‘Green’ bonds — meant to raise funds for environmentally friendly ventures — were seen as a critical financial innovation that brought in capital while also making an environmental impact.

Cumulatively, global issuances of green bonds have surpassed $3 trillion, reaching $577 billion in 2024, yet they still constitute a modest 3 per cent of the bond market.

India’s overall corporate bond market itself remains underdeveloped at approximately 17 per cent of GDP, which has restricted the growth of its green bond segment to about 4 per cent. Entities seeking to raise funds are often attracted to green bonds for the prospect of lower debt costs, signalling green commitments, and benefits in attracting ESG-focused investors. However, significant hurdles persist in harnessing their full potential, according to a note put out by Labanya Prakash Jena, Sustainable Finance Consultant at Institute of Energy Economics and Financial Analysis.

He points out that the primary challenge lies in the high issuance costs associated with compliance, certification, and reporting. Smaller entities, in particular, find these costs too high to absorb, creating an uneven playing field that favours larger corporations or government bodies. Also, the lack of a global standardisation in ‘green’ definitions across geographies creates confusion for investors and issuers, he points out, coming in the way of comparability.

Another worry, he says, is ‘greenwashing’ — misrepresentation of a bond’s environmental credentials, where proceeds may not genuinely fund green projects or deliver meaningful benefits — which dents investor trust and market credibility.

Jena points out that large financial institutions that fund thermal power projects, but also seek to raise funds for green initiatives tend to confuse investors.

He suggests that institutions and energy conglomerates commit to reducing carbon emissions from their loan portfolios or overall operations over time. “They may not be able to immediately abandon projects that spew high emissions, but by committing to a gradual lowering of revenue from such projects, they send a signal to the market.”

Compliance, including need for impact reports, after bond issuance also deters companies seeking to raise funds, especially from developing countries where technical expertise and resources are not easily available.

The other factor under scrutiny from investors is the ‘greenium’ or green premium — the lower yield historically accepted by those investing in green bonds.

Jena says recent studies show this premium is diminishing, or even become negative, at -5 to -2 basis points across currencies and credit ratings. Obviously, investors are less willing to settle for lower returns without a clear reduction in financial risk.

If this trend keeps up, warns Jena, issuers may begin to opt for conventional corporate bonds. Benefits that do not directly buoy the financial aspirations of investors, such as enhanced reputation, may not be enough to justify the additional cost of green bond issuance, he says.

Jena prescribes four key changes in policymaking to rectify market failures and spur demand:

Mandating large institutional investors such as pension funds, insurance companies, and mutual funds to allocate a small percentage of their capital to green assets.

Improving the credit quality of green bonds through mechanisms like partial credit guarantees from the government to attract institutional investors seeking higher credit ratings (AA or above). Hedging against potential defaults, this can enhance bond ratings.

Mitigating counterparty risk posed by government entities (such as power distribution companies, or discoms) in renewable energy projects. Mechanisms like those offered by Solar Energy Corporation of India (SECI), which guarantees payment if discoms default, or tripartite agreements involving the RBI and State governments, can significantly reduce counterparty risk for developers and investors.

Promoting long-duration bonds (15 years or more), as climate change risks are more likely to materialise over extended periods. Longer-duration bonds prove more attractive to investors seeking to mitigate transition risks in their portfolios, potentially boosting green premia.

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Published on September 1, 2025