CAIIB ABFM Module D Unit 6 : Green and Sustainable Financing

16/10/2023

Table of Contents

CAIIB Paper 3 ABFM Module D Unit 6 : Green and Sustainable Financing (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for CAIIB Exam 2023. Following the format of the current exam, CAIIB 2023 will have now four papers. The CAIIB Paper 3 (ADVANCED CONCEPTS OF FINANCIAL MANAGEMENT) includes an important topic called “Green and Sustainable Financing”. Every candidate who are appearing for the CAIIB Certification Examination 2023 must understand each unit included in the syllabus.

In this article, we are going to cover all the necessary details of CAIIB Paper 3 (ABFM) Module D (EMERGING BUSINESS SOLUTIONS) Unit 6 : Green and Sustainable Financing, Aspirants must go through this article to better understand the topic, Green and Sustainable Financing and practice using our Online Mock Test Series to strengthen their knowledge of Green and Sustainable Financing. Unit 6 : Green and Sustainable Financing

ISO Standards for Green Finance

Investors have been drawn to growing industrial areas, such as renewable energy, energy efficiency, green building, and recycling, not only due to the prospect of healthy financial returns in a developing part of the economy, but also by the ethos of ethical and environmental investments.
These, once “niche” green investors, are becoming more and more popular, leading to the emergence of tools and approaches that aim to determine what constitutes green and sustainable investing kinds and practices.
In light of this context, the International Organization for Standardization (ISO) is working on a set of standards to underlie and catalyse green and sustainable finance.
Investments in environmental initiatives and programmes will benefit from having more organisation, openness, and credibility, as a result of this.

The International Organization for Standardization (ISO) has already begun publishing standards to meet these needs within the confines of 3 ISO technical committees (TCs):

ISO/TC 207, Environmental management;
ISO/TC 322, Sustainable finance;
ISO/TC 309, Governance of organisations.

These committees fall under the umbrella of ISO. The various ISOs are

ISO 32210: Framework for Sustainable Finance
ISO 14007: Environmental costs and Benefits
ISO 14008: Monetary valuation of environmental impacts
ISO 14097: Assessing and reporting investments related to climate change

Building Green Finance

ISO 14000, released in August, 2022, provides guidance on identifying and assessing environmental aspects and impacts, and performance criteria for projects, assets and activities.

The intent is to support the development of green finance by assisting borrowers and financiers to take into account the environmental aspect and impacts or environmental performance of the project, asset or activity for which funds are sought.

Applicable to: individual, corporate or public entities providing or seeking green finance, regardless of size.

A framework to determine relevant environmental criteria supported by credible information is presented.

Objective: To avoid, minimize, reduce and mitigate adverse environmental impacts and risks, as well as to identify opportunities to optimize environmental performance.

Key concepts involved in identifying and assessing relevant environmental criteria, including significance, context and materiality as well as “do no significant harm”, are examined and examples presented.
The relationship between what is determined to be environmentally significant and materiality is also explained.
Concerns related to greenwashing that affect green financing decisions are addressed.
Relevant information is identified to assist borrowers and financiers to align with the principles presented and to facilitate access to green finance.
Intended users can determine the application that best suits their internal and external context.

Instruments to fund Green Financial Project

Governments, charities, banks, and private investors can finance “green” initiatives using a variety of methods.
They can be divided into four categories: loan, equity, and risk-mitigation products.
Global foundations and NGOs typically provide project-specific grants, such as for decentralised solar mini-grids for rural electrification.
Credit enhancement guarantees and insurance products are risk-mitigation tools.
In guarantees, government agencies, development financial institutions(DFIs), or financial services firms can assure lenders that payment will be made in full or in part in the event that the borrowers default.
Environmental risk liability coverage and environmental loss insurance are features of green insurance products.
The DFIs may offer early-stage seed money to launch a project under equity.
Additionally, for an ownership stake in such ventures or assets, venture capitalists and private equity funds may invest, or the general public may do so through initial public offerings (IPOs).

About Green Bonds

Green bonds are a type of unsecured debt instrument that is used to finance green projects that provide benefits to the environment.
The commitment of an issuer of a green bond to use the proceeds from the sale of the bond to finance or re-finance “green” projects, assets, or business activities distinguishes a green bond from a standard bond.
Can be issued up front by either public or private actors
In the same manner as traditional bonds, green bonds involve the issuing entity providing a guarantee that the amount borrowed will be repaid over a predetermined amount of time and compensating the creditors through the issuance of a coupon that bears either a fixed or variable interest rate.

Framework for Green Bond Issuance

The Green Bond Principles (GBP) : collection of optional process principles

Established by: International Capital Market Association.

Purpose: to increase the transparency and integrity of the green bond market around the world.

They advise the issuers to construct a framework for the process of issuing green bonds, which should include 4 essential components.

1^st: Usage of profits in situations when the GBP has established criteria for determining which types of initiatives are qualified to be labelled as “green.”
2nd approach: A technique of evaluating and selecting projects, in which the issuers are required to describe the environmental objectives of the project as well as the risks that are expected to be incurred and the strategies that will be used to mitigate those risks.
3^rd: Management of the proceeds, which requires the issuers to store the money in a sub-account or a separately managed account and to keep the lenders updated on the movement of the money.
Last: the GBP discusses different techniques for providing transparent reports to the lenders, including the impact that the project will have. The Climate Bonds Initiative has released a set of voluntary guidelines and a certification scheme in order to promote investments that are truly linked with the goal of tackling climate change.

Green Masala Bond: Bonds that are issued outside of India but are denominated in Indian Rupees rather than the local currency have been issued by Indian corporations.

Benefits of Green Investment

The green bond market may provide a number of significant advantages for environmentally responsible investment, including the following:

Providing an additional source of financing for environmentally friendly
Making it possible to finance more environmentally friendly projects over the long term by reducing the maturity mismatch
Improving the issuers’ reputations and providing more transparency regarding environmental strategy
Facilitating the “greening” of traditionally “brown” sectors
Making newly developed environmentally friendly financial products accessible to investors who are committed to the long term

Advantages and Disadvantages of investing and issuing Green Bonds

The advantages of investing in green bonds are as under:

Investors can balance financial and environmental returns
Meets ESG/green investing requirements
Improved risk assessment in an opaque fixed income market through proceeds reporting
Potential use of pure-play, project, and ABS to actively hedge against climate policy risks in a portfolio with emissions-intensive assets
Recognized by UNFCCC as non-state actor “climate action”
Private interaction with issuers on ESG topics relevant to green bond issuance results in more thorough credit profiles of borrowers.
Added openness of proceeds use and reporting requirements gives green bond investors an informational edge (on spending efficiency, project specifics and updates, impact performance).
Tracking and reporting proceeds utilisation improves internal governance and the issuer’s credit quality.

The disadvantages of investments in green bonds are:

A market that is still in its infancy and is quite small, with bond amounts that are relatively low.
The absence of universal criteria can increase the potential for confusion, as well as the damage to one’s reputation if the green integrity of a bond is called into question.
There is a restricted amount of room for the legal enforcement of green integrity
A lack of uniformity can result in research that is more difficult to understand and a requirement for further due diligence that is not always met.

The advantages of issuing green bonds are as under:

Presenting and carrying out the issuer’s approach to environmental, social, and governance concerns.
Strong demand from investors might result in oversubscription, which opens up the possibility of increasing the amount issued.
Increasing the investor base diversity of bond issuers, potentially lowering their sensitivity to changes in bond demand.
There is evidence of an increase in investors who “buy and hold” green bonds, which may result in decreased bond volatility on the secondary market.
Advantages to one’s reputation (for example, marketing can promote the issuer’s support for green investment and the issuer’s green credentials.)
Clarification of the sustainability plan and increased confidence in its validity.
The ability to take advantage of “economies of scale,” given that the majority of issuance expenses are associated with the process of setting up the system. h) The monitoring and reporting of how profits are used leads to improvements in internal governance structures, as well as communication and the exchange of knowledge between the treasury and project sides of a corporation.

The disadvantages of issuing green bonds are:

The one-time and continuing transaction costs associated with labelling and the accompanying administrative, certification, reporting, verification, and monitoring requirements.
The risk to a bond’s reputation if its “green credentials” are called into question.
Investors have the right to claim for damages in the event of a “green default,” which occurs when an issuer violates the terms of an agreement even though the bond was paid in full.

Public Policy In India

Since 2007, India has placed a significant emphasis on green financial practices.
Within the context of sustainable development, the Reserve Bank of India issued a notification in December 2007 titled “Corporate Social Responsibility, Sustainable Development and Nonfinancial Reporting – Role of Banks.”
Within this notification, the Reserve Bank highlights the significance of issues pertaining to global warming and climate change.
The National Action Plan on Climate Change (NAPCC) was developed in 2008
Goal: outlining the general policy framework for reducing the effects of climate change.
This plan was formulated with a vision.
Within the Ministry of Finance in India, the Climate Change Finance Unit, (CCFU) : established in 2011
Purpose: to serve as a coordinating agency for the many institutions in India that are responsible for green finance.
Since 2012, the Security and Exchange Board of India (SEBI) has made it required for the top 100 listed businesses based on market capitalization at BSE and NSE to publish annual business responsibility reports.
In May of 2017, SEBI published guidelines for the issuance of green bonds, in which the disclosure criteria were specified.
In addition, the Companies Act of 2013 requires businesses to report annually on their progress toward fulfilling their Corporate Social Responsibilities (CSR).
This requirement was enforced by the Ministry of Corporate Affairs.
The Report of the Committee on Corporate Governance, which was released in October 2017, suggested that the board of directors should gather together at least once a year to particularly discuss succession planning, ESG, risk management, and strategy.
In recent years, India has implemented a number of different economic and financial incentives.
These incentives are in line with the commitments that India made under the Paris Agreement in 2015
To reduce the intensity of its greenhouse gas emissions: by 33 to 35% below the levels that they were at in 2005
To achieve 40% of its installed electric power capacity from non-fossil sources by 2030.

Progress Of Green Finance In India

Improvement in General Awareness

There is a dearth of information available from traditional sources that may be used to evaluate the level of awareness regarding green finance and sustainable development.
When viewed in this light, Google Trends has the potential to be a very useful instrument for gaining a knowledge of the pattern of Google searches conducted in various places and at various times.
It is possible for us to have a better understanding of the interest in a particular subject by analysing the amount of searches conducted on Google.
In Google Trends, the information on the number of searches made in Google on any topic is normalised as the proportion of the total number of searches made in an area during the given time period on all topics.

Green Lending

As part of the green finance initiative, the Reserve Bank has included the small renewable energy sector under its Priority Sector Lending (PSL) scheme in 2015.
As at end-march 2020, the aggregate outstanding bank credit to the non-conventional energy sector was around Rs. 36,543 crore, constituting 7.9% of the outstanding bank credit to the power generation compared to 5.4% in March 2015.
The commercial banks’ exposure to the non-conventional energy sector varied among bank groups and the major states in India.

Green Bonds

Green bonds are the bonds issued by any sovereign entity, inter-governmental groups or alliances and corporates with the aim that the proceeds of the bonds are utilised for projects classified as environmentally sustainable.
For India, we first extracted most bonds issued by the corporate and government since January 21, 2015, irrespective of whether they are green bonds or not.
In this regard, we have taken those bonds where the country of risk has been marked as India, irrespective of the issuers’ country of incorporation.
Our data includes the initial issuance amount in US$, coupon rate, debt to total assets ratio, and we then looked at whether the bond proceed was to be utilised for green projects or not, for over 5000 bonds issued in Indian market since 2015.
India started issuing green bonds since 2015. As of February 12, 2020, the outstanding amount of green bonds in India was US$16.3 billion India issued green bonds of about US$8 billion since January 1, 2018, which constituted about 0.7% of all the bonds issued in the Indian financial market.
Although the value of green bonds issued in India since 2018 constituted a very small portion of the total bond issuance, India maintained a favourable position compared to several advanced and emerging economies.

SEBI Guidelines on issue of Green Bonds in India

In 2016, SEBI was responsible for establishing the green bond criteria in India.
30th May 2017: The Securities and Exchange Board of India (SEBI) came out with a circular stating the disclosure requirements for issuance and listing of Green Debt Securities in India.
Earlier in December, 2015, SEBI had come out with a Concept Paper for issuance of Green Bonds in India.
The Concept Paper brought out the need for enhanced disclosures for issuance of green bonds so as to differentiate it from other form of debt securities issued and listed in India and the Circular is largely in line with the concept paper.

Definition of “Green”

The SEBI Circular defines the term “Green” or “Green Debt Securities” in the following manner:

A Debt Security shall be considered as “Green” or “Green Debt Securities”, if the funds raised through issuance of the debt securities are to be utilised for project(s) and/or asset(s) falling under any of the following broad categories:

Internationally, for all issuance of Green Bonds or Climate Bonds, an independent reviewer/ certifier has to be appointed mandatorily who certifies whether the targeted project assets qualify to be eligible assets or not.
However, as per the SEBI Circular for any issuance of Green Debt Securities in India, the issuer may use its discretion to appoint an independent reviewer/ certifier and it is not a mandatory requirement. Disclosure requirements
In order to issue Green Debt Securities, the provisions of SEBI (Issue and Listing of Debt Securities – ILDS) Regulations, 2008 are to be complied with.
Therefore, the disclosure requirements provided therein in ILDS Regulations have to be adhered to.

Disclosure requirements

In order to issue Green Debt Securities, the provisions of SEBI (Issue and Listing of Debt Securities – ILDS) Regulations, 2008 are to be complied with. Therefore, the disclosure requirements provided therein in ILDS Regulations have to be adhered to. Additionally, the following details also have to be disclosed in the offer document:

A statement on environmental objectives of the issue of Green Debt Securities;
Brief details of decision-making process that the issuer has followed/would follow for determining the eligibility of project(s) and/or asset(s), for which the proceeds are been raised through issuance of Green Debt Securities. Indicative details to be provided is as under:
Process followed/ to be followed for determining how the project(s) and/or asset(s) fit within the eligible green projects;
The criteria, making the project(s) and/or asset(s) eligible for using the Green Debt Securities proceeds; and
Environmental sustainability objectives of the proposed green investment.
Details of the system/procedures to be employed for tracking the deployment of the proceeds of the issue.
Details of the project(s) and/or asset(s) or areas where the issuer, proposes to utilise the proceeds of the issue of Green Debt Securities, including towards refinancing of existing green project(s) and/ or asset(s), if any.
If the issuer appoints an independent third-party reviewer/certifier, for reviewing /certifying the processes including project evaluation and selection criteria, project categories eligible for financing by Green Debt Securities, etc. then such appointment of such reviewer/ certifier shall have to be disclosure in the offer document.

Responsibilities of the issuer

In addition to the responsibilities entrusted on the issuer of debt securities under SEBI (ILDS) Regulations, the following additional responsibilities have been entrusted upon the issuers of Green Debt Securities under the Circular:

The issuer must maintain a decision-making process which it uses to determine the continuing eligibility of the project(s) and/or asset(s), which would include, without limitation, a statement on the environmental objectives of the Green Debt Securities and a process to determine whether the project(s) and/or asset(s) meet the eligibility requirements.
The issuer must ensure that all project(s) and/or asset(s) funded by the proceeds of Green Debt Securities, meet the documented objectives of Green Debt Securities.
The issuer should utilise the proceeds only for the stated purpose(s), as disclosed in the offer document.