Unveiling the Impact: Amendments to the Green Debt Securities Regime

[By Aditi Kundu]

The author is a student at Hidayatullah National Law University.

 

Introduction

In an attempt to strengthen the sustainable financing regime in India, Securities and Exchange Board of India (SEBI) has revised its Green Debt Securities (GDS) framework, whereby it has expanded the definition of GDS, enhanced the disclosure requirements, and introduced guidelines to avoid greenwashing. SEBI’s review of the existing framework under Disclosure   Requirements   for   Issuance   and   Listing   of   Green   Debt Securities, 2017 is aimed at preventing misallocation of funds, ensuring transparency, and fighting greenwashing. GDS are green finance instruments specifically designed to fund environmentally sustainable projects.

By SEBI (Issue and Listing of Non-Convertible Securities) (Amendment) Regulations, 2023 the definition of GDS has been expanded to include new categories of projects for which the proceeds from the issuance of bonds can be allocated. These include: climate change adaptation; pollution prevention and control; circular economy adapted products; blue bonds; yellow bonds; and transition bonds. Subsequently, SEBI also released a Revised Disclosure Requirement for Issuance and Listing of Green Debt Securities which mandates the appointment of a third-party certifier by the issuer who would audit and track the use and management of proceeds during both the pre-issue and post-issue phases. This requirement is applicable for two years from 1st April 2023 on a ‘comply or explain basis’. The initial and continuing disclosure requirements in financial statements and annual reports on the part of issuer have also been enhanced. These include details of process and criteria used for selection of eligible projects, green taxonomies/standards followed, details of temporary placement of unutilized funds, perceived risks and mitigation plan, details of the projects, and reporting of impact on environment. Further, most importantly, to curb the over-arching problem of greenwashing, SEBI released a guidance paper for do’s and don’ts relating to GDS. SEBI has made a monumental effort to define greenwashing as “making false, misleading, unsubstantiated, or otherwise incomplete claims about the sustainability of a product, service, or business operation”. Now, the issuers need to regularly monitor their use of funds and ensure that projects are contributing towards a sustainable economy by reducing adverse environment impact. Issuers are prohibited from using funds for purposes other than those mentioned in the definition of GDS, using misleading labels, and cherry picking data that works in their favour. Further, if funds are utilised for unqualified purposes, then, on the option of debenture holders, there can be an early redemption.

At the centre of such regulatory revision lies India’s sustainable development and climate change action targets. India is a party to the Paris Agreement 2015 (the agreement), and the Nationally Determined Contributions (NDC) is an action plan for mitigating greenhouse gas emissions and adapting to climate change impacts under the agreement. According to NDCs, each country sets its Intended Nationally Determined Contributions (INDC) and identifies its climate action goals. India’s current INDC is reduction of emission intensity of its GDP by 33 to 35 % by 2030 from 2005 level and increase in share of non-fossil fuel based energy 40% by 2030. It also aims to cut emissions to net zero by 2070. However, estimates suggest that more than $10 trillion will be required only for power, green hydrogen and electric vehicles to meet such goals. Since such huge amounts are required for financing the green goals, climate/green finance which is intended to be used only for certain specified purposed becomes the key factor, and GDS is one of the promising ways to achieve the same.

Based on the aforementioned premise, this articles provides a critical analysis of the regulatory mechanism of GDS.

Analysis

What does “Green” signify?

SEBI has commendably amplified the definition of GDS as it increases the scope of categories of projects for which debt securities that can be issued. However, the current framework provides a description of GDS, instead of particularising the term ‘green’. It describes GDS as debt securities issued for raising funds which are utilised for certain categories of green and sustainable projects. SEBI has stuck to a list of vacuous subject areas that are generally considered crucial to sustainable development. There is no India-specific justification as to why subject areas like biodiversity conservation, sustainable waste management, etc. which are essentially general aspects of sustainable development have been included. There is a lack of logical co-relation between the subject areas and India’s INDCs. Due to the absence of well-defined criteria as to what constitutes green under the mentioned categories, issuers get more window to broaden the scope of their green activity and making it easier for them to squander the funds in the name of “green”. This ultimately discourages investors from buying green bonds. The issuers get more window to dictate the scope of their green activity, making it challenging for the investors to make informed decisions. A suggestion at this end would be that the GDS regulation should recognise major sectors in the economy and incorporate a sector-specific list of activities and the detailed environmental criteria these activities must meet to be labelled ‘green’. This list can be timely updated with emerging economic sectors, and the criteria for existing sectors may be changed by analysing their potential impact on India’s climate mitigation goals.

Furthermore, the current framework requires the issuer to state the environmental sustainability objectives of the issuance. However, there is no reference to the environmental targets which are being pursued by the regulation. This creates a gap between the environmental goals intending to be achieved by the issuer and green targets of India.

In this regard, it becomes imperative to formulate a standard green finance taxonomy which aligns with India’s environmental targets. Curating a taxonomy would mean a clear definition of ‘green’ and ‘sustainable’ by segregating both the concepts in terms of category of project for which the funds from GDS are to be utilised. This would result in a clear distinction and help identify sustainable activities from green economic activities. Currently, the issuers are at a liberty to take reference from any taxonomy/ standard as they wish, and disclose the same. For example, if issuer X aligns its GDS issue with the Green Bond Principles (GBP) by International Capital Market Association and issuer Y aligns its issue with the standard established by the Association of Southeast Asian Nations. Now, although none of these standards are contrary to India’s environmental targets, but they may not be specifically aligned with it. Also, if an investor wants to compare two issues, it becomes difficult to reach accurate conclusions because although the standards are similar but there exists various point of differences as well. Furthermore, varied standards/taxonomies will result in high costs of verification for the investor for making an informed decision discouraging large sums of investment. While a standard green taxonomy for the Indian jurisdiction would be applicable to not just the financial sector, it will have broad effect across sectors, thereby evening out discrepancies in the understanding of green/sustainable finance. Taking cue from EU’s proposed taxonomy, environmental objectives can be recognised which would help to identify whether the activities of corporates are actually green or not. The EU taxonomy regulation considers different circumstances for different economic actors and provides for reporting requirements to ensure the greenness of the economic activity.

Brief Detailing: not Satisfactory

SEBI requires the issuer to make continuous disclosures in its annual reports about the “brief  description  of such  project(s) and /or asset(s) and the amounts disbursed”. Going by the definition of ‘brief’ in the Cambridge Dictionary, it is doubtful how an issuer can reliably disclose the description about projects undertaken and dollars of funds allocated in a few words. Considering the importance attached with the projects and various stakeholders, what is required is a comprehensive report rather than a short summary. A precise tracking of capital flows is important to ensure that the funds are not squandered for unsustainable purposes. Taxing authorities need to know whether the income generated form green bonds is taxable or not. The government needs to keep a track of the progress made in pursuing environmental objectives. In this respect, it is suggested that SEBI outlines a set of particulars that is to be included as a part of the report.  EU’s Green Bond Standard has a format for annual reporting for allocation of proceeds which demands information on types and sectors of project, location, percentage of proceeds allocated, co-financing of projects, estimated dates of completion, etc. Reporting in a standardised format makes disclosures more objective, transparent, credible and comparable. Similar factsheets can be introduced for initial disclosures as well.

Mandatory Independent Third-Party Review/Certification

One of the most celebrated change made is mandating independent third-party review/certification in the form of assurance/opinion/rating/certification. The underlying benefit served is that it enhances transparency and proves the soundness of the bond’s environmental features. Making it mandatory creates trust among investors and facilitates a wider range of financiers to access the green bond market, further scaling up the investment volumes and getting closer to climate change mitigation targets.

Acknowledging Environmental and Social Risks

The amended regulations acknowledge the environmental and social risks (E&S Risks) that are associated with the intended projects under the GDS. Therefore, the disclosure of such risks and a proposed mitigation plan from the issuer have been rightly mandated. This will enable the investors to better assess the quality of the issue and boost the credibility of the bonds. Continuous disclosure of deployment of mitigation plan helps to keep a track of long-term sustainability of the projects undertaken and reduce overall risks with time.

Unregulated Temporary Placement of Unallocated Funds

SEBI mandates disclosure of details of the temporary placement of unutilised proceeds. No further requirements have been carved out in this respect, which increases the room for greenwashing. Greenwashing is an activity where companies make exaggerated and misguided claims regarding their eco-friendliness to create a deceitful ‘green image’. Ideally, 100% of the proceeds should be utilised for the identified projects but if there is a considerable share of unallocated funds, then the same should be temporary placed in reliable and liquid instruments which align either with the environmental sustainability objectives of the issue or fall under the so-called green categories identified by the regulation. It is also suggested that SEBI adopts an investment time horizon cap for temporary placement of the proceeds to prevent it from turning into a greenwashed placement. Investment time horizon refers to the time period for which one holds an investment. If unallocated funds will be allowed to be temporarily placed without any limitation, the chances of funds being misused increases manifold. Putting a cap on such investment horizon would ensure that the unallocated funds are tracked better by the investors and are put to use for which the GDS was issued in the first place. To tackle the problem of greenwashing, a similar concept of an investment horizon cap is present in China wherein temporary placement of unallocated proceeds is allowed for a period not exceeding 12 months.

Guidance Paper on Greenwashing: An Adequate Step?

In the absence of any universally acceptable definition of the term, SEBI’s efforts in defining the same are laudable. The do’s and don’ts circular puts certain compliance burdens on the issuer of GDS. The issuer is obligated to ensure that the transition path undertaken by it is reducing adverse environment impact. The issuer shall not make unsubstantiated claims regarding certification from a third-party. It places the responsibility to not use misleading labels or cherry pick data that is favourable to the environment conscious image, etc.

At a glance, SEBI’s efforts is noteworthy, however, the obligations seem to be a mere reiteration of the responsibilities of issuer. Arbitrary terms like ‘cherry picking’ and ‘quantifying’ externalities are used without any guidance on the mechanism that is to be used. There is no supervision on whether the disclosures reflect the reality or not. In this context, lessons can be taken from Australia’s regime which discourages using vague terminologies in disclosures like sustainable practice, protection of planet, etc. and prohibits making misleading claims/headlines. Essentially, the information provided should be interpretable and supported by up-to-date science, with transparency on the methodology used.

Finally, there is an absence of the consequences that shall follow if the requirements are not met, which makes the regulations/circulars somewhat ineffective. Once again, India can incorporate some tenets from the mechanism adopted in Australia. A proactive approach has been adopted by reviewing and responding to the breaches and misled disclosures; wherever the disclosures/statements are not supported by reasonable data or the data is incorrect, the regulator either orders correction or issues infringement notices. This reposes the faith of the investor and rightly channelises the efforts towards greener initiatives. This strikes a balance by being a corrective measure rather than having an interventionist outlook.

Conclusion

In light of India’s growing GDS market, the revision in definition of GDS, mandating third party review, quantifying negative externalities, impact reporting of the projects undertaken, and fighting greenwashing becomes vital for ensuring a transparent mechanism and credibility of such bonds. SEBI’s intentions are in the right direction but to remove vagueness, enhance the effectiveness of the framework, and foster the growth of GDS in India, SEBI should consider incorporating changes inspired from international frameworks and regulatory practices.

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