India marks a sustainable finance milestone with release of sovereign green bonds framework

India’s approval of the final sovereign green bonds (SGBs) framework is an encouraging step toward financing its clean energy ambitions.

The plans to finance green infrastructure using the proceeds of SGBs solidify India’s commitment towards its Nationally Determined Contributions targets, adopted under the Paris Agreement. SGBs should also help attract global and domestic investments in eligible green projects.

Compressed natural gas is a fossil fuel that cannot be considered green

While the bonds framework looks robust, it has a few misses. Key among them is the ability to fund compressed natural gas (CNG) when used in public transportation projects. Such a provision risks diluting the framework's credibility as CNG is a fossil fuel that cannot be considered green. Serious environmental, social and governance (ESG) investors will consider this a red flag.

India is replacing petrol and diesel with CNG in the short term as it progresses on the journey towards full electrification of its public transit systems. However, the expansion of CNG infrastructure should be funded through the issuance of conventional debt instruments instead of green instruments.   

Where the framework does score is in the exclusion of financing of other fossil-fuel projects, nuclear power generation, large hydropower, biomass using feedstock from protected areas, etc. These are good exclusions and provide clarity on what is not considered green.

The framework does score in its exclusion of financing of other fossil-fuel projects

The green bonds framework will, however, protect the interests of the investors from project-related risks. An important aspect is that the payment of principal and interest on the green bonds will not depend on the performance of the eligible projects. This makes sure that investors will not bear any project-related risks. Also, projects besides renewable energy, which have long-term cash flow visibility, can be funded through the proceeds.

Overall, the framework is comprehensive and gives sufficient details on all the core components. The framework mirrors the eligible project categories given by the International Capital Market Association’s (ICMA) Green Bond Principles (GBP), which lays down best practices in issuing such bonds. The broad ambit of eligible projects means that the government plans to finance green infrastructure besides renewable energy projects, which have been the primary assets funded through these instruments in India.

The green bonds framework has received a 'Good' governance score from a second-party provider, CICERO Shades of Green. This will help it gain credibility from global investors. CICERO Shades of Green – which evaluates the environmental robustness of green bond and sustainability financing frameworks – also graded the framework ‘Medium Green’ – a score it allocates to initiatives that "represent significant steps towards the long-term vision, but are not quite there yet".

It would be good to have an independent third-party audit of the processes and controls for the selection of projects

It would also be good to have an independent third-party audit of the processes and controls for the selection of projects, management of proceeds and reporting on allocation and impact of the proceeds. Sovereign issuers have complex information flows and decision-making structures to support their green bond transactions. Hence, clarity on the robustness of the process would be desirable for investors.

Another key thing is that ICMA’s GBP provides only a very broad range of high-level categories of green projects, but a strong project selection process will be required. As the next steps, it would be critical for the Green Finance Working Committee (GFWC) to have a robust project selection and verification process that aligns with science-based and globally accepted practices. The eligibility criteria are established easily for assets such as renewable energy. Still, it is not as straightforward for others, such as energy efficiency projects, which might have varying definitions of green.

The framework should provide more clarity on the use of unallocated funds. Green bond issuers invest or keep unallocated proceeds in highly liquid instruments such as high-rated deposit products offered by banks, treasury bills and other money market instruments.

It is imperative to work on creating a pipeline of ideally shovel-ready projects

The framework also lacks clarity on whether SGBs will refinance existing projects. Most of the proceeds must directly finance new projects instead of refinancing existing projects or operational expenditure. In India, corporates that have raised green bonds have overwhelmingly used them for refinancing operational projects. However, leading ESG investors are likely to require a part of the proceeds to go towards projects that have an incremental impact in reducing the economy's carbon intensity. Unfortunately, the framework does not clearly state if, and in what proportion the bond proceeds will be used for financing compared to refinancing.

A commendable first step, India’s green bond framework will definitely help in building credibility with global ESG-aligned investors. While there have been some misses, the framework as whole scores high on several aspects of a robust green bond framework. As the next steps, it is imperative to work on creating a pipeline of ideally shovel-ready projects, selected through a robust project selection and verification process, which need fresh financing as opposed to refinancing.