Sovereign Green Bonds : Work, Interest Rates, Examples & Benefits

What are Sovereign Green Bonds?

Sovereign Green Bonds are issued by the government to fund projects that work for the climate, environment, and sustainability. In other words, the national governments offer debt securities known as “sovereign green bonds” to finance initiatives that enhance the environment and the climate. These bonds are a part of Green Bonds, which are financial instruments intended to fund initiatives that have a good influence on the environment. Green bonds are usually asset-linked and are backed by the balance sheet of the issuing entity, thus carrying the same credit rating as the other debt obligations of the issuer. The issuance of sovereign green bonds, which signify a government’s dedication to sustainable and eco-friendly projects, sets them apart at the national level. India recently launched its first sovereign green bonds and it is expected that with this initiative, India will be able to boost the energy transition and fund green infrastructure and renewable energy projects.

Geeky Takeaways:

• The World Bank has defined a green bond as a debt security that raises funds for initiatives associated with the climate or the environment. Governments provide Sovereign green bonds to raise funds for these forms of initiatives.
• In 2008, the first green bond was issued by the World Bank. In 2022, India launched its first Sovereign Green Bond.
• When a federal or state government issues a Sovereign Green bond for the first time, it enhances the opportunities for green issuance across the country, according to the Bank for International Settlements (BIS).
• Since the initial market launch, the global green bond market has covered more than USD 1 trillion.

Who Issues Sovereign Green Bonds?

Governments (both central and state), organizations, and companies are eligible to issue green bonds. Green bonds can be issued only to finance projects that have a positive impact on the environment and climate and offer investors with a fixed regular income. The projects could involve green building, renewable energy, and sustainable transportation among other things. The profits generated from these bonds would be used for environmental projects. Hence, it is different from regular bonds which permit the issuer of the bond to use the earnings for several purposes.

Although green bonds can be issued by multiple entities, sovereign green bonds can only be issued by the national government. Hence, if ICICI Bank Ltd. issues a green bond, it will be as it is. But if the central government issues a green bond, it will be termed a “Sovereign green bond”. Due to its name, the sovereign green bonds are safer than the green bonds.

In the financial year 2021-22, the Chinese government issued the Sovereign Green Bond of $76 Billion, the highest till now by any nationals.

How do Sovereign Green Bonds Work?

1. The government issues sovereign green bonds in the market and they are usually sold via auctions or institutional investors. The proceeds earned from these bonds are designated to finance green, sustainable, eco-friendly projects.

2. Before issuing these bonds, the regulators design a framework where all the terms and conditions are specified. The framework specifies the eligible projects which would be funded and it provides transparency and assurance to the investors that their investment will be used for environmentally beneficial projects.

3. Investors interested in sovereign green bonds comprise asset managers, institutional investors, and environment-friendly individuals. There is an investor appeal, that resides in being able to support environmentally friendly projects and generate earnings from interest payments and final maturity of the bond.

4. The issuer of the sovereign green bonds must ensure to report regular updates on the environmental projects financed using the investors’ fund. This creates transparency and trust among the issuer and investors. Regular reporting on the sustainable and environmental outcomes depicts the effectiveness of the issuance of the sovereign green bond.

5. Sometimes, the issuers opt for certifying and verifying their projects from an external third-party entity that would ensure the viability and surety of the project. This gives a sense of assurance and satisfaction to the investors who invest in these eco-friendly initiatives.

6. The investors received a regular interest payment on their investment in these bonds and the final principal amount at the time of maturity. Similar to traditional bonds, sovereign green bonds do come with some financial risk and so the investors evaluate the creditworthiness of the issuer. The environmental factor is an additional judgment that the investor seeks before making decisions.

Sovereign Green Bonds Framework of India

1. The Sovereign Green Bonds Framework of India follows the pledges taken by India at the Conference of Parties (COP) 26 held in Glasgow in November 2021. These pledges were known as ‘Panchamrit’. Using these pledges, the Nationally Determined Contribution (NDC) targets set by the Indian government at the Paris Agreement, would be triggered.

2. The Green Finance Working Committee (GFWC) was established to look into different matters associated with issuing the Sovereign Green bonds. The framework has obtained a governance score of “Good” and CICERO (second opinion provider) from Norway has rated this framework “Medium Green”. If a project or idea receives a “Medium Green” classification, this means that crucial progress has been attained toward the long-term objective, but the final objective is yet to be achieved.

3. The Government of India has proposed nine categories that could be financed using the proceedings of the Sovereign green bonds: Renewable energy, Clean Transportation, Energy efficiency, Sustainable water and waste management, Climate change adaptation, Sustainable management of living natural resources, and land use, Terrestrial and aquatic biodiversity conservation, Green buildings, and Pollution prevention and control.

4. The framework of India lists out the investments made in solar, wind, hydro, and biomass energy projects, urban transportation projects (for example metro rail), pollution prevention and control projects, and green buildings.

5. The fossil fuel-related projects have not been included in the framework along with the biomass-related renewable energy projects that is based on the feedstock from protected areas. Another exclusion is linked to projects related to nuclear power generation and direct waste incineration.

6. The expenditure allowed is limited to the amount of government spending which have taken place within one year from the date of issuance. Further, within 24 months of issuance, the proceedings must be allocated to projects. Somehow, if an eligible green project is cancelled or postponed, the proceedings will be allocated to another eligible green project.

Sovereign Green Bonds Interest Rates

The interest rates of Sovereign Green Bonds can be termed “Greenium”. This means, that bonds have lower interest rates and investors agree to avail of this bond due to the noble cause of the sovereign green bonds. Thus, the issuers (governments) take advantage of this and grant lower interest rates as compared to the normal bonds. By offering lower interest rates, issuers reduce their burden and the investors are also satisfied as their money is being used for some noble cause.

The latest 10-year Sovereign Green Bond implied an interest rate of 7.29% in India. On the day the bond was issued, the general 10-year bond yield was 7.38%. This signifies the geranium of 9 basis points.

Tax Incentive on Sovereign Green Bonds

There is no tax incentive applied to Sovereign Green Bonds. Tax incentive implies tax saving or tax exemption features. Tax saving means reducing the taxable income by investing the amount in specific financial instruments such as provident fund (PF) under Section 80C of the Income Tax Act. On the other hand, tax exemption means there is no tax levied on the interest received from the tax-free bond. The income of these bonds is tax-free for the investor under Section 10(15) of the Income Tax Act.

Examples of Sovereign Green Bonds in India

In India, the first Sovereign Green Bond was issued by the Government of India, Ministry of Finance on 25th January 2023. The total issue size was about Rs. 8000 Crores (INR 80 Billion). The details of the bond are mentioned below:

Type of Bonds	5-year Sovereign Green Bond	10-year Sovereign Green Bond
Issue Size	₹4000 crore (₹40 Billion or $490 million)	₹4000 crore (₹40 Billion or $490 million)
Issue Date	25th January 2023	25th January 2023
Coupon / Yield	7.10% / 7.10%	7.29% / 7.29%
Premium	10 basis points	9 basis points
Interest Payout Frequency	Semi-Annual	Semi-Annual
Oversubscription	2.4 times	3.8 times
Total Bidders	32 bidders (96 bids)	57 bidders

Another reopening of the Sovereign Green Bonds was issued by the Indian Government on 9th February 2023. The details of this second bond are mentioned below:

Type of Bonds	5-year SGB	10-year SGB
Issue Size	₹40 Billion ($484 million)	₹40 Billion ($484 million)
Issue Date	9th February, 2023	9th February, 2023
Coupon / Yield	7.10% / 7.23%	7.29% / 7.30%
Total Bids	62 bids	91 bids
Oversubscription	1.7 times	2 times

Other corporations have issued several green bonds (non-sovereign) in India over the years.

Benefits of Sovereign Green Bonds

The benefits of SGB (Sovereign green bonds can be mentioned as,

1. Noble Initiative: The Sovereign Green Bonds have portrayed the initiative of the Government and authorities towards sustainable development and climate change.

2. Growth of Local Market: As these bonds are issued in the local market, it will boost the local market and also the institutional investors. The issuance of these bonds will contribute to expanding the local market and set benchmark pricing and liquidity. Further, set an example for the local issuers.

3. Significant Capital Inflows: These bonds can contribute towards significant capital inflow. As per IEA’s World Energy Outlook 2021, for emerging/developing countries to reach the target of net zero, an estimated 70% of the additional USD 4 trillion needs to be spent.

4. Strengthen National Currency: In India, SGB contributes not only to the sustainability goals but also to strengthening the Indian currency. When these bonds are issued in local currency in the global market, domestic investors will come forward to invest and contribute to the fund of the central bank. This increase in the currency depicts the trust and confidence built among the investors towards the Indian currency, thereby maintaining its stability.

5. Increase in Demand: The growing demand for socially and ecologically responsible investments is leading investors to invest in projects that contribute to sustainable development. A constrained supply of green bonds in the market combined with increased investor demand may cause the price and yield of green bonds to rise.

6. Attract Foreign Investment: Green bonds can also encourage foreign investment while reducing currency risk related to changes in foreign exchange rates influenced by geopolitical and economic events overseas. They offer better yields than standard debt products. India lowers its exposure to such volatility and helps to maintain the stability of the local currency by issuing these bonds in Indian rupees.

Challenges of Sovereign Green Bonds

1. Maintaining Liquidity and Enabling Trade: As per RBI, SLR (statutory liquidity ratio) and repo transactions will be available to green bonds. This will help in maintaining liquidity and facilitating trading of the SGB bonds. Similar to Denmark, twin bonds can be issued to maintain liquidity. Here, two comparable and interchangeable bonds are issued where investors can shift between these two bonds and this facility promotes trade and liquidity. Earlier, based on the twin bond strategy, the Indian government issued market stabilization bonds.

2. Interest Rates Issue: As investors are aware of the geranium, their expectation also increases as per the government rules. The interest rates of the green bond and traditional bonds are always under comparison. As per the US Federal Reserve, a minimum of 8 basis points is necessary to imply the green bond compared to the traditional bonds.

3. Lack of Awareness: A major obstacle for developing economies with green bond markets is a lack of knowledge about the concepts and advantages of green bonds. Investors must have a thorough grasp of the specifications used to designate green bonds because uncertainty might prevent them from participating. On the other hand, taking advantage of possibilities, such as government incentives or subsidies that encourage investment in green initiatives, requires educating investors about the financial returns and environmental advantages of green bonds. These issues have resulted in the limited involvement of investors in green finance initiatives in developing nations.

What distinguishes Green Bonds from Conventional Bonds?

The proceedings from a conventional bond can be used for a variety of purposes at the discretion of the issuer. In the case of green bonds, revenues are used only for environmental projects. Green bonds must list the details of the projects where the fund will be used and the expected effect on the environment and the climate.

Difference between Green Bonds and Standard Bonds

Basis	Green Bond	Standard Bond
Purpose	Used for funding only environmentally viable projects.	Used for any financial projects or purpose depending on the issuer.
Can be issued by	Governments (both central and state), municipalities, or corporations.	Corporations, Governments, and municipalities.
Framework	There is a green bond framework where all the eligibility criteria and project guidelines	No such framework guidelines pertain to standard bonds
Investor Appeal	Socially responsible investors are attracted	Investors who seek financial returns invest in these bonds
Certification or Verification	Prior to investing, certification or verification is sought by investors.	No such certifications are required.

Sovereign Green Bonds – FAQs

Do you get a higher yield or interest on sovereign green bonds?

No, theoretically sovereign green bonds come with lower interest charges. This is due to the fact that investors can invest in bonds which serve a noble purpose, i.e., for the benefit of the environment. Some investors willingly pay a greenium or premium that further reduces the yield. In India, the yield of green bonds is more or less equivalent to the regular government bonds, hence citing not much difference.

How will SGB benefit the Indian economy?

As the sovereign green bonds are issued for funding environmental friendly public sector projects, this will reduce the carbon footprint on the economy. Further, these green bonds would contribute in achieving the targets set by the government, such as 175 GW of renewable energy capacity by 2022 and net zero carbon emission by 2070.

Few examples of green projects.

Renewable energy, clean transportation (electric vehicles), green buildings, waste management etc.