Green Bond option for climate finance

Green bonds are not just fanciful hype, they can be a useful tool to fund sustainable assets in Nepal

Photo: SUSHMITA DULAL

Green Bonds figure consistently in recent discussions among activists and financial institutions in Nepal as an option for climate finance. The scope of green asset class segregation is supposed to commence soon as the Government of Nepal and the Central Bank have introduced the draft of a Green Taxonomy. 

Green bonds are seen as a source of sustainable investment. Access to funds at soft terms has given hope to investment companies and banks about green bonds.

Green bond is a financial instrument where investors lend money at a fixed interest rate to an entity, business, government agency, or other organisation and subscribers get their investment back in the form of periodic interest payments called coupons and the redemption of principal upon maturity. 

Companies, organisations, states, local governments, and sovereign governments use green bonds to finance green classified assets. The issuer is obligated to use the funds for green assets and projects. The funds should be deployed transparently, and coupon rates are relatively lower than conventional bonds. 

Green bonds do not appear to generate additional benefits for the issuer unless a subscription can happen at a cheaper coupon rate. Thus, the narrative that ‘a bond is a bond whether green or brown’ gets some validation from a surface-level business standpoint.

If a green bond is issued in foreign currency, ideally the issuing entity should invest in the asset of the same currency or any other hard currency with a sufficient margin that is very much constrained in the case of Nepal due to the limited scope of financing opportunity. 

Foreign exchange risk may affect cash flows, profitability, investment returns, and financial performance. Bond issuing entities may employ hedging techniques like forward contracts, options, or currency swaps to reduce the adverse effects of currency fluctuations to manage this risk.

The volatility in Nepal’s currency (NPR) is the function of volatility in the Indian rupee (INR) as  NPR is pegged to INR. This and the lack of appropriate hedging tools have made the foreign currency bonds less attractive and less lucrative from the prospects of financial benefit.. The depreciating NPR would affect issuers’ ability to pay back the bond’s principal and coupon payments in foreign currency. 

Locally available platforms for hedging are in a nascent stage and, thus, do not provide adequate liquidity. The international platforms are costlier as they need to cover liquidity as well as peg risk. Given the above, hedging against currency risk in Nepal is noticeably more expensive. The political and economic climate of Nepal are the reasons of higher country risk in the international market, which drives up the cost of hedging products including currency forwards, options, and swaps. 

Significant interest rate differences can also increase the carry costs of hedging instruments. Nepal faces challenges to the commercial feasibility of a green asset portfolio, especially when it comes to energy sources other than hydropower and electric vehicles (EVs). Because of Nepal’s geographic advantages, solar energy projects have also witnessed a brighter future scope.

Initiatives focused on biogas and biomass can also benefit from livestock waste and agricultural residues, although their scalability and reliability are frequently questioned by experts. While energy-efficiency initiatives and sustainable agricultural methods provide potential long-term advantages, they also come with significant upfront costs and call for a shift from conventional livelihood practices to achieving commercial viability. 

Public-private partnerships, capacity-building initiatives, and government policies must work together to improve the commercial viability of these green sectors. Financial obstacles could be reduced by subsidies and foreign direct investment. Furthermore, funding educational and training initiatives can develop local expertise, increase public knowledge of green investments, and attract more stakeholders.

The cost of capital for green projects can be reduced by using green bonds, concessional loans and blended finance. A multifaceted strategy combining financial innovation, strategic alliances, and supportive regulations is needed to address the issues with these sectors’ commercial viability and foster an atmosphere that encourages sustainable investments in Nepal through green bonds.

Nepal’s bond market is still underdeveloped due to factors like a small pool of investors, inadequate market infrastructure, and a low-risk tolerance appetite. Low liquidity and transparency, together with ineffective trading platforms and settlement procedures, all hinder functional bond trading activity. 

The expansion of sustainable finance depends on investor knowledge regarding green bond investments. Green bonds are more enticing when there is transparent and thorough reporting on the environmental impact and usage of revenues.

Wider investor participation is hampered by the intricacy of green bonds, which have unique requirements such as certification procedures and impact assessment techniques that can be difficult for investors to fully comprehend.

The implementation of globally accepted standards, such as the Climate Bonds Standard by CBI and the Green Bond Principles (GBP) by ICMA, which help create a common understanding of green bonds, is one way to improve investor awareness. 

Attracting investors also heavily depends on government initiatives and supportive policies like tax breaks and regulatory frameworks. Furthermore, informing customers and incorporating green bonds into investment portfolios are important tasks for financial advisers and investment managers. The market for green bonds in general will increase as a result of these concerted efforts to involve investors more and more.

Issuers can use globally accepted standards, such as the Climate Bonds Standard by CBI or the Green Bond Principles (GBP) by ICMA, to solve this. Sophisticated due diligence and strong frameworks for project appraisal that include environmental, social, and governance (ESG) criteria are necessary to find achievable projects. 

Compared to conventional bonds, green bond issuance has greater upfront costs. These are mainly caused by certification fees, legal and consulting fees, and expenditures associated with carrying out in-depth sustainability and environmental impact analysis. It is frequently necessary to handle the complexities of green bond standards and regulatory requirements with the help of legal experts and consultants who specialize in sustainable finance. The green bond issuance process is more complex and resource-intensive due to the higher starting expenses, which guarantee that the projects supported by the bonds meet strict environmental, social, and governance (ESG) standards.

Internationally accepted guidelines that guarantee environmental integrity, transparency, and authenticity serve as a framework for the issue of green bonds. The International Capital Market Association (ICMA) created the Green Bond Principles (GBP), which offer issuers a thorough framework for creating, disclosing, and overseeing green bonds. The use of profits, project appraisal and selection procedures, fund administration, and open reporting on environmental effects are just a few of the important topics covered by these principles. In a similar vein, the Climate Bonds Standard (CBS), created by the Climate Bonds Initiative (CBI), is dedicated to investments that support adaptation or mitigation of climate change.

It establishes eligibility requirements, demands independent certification and verification, and calls for open reporting on the environmental results of projects that receive funding. Adherence to these guidelines bolsters the legitimacy of green bond offers, thereby reassuring investors and promoting the expansion of sustainable financing.

By attempting to comply with these guidelines, issuers draw in investors who value ethical investing while showcasing their dedication to environmental sustainability. Green bonds that finance initiatives with demonstrable environmental advantages, like energy efficiency, renewable energy, and sustainable transportation, are guaranteed by adherence to the GBP and CBS. 

These guidelines are regularly reviewed and updated to reflect changing market demands and best practices, guaranteeing their applicability and efficiency in encouraging investments that favorably impact environmental goals. This continued dedication to environmental integrity and openness upholds investor trust and promotes the growth of a healthy and long-lasting green bond market. 

The requirements for reporting and verification make green bonds even more complicated. Independent evaluations and recurring reviews by a third party are necessary to verify the bonds’ compliance with set green standards before and following issuance. Validating the environmental benefits requires adherence to standards such as the Climate Bonds Standard by CBI or the Green Bond Principles (GBP) by ICMA. Issuers also have to report in a clear and comprehensive manner on how revenues are used and how the projects they support are affecting the environment. This ensures continuous disclosure and accountability to investors and stakeholders. It also includes regular updates on fund allocation and thorough reports on environmental consequences. In addition to raising the issuance and management expenses of green bonds, these stringent regulations also preserve the product's efficacy and integrity.

Green bonds are not just fanciful hype, they are a genuine and useful tool for funding sustainable  assets. They offer a concrete means of allocating funds to environmental projects, including energy efficiency, renewable energy, and sustainable infrastructure. The market for green bonds is expanding, indicating both its potential and the growing interest from investors who are eager to promote sustainable development. 

Green bonds provide transparency, accountability, and quantifiable environmental effects by conforming to recognized frameworks and standards like the Climate Bonds Standard and the Green Bond Principles (GBP), which makes them a reliable choice for sustainable financing.

Adopting green bonds can be a calculated decision for nations like Nepal to finance their sustainable development objectives and green infrastructure. To draw in both foreign and domestic investors, Nepal should first establish a strong regulatory framework that complies with worldwide green bond requirements. To boost the market, the government can also offer incentives like tax cuts or subsidies for the issue of green bonds. 

Building capacity is also essential, thus, spending money to inform financial institutions, project developers, and possible investors about the advantages and workings of green bonds will create a welcoming atmosphere. Nepal can use green bonds to finance important initiatives, spur economic expansion, and improve environmental sustainability by implementing these actions.

Govind Ghimire is Deputy Chief Executive Officer of NMB Bank.

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