[By Tejas Venkatesh]
The author is a student of Jindal Global Law School.
Introduction
On 16th August 2024, the Securities and Exchange Board of India (“SEBI”) released a consultation paper on Expanding the Scope of Sustainable Finance Framework in the Indian Securities Market. The purpose of the paper is to solicit public comments on the appropriateness and adequacy of the proposed new framework for ESG debt securities and sustainable securitized debt instruments. The new framework incentivizes sustainable debt financing and also provides much-needed flexibility to issuers who aim to pursue projects that align with their ESG objectives. Yet, the proposal raises certain vital concerns.
SEBI’s Existing regime on Sustainable financing in India
SEBI’s approach to encouraging sustainable finance has mainly focused on the Indian debt markets. The focus on the debt market seems to stem from the need for a large pool of potential investments in various sustainable projects. An estimate by the Reserve Bank of India (“RBI”), indicates that a green finance pool of up to 2.5% of the GDP is necessary to meet the infrastructure gaps resulting from disastrous climate events in India.
In 2023, in an effort to boost investments in the sustainable debt financing market, SEBI introduced the Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities) (Amendment) Regulations, 2023, wherein it allowed for the issuance of “Green Debt Securities” as a debt security instrument to raise funds for sustainable projects like renewable energy plants, clean transportation, pollution prevention and biodiversity conservation projects. Although the issuance of “Green Debt Securities” was allowed under the SEBI (Non-Convertible Securities) Regulation, 2021, the scope and ambit of activities that could be financed through the instrument remained vague and ambiguous until an illustrative list of activities was provided in the amended regulations in 2023. Further, the board continuously revised and expanded the scope of activities to include blue, yellow, and transition bonds as other sub-forms of green debt securities under the regulations.
In order to align the framework for the issuance of green debt securities with globally accepted standards like the Green Bond Principles (GBP), issued by the International Capital Markets Association (ICMA), SEBI introduced additional disclosures for green debt securities. The focus of the revised disclosure requirements was on ex-ante disclosures regarding the utilization of proceeds, the process for evaluation and selection of a project, management of proceeds, and improved reporting mechanisms. Impact reporting and involvement of third-party reviewers or certifiers were sought to be strengthened to ensure transparency and reliability in the utilization of bond monies by issuers.
However, the growing need to adopt an intersectional approach for tackling economic, social, and environmental aspects of sustainable development has been felt. Further, the tremendous lag in funding for the attainment of Sustainable Development Goals (SDG) has prompted SEBI to propose the introduction of Social Bonds, Sustainable Bonds, and Sustainability Linked Bonds (which together with Green Debt Securities would be termed ESG debt securities). Additionally, to leverage the underlying sustainable finance credit facilities for the benefit of potential investors, SEBI also seeks to introduce ‘Sustainable Securitised Debt Instruments’ as a form of finance that has the backing of the underlying sustainable credit.
Proposed framework for ESG debt securities
The introduction of Social Bonds and Sustainable Bonds marks an addition to the theme of Use of Proceeds (UoP) Bonds, wherein the proceeds are earmarked for specific projects designed to achieve the intended impact. Whereas, Sustainability-Linked Bonds (SLB) are categorized as Key Performance Indicator (KPI) bonds wherein the proceeds are not tied to a specific project but are intended for the issuer to achieve self-imposed sustainability targets in the course of their operation.
Although SEBI has not specified the scope of projects falling within the ambit of Social Bonds, the Social Bond Principles (SBP) given by the ICMA provide valuable direction. The SBP includes a wide ambit of activities including projects that aim to provide affordable basic infrastructure like water, sanitation, health, housing, and food security. However, Sustainable Bonds are an effort to acknowledge the intersectional co-benefits that a combination of Green and Social projects present.
The extant framework for the regulation of Use of Proceeds Bonds (i.e. Green, social, and Sustainable Bonds) remains uniform with a special focus on core components such as the mechanism for categorization of projects, criteria for project evaluation and selection, managing proceeds, and reporting. However, the focus on transparency and accountability is diluted due to the voluntary nature of the guidelines given by the ICMA. The framework provides no liability mechanism in instances of greenwashing or failure to meet intended targets.
Unlike UoP Bonds, Sustainability-linked bonds are debt instruments that are catered to finance the incorporation and achievement of forward-looking ESG outcomes by the issuer. The core components of the bonds include the selection of Key Performance Indicators (KPIs) and calibration of Sustainability Performance Targets (SPTs) by the issuers. The focus is on the declaration of bond characteristics, reporting on the attainment of targets, and third-party verification of bond targets achieved.
Critical Analysis
The new debt instruments raise several concerns as regards their ambit and effectiveness. First, the qualifying factor for the utilization of bond proceeds of a Social Bond is that the monies have to be committed to generating a ‘social impact.’ Although the ICMA Social Bond Principles (SBP) provide guidance on projects that can be pursued by the issuance of Social Bonds, pertinent questions regarding the quantification of the term “impact” arise. For instance, it is unclear whether a social project can avoid generating a negative environmental impact. Therefore, in instances such as affordable housing projects wherein the social impact contrasts with the environmental impact, there is no direction on what interest will prevail.
Further, the Social Bonds framework fails to differentiate between challenges posed by varied timelines for achieving the desired impact For instance, a loan-based social bond will achieve its social impact merely by financing the beneficiary using the proceeds received whereas other forms of social bonds require active collaboration between the beneficiary and the issuer. The legal implications posed by the varied impact timelines of projects ought to be considered to develop a holistic social bond framework.
Second, the issuance of Sustainability-linked bonds poses various legal and ethical concerns. For instance, the issuance of these instruments could lead to a misalignment of motives for both the investor and the issuer. This is due to the financial incentive model of these bonds (called coupon step-up rates) which inversely rewards the investors for the failure of companies to meet their sustainability targets. Thus, the vested interest of the investors lies not in the attainment of sustainable targets but in the failure to do so.
Additionally, the concerns about the utilization of the lower cost of capital received through these bonds for purposes other than meeting ESG targets i.e. greenwashing, are ever-existent. Further, methods such as keeping low penalties for not meeting targets and minimizing the impact of penalties by keeping the target dates closer to maturity dates, help in evading any scrutiny associated with Sustainability-linked bonds. Another indirect method to avoid compliance is the inclusion of call options clauses during the issuance of bonds to ensure the re-purchase of these bonds before maturity to evade any form of accountability regarding the utilization of bond proceeds.
Lastly, the introduction of Securitised Sustainable Debt Instruments does not have the backing of a robust international framework for green securitization. In the absence of a robust framework, crucial aspects such as eligibility criteria and trigger events to constitute a green security asset remain ambiguous. Further, there are neither any established disclosure requirements nor third-party review mechanisms for the same. Thus, a robust international framework needs to be developed before its adoption in the Indian securities market.
Conclusion
The rising climate crisis poses a significant threat to the Indian economy. While government intervention is inevitable, the scale of the crisis demands the participation of a massive pool of investors in the debt securities market. While green bonds have provided the much-needed start to the debt financing journey, it is pertinent to expand the scope of instruments that can be issued to investors to provide enough flexibility to potential investment appetites across the country. The introduction of Social, Sustainable, Sustainability Linked Bonds and Sustainable Securitised debt instruments, helps in providing such flexibility to investors. Yet, as highlighted, they pose several concerns as regards their scope and effectiveness. A deeper analysis of the international frameworks for each instrument ought to be made before its transplant into the Indian debt securities market.