The need to invest in greener solutions is growing in urgency and amount. And retail investors can play a role in this and earn returns by investing in green bonds. A green bond is a prominent financial instrument in the capital markets for funding ‘green’ projects such as installing renewable energy capacity. It is a fixed-income instrument like any conventional bond, but the difference is that the proceeds are earmarked for green projects. The issuer of green bonds are corporates, banks and financial institutions, multilateral development banks, and sovereign nations. The Government of India is contemplating issuing sovereign green bonds and this was indicated in the recent Budget.
The issuer of the green bond does not offer a higher return than any conventional bond. However, the adjusted return of green bonds could be higher than conventional bonds as the credit and liquidity profile of green bonds are expected to be better. This is attributed to favourable policy and regulations, and positive market sentiment. There is some evidence that suggests that green bonds are traded at a premium compared to conventional bonds —the premium, called ‘greenium’, exists in primary and secondary markets, as per a 2021 research study of 2,000 green bonds and 1.8 lakh conventional bonds by Kristin and Aleksandar.
While the riskiness of any bond depends on the credit profile of the issuer, some unique features of green bonds make them less risky than similar bonds. For one, as climate change is a risk, carbon-emitting sectors are likely to be penalized and carbon-mitigating sectors—which may typically issue green bonds—are incentivized. For example, if we compare the bonds issued by an energy conglomerate with interests in both conventional and renewable energy, their green bonds will be less risky, assuming all things are constant.
Two, at a portfolio level, climate change risk potentially affects the performance of portfolios exposed to carbon-emitting and polluting sectors. Green bonds provide a simple way to hedge this risk. This is especially true over the long-term as climate change risks would likely be fully realized. Adding a green bond in the portfolio could reduce this risk over this period.
The Securities and Exchange Board of India (Sebi) has guidelines on issuing green bonds that outline the eligible sectors where the proceeds can be used. Those sectors include renewable energy, clean transportation, energy efficiency, water, and sustainable waste management, etc. Sebi also has disclosure norms for green bonds, as per which the issuer must make disclosures, including the use of proceeds and a list of projects to which green bond proceeds have been allocated. Borrowers also follow green bond guidelines set by International Capital Market Association (ICMA), an international capital market developing body, to ensure transparency. There are third-party organizations that verify whether the proceeds are used for green projects.
Buying green bonds may seem a simple way to do our part for climate action, but there are two issues to consider. One, a corporate may issue green bond and use its own funds to expand its polluting business. An empirical study by the Bank of International Settlement suggests green bond labels do not assure that the issuer’s overall carbon intensity is falling significantly or comparatively lower. Two, corporates may do ‘green washing’ using the proceeds for carbon-emitting or negligible carbon-reducing projects. Regulators in various countries are developing stringent green bond standards to tackle this. For example, Sebi has a green bond standard, forcing issuers in India to follow prescribed standards to label a bond as green.
Like any other corporate bond, a retail investor can buy these through a broker. Indian corporates also issue green bonds in dollars and these are listed in foreign stock markets such as the New York Stock Exchange and London Stock Exchange. The minimum subscription amount varies with the bond, similar to conventional bonds, and is priced at about ₹10 lakh. The tenure of green bonds issued by Indian corporates is wide—2 to 20 years. The yield on these bonds is in the range of 6.5-10.5% in rupees, based on the bond credit rating, and 5-7% in dollars. Most are investment-grade and hence the credit risk and interest rate tend to be low. In India, there is no tax exemption status, only the satisfaction of doing your bit for the planet.
Labanya Prakash Jena is a regional climate finance advisor, commonwealth secretariat, and a doctoral scholar at XLRI, Jamshedpur. Meera Siva, CFA, works with early-stage startups and investors. The views expressed here are personal.