India’s push and pull with Climate Finance: The Roadmap Ahead

In the backdrop of an unabating pandemic and a spate of natural disasters attributed to climate change, the nations of the world met at the COP26 Glasgow in 2021, to review and renew their climate pledges, and discuss thorny issues such as climate finance.

India, for one, announced new climate commitments which go significantly beyond its Nationally Determined Contribution (NDC) targets previously set under the Paris Agreement of 2015. India set aggressive targets to reach a non-fossil energy capacity of 500 GW and reduce the carbon intensity of its economy to less than 45 percent by the year 2030, and for the first time committed to a Net Zero emissions target for the year 2070. While India stepped up its climate action goals, it also made its expectation of developed countries to make $1 trillion available as climate finance quite clear.

Climate finance obligations based on the principles of ‘polluter pays’ and ‘Common but Differentiated Responsibility’ has its roots in international law. In 2010, and more recently reiterated in the Paris Agreement and Copenhagen Accords, developed countries had pledged to mobilize $100 billion per year through 2025 towards the adaptation and mitigation of climate change in developing countries. It has been argued that the commitment to provide financial resources to developing countries is a legally binding obligation of developed countries under these treaties. What is less clear is the form in which such funds would be mobilized and measured. According to the OECD, almost $79 billion was provided as climate finance by developed countries for developing countries in 2019. On the other hand, Oxfam’s ‘Climate Finance Shadow Report 2020’ states that the contribution was as low as USD 19-22.5 billion in the last few years, and most of this was in the form of bilateral and multilateral loans with interest. The Glasgow Climate Pact seeks to close some interpretational gaps - it calls upon financial institutions, development banks and the private sector to participate and increase their contributions, and stresses that funds should be given in the form of grants, other concessional forms of finance and equity over loans. India should leverage these international laws in negotiations and engagements to attract climate finance.

India is a country of 1.3 billion people and the third largest emitter of greenhouse gases in the world, yet a growing economy with still expanding needs for infrastructure development. To achieve its climate targets and fund its green transition, India needs a large budget allocation, international climate finance from bilateral and multilateral sources and climate-related private investments. India needs to improve its readiness to access and deliver climate finance from all available sources. This involves different aspects:

• (i) political and strategic readiness with a national ‘climate policy’, planning and resource allocation,
• (ii) creating investible projects, adopting measurement and disclosure standards, and
• (iii) legal readiness to provide a framework that enables innovative financing structures and de-risking investment opportunities.

Policy interventions

Over the last decade, India’s policy efforts have achieved significant renewable energy deployment. India already generates 20% of its power requirements from renewable sources. Producing renewable energy has become more cost efficient and supply is available at competitive pricing. The recently introduced production linked incentive (PLI) scheme for solar panels will reduce dependence on imported components and allow supply chains to be more resilient. India launched the ambitious ‘One Sun, One World, One Grid’ (OSOWOG) programme at COP 26 along with the Green Grids Initiative (GGI) of the UK, which entails connecting clean energy grids across continents. This is an opportunity for India to participate across the global renewable energy value chain.

While India has expressed a net zero emissions target, there is no official measurement or projection of India’s emissions, and the interpretation of what this target entails is not entirely clear. Achieving these climate targets would require countering emissions from agriculture and land use, not just emissions from energy and industrial processes. Incorporating net-zero targets into overall domestic policy will provide regulatory clarity to investors to finance India’s plans for decarbonization and net-zero pathways to development. For example, transition to green mobility is quickly picking up with policy intervention and market response. The Faster Adoption and Manufacturing of Hybrid and Electric Vehicles scheme (FAME) and a Production Linked Incentive (PLI) scheme incentivises EV manufacturers and charging infrastructure providers, and different state governments have implemented their own EV policies and subsidies to promote e-mobility.

For India, more challenging than phasing out coal in the power sector would be phasing out the industrial use of coal and fossil fuels particularly in the production of steel and cement which need high industrial heat which is not technologically feasible to obtain from non-fossil fuel sources. Alternate sources for thermal substitution are at a nascent stage and need finance, R&D and technology availability particularly for carbon capture, energy storage, green hydrogen and nuclear energy supply. India is not a member of the Nuclear Suppliers Group to be able to access sophisticated nuclear technology and raw materials. India should continue to push for membership of the Nuclear Suppliers Group, linking this to its climate goals.

Another challenging policy issue is of carbon taxation. Currently India has a coal cess penalising the use of coal and excise duty on petroleum products, and certain states have implemented green taxes within their territories. India could introduce a uniform carbon tax policy which would incentivise Indian companies to prefer alternative energy sources.

Disclosure and transparency

One of the barriers that India faces in accessing climate finance, is the lack of a green taxonomy. The Reserve Bank of India (RBI) has also acknowledged that reporting asymmetry and the lack of a standardised global taxonomy are the key reasons for the relatively high cost of green bonds which have seen low interest from investors.

A green taxonomy would provide clarity on what activities qualify as ‘green’ and establish the eligibility criteria for green finance. Adopting such a taxonomy would reduce the chances of greenwashing and enhance investor confidence. A green taxonomy will also lead to attention towards sectors in need for investment taking away the sole focus from renewables which tends to garner the most attention in India. Additionally, it will ensure that regulators such as Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) align their regulations with the taxonomy. While developing this taxonomy, policy makers could look at the green financing definitions as provided by Sustainable Banking Network (SBN); Principles for Responsible Investing (PRI); Carbon Disclosure Project (CDP); Sustainable Accounting Standards Board (SASB); OECD and UNFCC.

India’s environmental laws specify environmental impact assessment protocols, pollution standards, compliance and disclosure requirements for industries. However, the current environmental legal landscape is insufficient and needs to be augmented to bring in a strong climate transition plan which industries can follow, and regulators can use to regulate. National environmental regulations may also need to be strengthened to align with standardisation norms under a new taxonomy.

The standards for disclosure and sustainability reporting are still at a nascent stage in India. In May 2021, SEBI issued a sustainability disclosure norm, ‘Business Responsibility and Sustainability Reporting (BRSR) by listed companies’, which mandates the reporting of ESG performance by top listed 1000 companies with the largest capitalization. It is voluntary from FY 2020-201 and will be mandatory from FY 2022-2023. Over time the sustainability standards under BRSR should be made mandatory for all companies which will allow companies to be transparent with investors about their ESG practices. BRSR will bring about uniformity since it is a culmination of various global reporting frameworks such as CDP, GRI, SASB and TCFD.

Different countries such as the UK, Singapore, France, New Zealand have already adopted mandatory climate disclosure reporting requirements for companies as a response to demand from lenders, investors and other key stakeholders. Banks, insurers, asset managers, pension funds and global investors need to rely on data and metrics to make informed decisions on capital allocation and risk underwriting. In the Indian context, investors have had to rely on voluntary disclosures by companies, which are often incomplete, inconsistent and subjective. The Bombay Stock Exchange offers a benchmark index, which assesses the ‘carbon performance’ of stocks based on quantitative performance parameters. This is a step in creating an inclusive market-based mechanism to promote energy efficient practices amongst issuers and attract green finance. However, India needs regulatory standardisation of climate disclosure and reporting, to enhance its credibility and negotiate for green finance. Mandatory reporting standards, data and measurement will help to channelise institutional green investments to India.

Sources of finance

Raising climate finance requires access to diverse sources of capital, public and private sector participation and appropriate financing structures. According to the RBI, climate finance could be an opportunity to diversify financial assets and enable mobilization of private capital for sustainable development in India.

- Green Bonds

SEBI has enabled raising capital through the issue of green bonds by Indian companies and mandated related disclosure norms. Green bonds can be issued only for assets or projects with an environmental purpose such as renewable energy, clean transport, sustainable water or waste management, energy efficiency and climate change adaptation, and funds raised need to be utilised entirely for the same purpose. The eligibility criteria is clearly demarcated and many companies may not be eligible to issue green bonds to support their clean energy transition if they have long investment cycles in carbon assets.

The uptake of green bonds has been slow largely due to the lack of a green taxonomy and an assessment and rating framework. Only certain renewable energy projects have so far taken the green bond route issued in overseas markets. Green bonds can be scaled if the domestic bond market is made stronger, the existing regulations are made more inclusive, the use of proceeds criteria is broadened, and preferring green investments in central bank operations. Credit enhancement methods through the creation of guarantee funds, issuing of sovereign green bonds, and extending tax incentives to such bonds tax will further support the use of this instrument. India’s International Financial Services Centre (GIFT City) would also provide a suitable framework to channelize foreign capital for sustainable financing as it provides a platform within India where foreign currency can be accessed with low tax impact, trading exchanges are available for all asset classes, and innovative financial products and structures for debt financing can be explored with regulatory support and transparency.

- Developing an internal carbon market to attract green finance

A key outcome of the COP26 conference was the conclusion of the Paris rulebook which included the agreement of the fundamental norms which will govern carbon trading. This development will give a push to develop a domestic carbon market for emission trading in India.

Currently India does not have an explicit mechanism for carbon pricing or market-based carbon trading. Energy intensive industries are allotted energy saving certificates (ESCerts) if they achieve their assigned energy reduction targets or need to purchase ESCerts through a centralised online trading mechanism hosted by the Indian Energy Exchange (IEX). Similarly, power distribution licensees are required to purchase renewable energy certificates (RECs) on the power exchanges if they fail to achieve their renewable purchase obligations.

The key to developing a voluntary carbon market for the private sector is to define a mechanism for identifying quality carbon offsets, develop carbon accounting standards and a transparent pricing mechanism, and standardise the various carbon trading instruments and their fungibility.

- Blended Finance

Accessing finance for small scale and micro impact projects requires moving away from traditional public grants, institutional lending and philanthropic sources, and explore blended finance structures that allow strategic use of development finance from private investors for sustainable development. Social impact bonds for climate transition can be used as a funding structure for small budget interventions at the district, municipal and state levels, which blends impact investing, public-private partnerships and outcome-based finance. The structure enables investors to provide upfront early risk financing to implement a green project which could even include R&D or a pilot project, while the commissioner (national or local level government) pays the investors a return if the intended outcome of the project is achieved. Outcome based funding is a great tool to transfer the risk of poor performance from the government to the investor, while investors receive a financial return for taking this risk as well as a social return through the outcomes achieved. There is a need to incentivise more funds willing to provide such “first loss capital” to de-risk projects and catalyse further investments. Such incentives may be provided by offering more viable/investible projects where the outcome parameters are clearly defined, providing guarantee support to back stop unknown risks and providing regulatory relaxations to facilitate flexible funding structures.

- Corporates and retail investors

Corporate funds can be a useful source for climate finance. Indian company law mandates profit making corporates to allocate funds towards corporate social responsibility (CSR) activities which are unrelated to their own business. Many corporates choose to fund environmental causes as part of their CSR strategy, for e.g. afforestation or developing solar parks. That said, there is potential for more concerted utilisation of CSR funds towards climate and greater impact can be achieved by creating CSR fund pooling vehicles which specifically target climate mitigation measures. Recent amendments to the CSR rules require companies to undertake impact assessments of their CSR projects. Tapping CSR funds for outcome funding of climate related projects, particularly for R&D and gap assessments, may find wide acceptance among the corporates as their funds would be channelled into defined transparent projects with measured outcomes. This also aligns well with the primary policy objective of CSR, which is the promotion of responsible and sustainable business philosophy. However, certain compliance requirements under the CSR rules, particularly the requirement to transfer ‘unspent’ CSR funds to specified government relief funds, could be inconsistent with the needs of climate projects which have longer gestation periods.

SEBI also recently launched the Social Stock exchange in India which provides social enterprises and social venture funds an alternate platform to raise funds from institutional and retail investors and attract CSR funding with transparency. Clarifications will be required under the Foreign Contribution (Regulations) Act to enable foreign investors to invest in social venture funds listed on the social stock exchange. In addition, the CSR rules can also be clarified to allow trading of CSR fund instruments on the social stock exchange.