Home / Money / Personal Finance /  Sovereign green bonds: Know the risks and rewards

The Reserve Bank of India (RBI) recently auctioned its maiden sovereign green bonds worth 8,000 crore. These comprised sovereign green bonds 2028 and sovereign green bonds 2033 with a cut-off yield of 7.10% and 7.29%, respectively, a few basis points lower than the G-sec of the same tenure. The second tranche of the auction will be held on 9 February. The proceeds will be invested in environment-friendly projects like solar, wind, small hydro power projects, etc. Five percent of the total amount of bonds will be made available to retail investors. Let us understand the green bonds and risks associated with investing in them.

Green bonds, popularly known as climate bonds, are fixed interest-bearing financial instruments issued by any sovereign entity / inter-governmental organisation /corporation. The proceeds of these bonds are used only for environmentally conscious, climate-resilient projects. In India, the framework for the sovereign green bond was issued by the government late last year. It is worth noting that there is no cap on foreign investment in these bonds because these instruments are considered as specified securities under the fully accessible route.

A few foreign portfolio investors have compulsions to invest in green bonds and will seek higher participation in these bonds, going ahead. Green bond, by design, is issued at a premium and provides capital at cheaper costs for projects that support the environment. Hence, ‘greenium’ is the market term used to describe the premium on green bonds. When a debt instrument is deemed to carry a premium, the yield or return is lower, and the price is accordingly higher.

Benefits: Since these bonds are issued by the government entity/inter-governmental organisation/corporations, they carry nil credit and default risks. This and the ‘greenium’ of these bonds explain the lower yields that they come with. Further, investors in these bonds do not bear project related risks, according to the framework released by the government. That is, payments of principal and interest on the issuances are not conditional on performance of the projects.

Green bonds are a good investment vehicle for those who are more concerned with the sustainable social development and greening of brown industries. Those who are interested in knowing how the funds are invested, note that the government provides investors with transparent reporting on the allocation of proceeds of sovereign green bonds as well as on the environmental impact of projects funded by the proceeds.

The allocation report will be updated annually until full allocation of proceeds of outstanding green bonds. Retail investors can invest in green bonds through the RBI retail direct website or through the account maintained with your broking house, if it is made available.

In terms of taxation, there are no specific tax benefits provided for investment in sovereign green bonds. The interest earned will be taxed at the individual’s slab rate. If the instrument is sold in the market before maturity, any appreciation in the bond price will be taxed at 10%, if held for at least one year. Otherwise, short-term capital gains will be taxed at an applicable slab rate.

Associated risks: Generally, one of the most recognized risks in green bond is ‘greenwashing’, which means that environmental claims are made without evidence. In other words, the funded projects may not produce a net environmental benefit.

Also, select large investors might hold green bonds until maturity (due to their investment mandate) thus leading to lower liquidity and widening pricing differentials in the bond market. In some cases, a lack of liquidity also increases trading costs.

India is in a nascent stage to assess if there would be any greenwashing and if so, the degree of it and the liquidity position of these bonds. Environmentally-conscious investors can invest only a portion of their money for now and monitor the performance and reporting aspects of these instruments as it evolves.

Investors need to be aware that though the terminology used sounds fancy, it may not suit everybody’s investment requirements. Before investing in such bonds, investors should assess their investment goals, risk appetite, their existing portfolio, etc. to take a call. Certainly, it may take some more time for the green bond market to mature and to improve.

P Saravanan is a professor of finance and accounting and A Paul Williams is a research staff at IIM Tiruchirappalli

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