Green Bonds - Advantages and Risks

Green Bonds - Advantages and Risks

Question - Yes Bank and EXIM Bank recently launched green bonds. Explain what green bonds are and discuss their advantages and risks.

Green bonds are a relatively new way of financing renewable energy projects. There is need for green financing because unfavourable terms and higher interest rates under which debt is prevalent in India inflate the cost of renewable energy by 24 to 32 per cent as against Western nations such as the US.

Features of Green Bond

• A simple bond refers to a debt instrument through which an entity raises money from investors. Following maturation of the bond, the money is repaid. Green bonds publicly state that money is being raised for funding green projects such as renewable energy, emissions reduction and such like.

• Indian firms such as Greenko and Indian Renewable Energy Development Agency Ltd have issued bonds in the past used for financing renewable energy sans the green bond tag

• But in recent times, green bonds have gained currency as a means of green financing

• Green bonds have been issued by multilateral agencies such as World Bank corporations, municipalities and government agencies to investors. This includes institutional investors and pension funds.

• Certain investment funds such as BlackRock have detailed mandate from investors to invest in green bonds only

Advantages of Green Bonds

• India has targeted 175 gigawatt of renewable energy capacity by 2022 from 30 gigawatt right now; green bonds are an effective way to gain the USD 200 billion in funding required for this

• Higher interest rates and unattractive terms have raised the cost of renewable energy installations in India; green bonds are excellent for bridging the gap

• Moreover, budget allocations for renewable energy are insufficient in the face of which green bonds are a efficient way of financing such projects

• Also, options for raising funds and investing in renewable energy in the public markets in India are restricted which is why green bonds are a good option

• For independent power producers, green bonds are better because the carry a lower interest rate as against commercial bank loans

• For investors as well, green bonds are beneficial because they carry lower risks than other types of bonds

• Also the risk of projects not performing well remains with the issuer and not the investor in case of green bonds as repayment is tied to the issuer and not the success of the projects

• As per Bloomberg New Energy Finance, record USD 38.8 billion in green bonds was issued in the year 2014 which is 2.6 times higher than USD 15 billion issued in 2013 indicating a strong preference for such bonds especially when there is a bona fide issuer such as big corporates or government agency

Risks of Green Bonds

• There has been much debate about whether projects for which green bonds are issued are green enough Example: Reuters reported how activists said proceeds of French utility GDF Suez’s USD 3.4 billion green bond issue was being used for funding dam project harming the Brazilian Amazon forest

• The tenor and rating of green bonds as well as the currency risk involved are serious issues as far as risk is concerned

• Green bonds in India have briefer tenor periods of 10 years in India while typical loan is for minimum of 13 years, which is less compared to international issuances

• Bond buyers may not invest in bonds rated lower than AAA- also.

Facts and Stats

• EXIM Bank recently issued a 5 year USD 500 million green bond in March

• This is India’s first dollar denominated green bond

• The issue was subscribed over 3.2 times

• EXIM Bank’s green bond was priced at 147.50 basis points over and above US Treasuries while bonds are generally priced at treasuries plus 150 basis points at fixed coupon rate of 2.75 per cent per annum

• The bank also indicated that net proceeds would be used for funding eligible green projects in nations such as Sri Lanka and Bangladesh

• Yes Bank has also raised INR 1000 crore through a 10 year green bond which was oversubscribed twice in February

• In the period between 2007 and 2012, supranational organisations such as World Bank and governments were the major issuers of green bonds

• Following this period, corporate interest in green banks also rose

• In the year 2014, green bonds were also issued by energy and utilities companies, consumer goods firms and real estate firms accounting for nearly a third of the market as per KPMG estimates.