.
Research by a team from the University of Colorado Boulder found that just 5% of the world’s fossil fuel plants are responsible for a staggering 73% of global emissions from electricity generation. This amounts to around 1,450 plants, admittedly a not insignificant number, mainly found in the 10 most populous and/or industry-oriented nations: China, United States, India, Japan, Russia, South Korea, Germany, South Africa, Australia, and Indonesia.
The team calculated that by just upgrading these hyper-emitters to operate on the same intensities as the global average would lead to a 25% fall in the world’s carbon emissions, not just the energy sector’s, the world’s. If these coal and oil plants switched to natural gas as their energy source, emissions would reduce by 30%. If these 1,450 plants were to implement carbon-capture technologies, the world’s global emissions would reduce by 50%.
What this research shows for us, is a route to bypass the traditional roadblocks of inertia that hide behind a reluctance to transform the energy sector. We do not need to focus our efforts on a wider transformation. Targeting this select group of super polluters on its own will lead to disproportionate climate benefits for countries and the world.
3 degrees warmer
Last week, the Economist cover story warned us that a world that is 3 degrees warmer compared to pre industrial era is looking plausible in second half of the century. NY Times chipped in with a dire prediction of its own: “No Place is Safe”. These alarming predictions are prompted by some truly extreme weather events seen around the world in the past month. Just in the course of a few days, we saw flooding in both Western Europe and China, as well as extreme and unprecedented heat waves in North America. The frequency of these climate events is making many, including us at CFI, wonder whether we are already at the point of no return: even if we were to reduce emissions significantly, is it even possible to stop the world from warming a disastrous 2 degrees and beyond.
The Paris Agreement was designed so that if all countries meet their commitments, global warming will stay well below 2 degrees. However, Climate Action Tracker, an organisation that tracks all the policies that have been put in place after the Paris Agreement, estimates that the world will be 2.9 degrees hotter by 2100 even if all the policies that have been put in place by member countries come to fruition. This means that we need more climate action than what’s been committed so far, and we need to see tangible progress far quicker than before. IPCC’s models suggest that the investments we make in the next ten years will be critical to restrict global warming below the magical 2 degrees. We find it heartening that EU has come up with a concrete plan that will push its climate goals towards net zero emissions by 2050. The rest of the world needs to follow suit.
USD 300 billion
It says a lot that the United Nations Environment Program has an annual report titled the Adaptation Gap Report, emphasis on the Gap part.
Annual adaptation costs are expected to be between USD 140–300 billion in 2030 and USD 280–500 billion in 2050. The variance is attributed to the difficulty in forecasting adaptation needs to the costs to address it. Given how we have tended to underestimate a lot about impact of climate change, it does make sense for us to view the higher range as the target to be met.
We focus on the metrics for 2030, as the next 10 years are critical in our ability to mitigate the impacts of climate change. So how are we doing in trying to meet this target? There is already a significant gap in adaptation funding. The estimated adaption cost for developing countries today is USD 70 billion a year. Pre-COVID, in 2017 and 2018, the annual flow to adaptation projects was USD 30 billion. This gap will only increase over the coming years as the need for adaptation investments outpaces the increased funding projected by UNEP.
Even more stark is the lack of private investment. A report by the Global Center for Adaptation shows that the bulk of the USD 30 billion that was invested into climate adaptation in 2017 and 2018 was from development finance, often with bilateral and multilateral support. Only 1.6% was from private financing. This could, however, be changing. Recent climate events show that properties and businesses will suffer significant damage if investments are not made into building resilient cities. Even if adaptation has not made sense to private investors thus far, it is time that insurance companies and asset managers take notice of the cost of climate disasters and invest in adaptation instead.
THE BIG READ
The Future of Green Bonds in India
Green bonds are labelled as one of the most effective ways to finance climate and environmental solutions at scale but what are their prospects in India?
They have been called the best bet we have against climate change. They are blossoming. And yet there is more to green bonds than a big bang headline announcing that India is the second largest market for Green Bonds after China in the emerging markets.
To understand green bonds better, CFI HQ sat down with Sandeep Bhattacharya, the India Projects Head of the Climate Bonds Initiative, for a long free-wheeling conversation around the future of green bonds and their ability to address climate change and environmental issues for India.
A nuts-and-bolts question: What makes a green bond, a green bond?
“The basic concept is very simple, that the use of proceeds raised from the bonds must be towards green purposes, when you get to the application however, that’s where details matter.
The key question is: what is green?”
Green can mean many things to different people. One example is a request that Sandeep received to issue bonds against flue gas desulfurization of thermal power plants. Now fossil fuel related projects are clearly not green, but to avoid ambiguity, Climate Bonds Initiative has created a detailed taxonomy. So how do Sandeep and the Climate Bonds Initiative (CBI) define green?
“We go by The Green Bond Principles of the International Capital Markets Association which lays down the definition, governance, and boundary of what can be classified as green. The CBI has taken those principles and made them granular; making a Green Bond Standard, and worked towards defining a taxonomy, first issued in 2012, for what is green that is compatible with the Paris Agreement targets, and has been largely adopted by many investors, mainly in the West. CBI also looks at the governance standards as part of its certification process”
Not all green bonds issued in India are certified by the CBI, only 48% of all Green Bonds issued till 2018 were. The remainder were verified through other agencies, including ones whose taxonomies are not published, unlike the CBI’s very publicly accessible one. However, Sandeep says that with increased investor awareness, there are only a few bonds being issued without any sort of external verification currently. There is also a definite move towards verification agencies making their taxonomy more transparent.
What is driving Green Bonds in India?
India is the second largest emerging market from where approximately USD 6.5 billion was issued in the first half of CY 2021 alone, but what exactly is driving the green bond market in India?
We asked Sandeep to cast his eye over a couple of things here: what sectors and areas will attract financing through green bonds, beyond renewable energy, and where will this financing come from?
“There are quite a few potential sectors. I would say the electric vehicle (EV) ecosystem, for starters, will need a huge amount of capital [one estimate puts India’s EV capital needs at USD 180 billion by 2030]”
Sandeep projects that in 5 years time, we will likely see significant green bond issuances across the EV value chain. Distributed solar, utility-scale renewable energy’s little cousin, is another expected area that will see green bond issuances.
“Rooftop solar is now in a bit of a plateau waiting for battery costs to go down a bit. The moment battery costs becomes competitive, we will see an upsurge in distributed solar. There are already solar companies borrowing amounts from between USD 50 to USD 80 million; that can show a way forward in green bond issuances.”
A sector that Sandeep has a bullish crystal ball gaze towards is India’s waste management and recycling space, a sector that is more mature than EV. However, Sandeep mentions that the need for capital there is not as high as solar or EVs so we will see smaller issues here. The reason that solar, EV and waste come across as good candidates for green bond issuances is clear: these are sectors where there is a clear need for capital, there is supportive government policy driving the adoption of solutions and innovations and there is a clear impact story.
Waste management, for instance, is solving for problems like garbage dumps that are becoming landslides killing people, and health-related risks to communities from wastes dumped in water bodies and grounds. These are problems that cannot be ignored and fixes are needed at scale.
“[In the same vein] we have an over-reliance on imported fossil fuel for energy that influences wider factors like our fiscal deficit and inflation. This makes it a necessity for energy security to be driven by renewables. Not just in energy generation, but also with EVs to replace internal-combustion engines (ICE) vehicles in the long-run.”
That said, green bonds are meant to issue capital at scale which means that emerging sectors have a way to go before they can access this capital. Climate resilient agriculture is one such area with a huge potential, but where few innovations exist at a scale to raise green bonds. Water, another critical sector, has a different challenge:
“Water is largely managed by municipal corporations who do not have timely prepared balance sheets and high investment grade ratings (AA and higher). Their capacity to meet the stringent reporting requirements of the investors is also a constraint.”
The first green municipal bond in India from the Ghaziabad Municipal Corporation, however, could refocus how municipal corporations can take green bonds on the water front.
Who finances the USD 6 billion in green bonds in 2021 we have seen so far, and future green bonds?
“What's driving this financing is the presence of green capital from the West. Even in 2017, Indian corporates garnered more than USD 3 billion from the offshore market. This is because the offshore market has a lot of dedicated green capital that can be deployed across the world.”
Domestic capital provides a very small fraction towards green bonds. The main reason is a lack of dedicated green capital at the scale required to finance green bonds. Environmental, Social, and Governance (ESG) funds in India do not necessarily focus on environmental impact as their primary investment focus.
“This is a chicken-and-egg issue: assets need more investor demand to become more investable, but investors need investable assets to start a dedicated green fund.”
Sandeep expects the ESG firms to take notice of the green bonds market when net-zero regulations push more issuers towards higher compliance, creating a larger pipeline of high quality bond issuers. But in the short term, offshore capital will continue to dominate green bond markets in India.
“What drives dedicated green capital in the West is basically consumer awareness. People are aware of the consequences of environmental action and have the influence and need to direct capital, such as through pension funds, towards green assets that offer a better chance of reducing negative environmental consequences with a lens on the long-term.
“That kind of awareness with individuals in India is just not there. There's no ask from the individual, and therefore, a fund manager does not need to do anything and therefore capital does not flow.”
But there might just be some hope for the domestic bond market.
While not the largest green bond issuance, Vector Energy’s recent green bond issuance through its 6 subsidiaries, was able to raise USD 166 million, by far the largest domestic green issuance in the country so far. The issuance saw widespread interest from a variety of investors like banks, mutual funds, insurance companies, corporate houses, and ended with half held by mutual funds, and the other half by banks.
With this perceived demand, why are more companies not following the domestic route?
Vector Energy’s bond issuance may show a way, but it is still something that will take time to become more common. While Vector opted for a domestic capital due to no foreign exchange risk and a lower cost to funding, any larger transactions and anything lower than the AAA rating that Vector Energy had would not likely have led to the issuance transpiring; in fact, Vector’s CFO T Pattabiraman pointed to the credit rating as the key differentiator for them.
There’s a long way to go for the domestic green bond market to develop, but the buzz created by this issuance should certainly help things further.
How are the actual environmental impacts created through projects that raise green bonds measured?
“We make a sector criteria and taxonomy, in a stringent and in-depth manner that allows us to determine how a project in that sector will create impact. Everything is certified after a lot of diligence on end use and governance. Given this initial diligence, we do not insist on quantifying the actual carbon savings.”
However, Sandeep mentions that even without a requirement from an agency like the CBI, a lot of issuers end up undertaking measurement and tracking of their environmental impact, for a different goal: PR. The choice not to opt for regular monitoring as a requirement of a green bond issuance is also a practical decision:
“If we had a need to commission regular studies to measure impact, it would add to transaction cost tremendously. Adding granular and complex monitoring requirements could halt global flow of capital to sectors that have demonstrable impact, but are nascent and not mature.”
But it can change in the future, Sandeep says, as green sectors become more developed and mature. This scale and consequent data availability can make information more readily available that reduces transaction costs. PR and investor requirements are also likely to drive voluntary impact measurement and reporting further.
How do we improve the green bonds ecosystem in India?
“India needs more domestic capital to finance green bonds and needs the ability for smaller ticket sizes to be financed.
A dedicated green fund sponsored by a multilateral organisation could be a big driver to kickstart the domestic market and create demand for other funds to join in.”
Sandeep also adds that given the nascent stage of markets, a second solution would be a bond guarantee institution that could provide confidence to early investors and encourage smaller issuances.
“Currently offshore financing below USD 100 million does not make sense as transaction costs are too high, but there is a lot that can happen below that transaction size. There could be funds set up, with a smaller corpus managed with a decent margin who could focus on emerging segments”
Sandeep points to Sammunatti’s green bond, announced on 28th July, and raised to back climate-resilient financing to agricultural small-holders in India, as something that people should take notice of. At a raise of USD 4.6 million it is too small even for the USD 10 million that a bond guarantee institution would likely be comfortable with. And yet it has been financed by Symbiotics, a European-based investor.
“A fund based in India could easily replicate what they are doing because if you are in the country, you understand the local context and the credit risk much better.”
To encourage market growth, a large part of CBI’s work is building the pipelines of relatively smaller issuers who can grow over time to a level where they can access the bond markets. As an example, Sandeep points to an engagement that The Climate Bonds Initiative is looking to do with NABARD to get them to include newer innovations around climate resilient agriculture into their refinancing list, and simultaneously try to put it up in front of MFIs for their adoption.
“From these initial MFI investments we hope for portfolios to build and grow in the climate agriculture sector that can allow for green bonds to be tapped. We need to do this work across the entire ecosystem.”
Along with building a pipeline of potential issuers, building credibility is the other near-term action that needs focus on, something that The Climate Bonds Initiative builds through tie-ups to get to as many stakeholders as possible.
“We have designed a course with IIT Bombay on sustainability. We have done a tie up with the CFA Institute for two papers, one on green bonds and the other on climate smart agriculture, all towards building credibility with stakeholders active in the space.”
Sandeep points to the importance and critical nature of such engagements that are necessary to align the ecosystem in a nascent green bond market like what India has. It looks like everyone in the climate ecosystem has a role to play for green bonds to emerge as a scalable financing option for ventures in India.
Engaging with CFI
As always, if you are keen to engage or talk to us on our work plans (check out the deck here) or if you have something of your own to collaborate on, reach out to us below!
That’s it for Edition #12 of our newsletter.
As always, send all feedback, compliments and brickbats our way. And of course, we do appreciate you spreading the word about this newsletter.
We are also looking to write more collaborative research. If you have a climate finance story to tell, do get in touch!
Simmi Sareen and Shravan Shankar