Over the last few years, the environmental, social and governance (ESG) movement has picked up pace across the world with its special focus on low-carbon growth, social impact and good governance in the corporate sector. With that, the spotlight is now on sustainable financing, the force fueling that drive.
Today, under sustainable financing, investment decisions are being made considering the ESG factors of a business opportunity, and investors in India, too, are looking for ESG-compliant assets.
Although ESG is a recent phenomenon in India, of late, action has been picking up in the space. “A positive momentum is visible as far as sustainable finance in India is concerned on both the products and policy front. This is just the tip of the iceberg for now,” says Namita Vikas, managing director, auctusESG LLP, a global sustainable finance and ESG advisory firm.
Touching $19.5 billion in 2021, India’s cumulative green, social and sustainability (GSS) debt volume has gone up considerably. GSS debt totalling $7.5 billion was issued in 2021, according to a report by Climate Bonds Initiative, an international organisation mandated to mobilise global capital for climate action. Similarly, ESG-oriented mutual fund assets in India stood at Rs 130 billion in 10 funds as of December 2021—about a five-fold increase from Rs 27 billion in 2019, as per the Association of Mutual Funds in India. “Impact investing, both venture debt and equity, is also scaling up with several social enterprises receiving capital. In terms of innovative products, the country has seen issuance around blended finance structures, outcome-linked financing and impact bonds, especially products targeting core developmental needs like education and livelihood creation,” adds Vikas.
Besides those needs, successful models for sustainable finance mobilisation include public procurement of LED bulbs to promote energy efficiency in households, reverse bidding mechanism to promote expansion of solar energy capacity and bio-fuel blending for emission reduction, among others.
Experts, however, say that the current volumes are not enough. The Ministry of Finance has estimated that a cumulative investment of approximately $3.5 trillion is required by 2030 to meet India’s nationally determined contributions under the Paris agreement. “Green finance in India is grossly inadequate, considering the ambition expressed in our climate change goals,” says R.R. Rashmi, distinguished fellow, The Energy and Resources Institute, and former special secretary in the Ministry of Environment, Forest and Climate Change.
The Regulation Question
In the face of the challenges in achieving the country’s climate action targets, the government, policymakers and regulators, such as the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), have been proactive.
In its recently released discussion paper and results of a survey on climate risk and sustainable finance conducted by its Sustainable Finance Group (SFG) in 2022, the RBI stated its intention to formulate a strategy to mitigate climate risks based on the learnings from global good practices and its interactions with standard-setting bodies.
Following the survey, which was based on responses from 34 scheduled commercial banks, including 12 public sector banks, 16 private sector banks and six foreign banks in India, the RBI noted that the top management of banks have inadequate engagement on issues of climate risk and sustainable finance. “The responses indicate that although banks have begun taking steps in the area of climate risk and sustainable finance, there remains a need for concerted effort and further action in this regard,” the apex bank added.
The RBI’s SFG is leading the central bank’s climate risk and sustainable finance initiatives. In 2021, India’s central bank also joined the Network for Greening the Financial System set up by global central banks and regulators to catalyse sustainable financing.
As for SEBI, the most significant development has been the steps it has taken to make it mandatory for the largest 1,000 listed companies to file business responsibility and sustainability reports and disclose their performance on ESG indicators from 2022–23. This would be useful in tracking data on ESG indicators across companies. It has also introduced a consultation paper on disclosure norms for ESG mutual fund schemes.
The National Stock Exchange (NSE)-International Financial Services Centre, a subsidiary of NSE, recently launched an international sustainability platform at the Gujarat International Finance Tec-City, popularly known as GIFT City, in Gandhinagar to enable the government and the corporate sector to raise capital for pursuing the sustainable development goals as well as nationally determined contributions under the Paris agreement. It is envisaged as a one-stop platform for all sustainability products, like green bonds, voluntary carbon, sustainable bonds and green real estate investment to be listed by companies that adhere to ESG benchmark standards.
Prathmesh Raichura, partner, KPMG India, says that the platform will support global capital flows to help meet India’s development needs. “The sustainable finance supply-demand relationship of capital can be further aligned. Existing policies provide tailwinds, promoting sustainable investment by helping and improving transparency, which help effective decision-making but there is a need for greater regulatory and policy support,” he adds.
Evolution of an Ecosystem
The financial ecosystem could do better with progressive changes in policy framework, regulations and market mechanisms, say experts.
The regulatory framework needs to be updated to create a more enabling system for sustainable financing and incentives can help in mainstreaming it. For example, priority sector lending by banks can be helpful in widening the spread of ESG activities.
Lowering the cost of capital for sustainable finance and raising its availability through the normal commercial banking system is critical, says Rashmi. “Adoption of a sustainable green taxonomy endorsed by the financial regulator and its inclusion in priority sector lending may perhaps impart certainty and help reduce the risk,” he adds.
Dhruba Purkayastha, director of climate think tank Climate Policy Initiative, could not agree more. “Promoting sustainable finance requires a conducive policy and regulatory landscape. Recognising and managing climate risk for banks and capital markets, and taxonomy are two important interventions that could help promote sustainable finance,” says Purkayastha.
“Sustainable finance is often perceived to be a riskier investment and, therefore, derisking such investments is the need of the hour,” he adds. A Climate Policy Initiative report titled Mobilizing Green Finance while Managing Climate Finance Risks in India has charted out the roadmap to catalyse the growth of sustainable finance.
Also, market mechanisms call for measuring and disclosing ESG-related financial risks in a comparable manner. Several financial rating agencies are looking at ESG ratings, which can give banks the much-needed confidence to include ESG in their evaluation process, says Chaitanya Kalia, partner and national leader, climate change and sustainability services, EY India.
“The benefits of the same can be passed on to the companies in terms of reduced cost of borrowing. While the same has not been fully adopted in India, considering the long-term benefits of ESG investing, it should be implemented,” Kalia adds.
Expansion of Scope
There are other challenges, too. Currently, sustainable financing is skewed in favour of renewable energy and energy efficiency.
“Sustainable finance must also flow into other sectors that are conventionally perceived as financially unviable such as carbon-intensive industries like steel and cement, infrastructure, transport, low-carbon agriculture and water management. Sectoral targets, with provisions for manufacturing and scheme of incentives and disincentives, can encourage such flows,” opines Rashmi.
Like Rashmi mentions, focus also needs to spread to the greening of other sectors.
Raichura interestingly points out that steps should also be taken to finance the green transition of the micro, small and medium enterprise [MSME] sector. “These companies are large emitters of greenhouse gases and often lack the access to capital to adopt sustainability measures such as improving energy and water efficiency or access to clean energy. There is an urgent need to provide a source of financing to these companies,” he says.
There are a variety of measures that can be taken to enable this, says Raichura—from categorising such financing under priority sector lending to creating special purpose vehicles underwritten either by the government or international development banks. “Such instruments will not only help India achieve its sustainability targets but also help reduce costs for MSMEs in the long term,” he adds.
Vikas says that sustainable finance needs to move to sub-national and municipal levels since provincial and local-level government bodies are also responsible for developmental needs in a country as large as India. “This is a significantly untapped space for sustainable finance in India but scaling this up will require putting in order books of accounts and other documentation.” In that respect, the recent $20-million municipal green bond issuance by the Ghaziabad Municipal Corporation is noteworthy.
A robust sustainable financing ecosystem is a function of an enabling policy, regulations and disclosures. For now, India could do well by defining a green taxonomy which would help key stakeholders overcome information asymmetry, guide policymakers and regulators to be on the same page as the global leaders, enable businesses to take informed decisions, reduce chances of greenwashing and give investors the much-needed confidence.