[Vatsal Jain and Vedant Bhardwaj Singh are 3rd year B.A., LL.B. (Hons) students at Hidayatullah National Law University]
On 4 May 2023, the Securities and Exchange Board of India (‘SEBI’), by way of a circular titled ‘Additional requirements for the issuers of transition bonds’ (‘Circular’) laid down certain additional compliance measures for the issuance of transition bonds to prevent the misallocation of funds, and to ensure transparency and fight against greenwashing. Transition bonds are investment tools designed to finance projects aimed at facilitating the transition to a greener and more sustainable economy.
The Circular mandates that the issuer would denote the transition bonds with the title ‘GB-T’ on the cover page of the offer document and the relevant areas on the term sheet. The issuer needs to disclose a transition plan as well. Tenets of the transition plan would include interim targets to reduce emissions, an indicative timeline to complete the transition, an implementation strategy, details on the usage of the technology and a mechanism to check the usage of funds raised through these transition bonds. The issuer is obligated to disclose to the stock exchanges all the revisions along with explanations during the pendency of the project. Moreover, the annual report of the issuer company shall include a brief regarding the implementation of the transition. The Circular further empowers the stock exchanges to monitor the disclosures made under this Circular.
The Circular is drafted solely for transition bonds. It is an extension to the circulars titled ‘Revised Disclosure Requirements for Issuance and Listing of Green Debt Securities’ (‘Circular on green debt securities’) and ‘Dos and don’ts relating to green debt securities to avoid occurrences of greenwashing’ (‘Greenwashing circular’) dated 6 February 2023 and 3 February 2023 respectively. The introduction of transition bonds can help solve the issue of unsustainable practices followed by certain companies and industries and play a crucial role in fulfilling India’s environmental obligations.
Based on the aforementioned premise, this post underscores the reasons for the introduction of these additional compliance measures by SEBI and provides a comprehensive review of the regulatory mechanism of transition bonds.
International Hesitancy on Transition Bonds
The field of transition finance has largely overlooked transition bonds. Currently, the market is teeming with apprehension against these bonds. Since the first sale of transition bonds in 2017, they have been struggling for relevance. As of June 2021, only $7.3bn has been raised through sales of these bonds. Only Japan and China are endorsing the use of transition bonds. However, as of February 2023, the Japanese government is yet to issue its first transition bond.
The fears find their rationale based on the International Capital Markets Association’s (ICMA) hesitancy in acknowledging the legitimacy of these bonds. Since ‘transition’ is a continuous process rather than a product, it has been unable to garner a proper definition with tangible criteria. The ICMA puts these bonds on a pedestal lower than the green or sustainability bonds. It refuses to recognize such an instrument as a standalone financing method and regards it as a ‘label’ given to sustainability-linked or green bonds. Thus, there is a visible lack of transition principles to provide a structure to these transactions.
The Semantic Challenges in Defining Transition Bonds
In SEBI (Issue and Listing of Non-convertible Securities) Regulation,2021 (‘Regulations’), the Securities and Exchange Board of India (‘SEBI’) has sub-categorized transition bonds as ‘green debt security’ under regulation 2(1)(q)(xii). It is defined as the funds acquired for transitioning to a sustainable form of operation that is in line with the Intended Nationally Determined Contributions (‘INDC’) by India as determined in COP21 and COP26.
Though SEBI’s efforts are laudable, the definition suffers from a lot of inconsistencies. The definition makes a reference to the Paris Agreement. More specifically, the form of operation should meet the 1.5-degree Celsius requirement under the Agreement. However, there are still a lot of discrepancies regarding the choice of mechanism to meet the aforementioned requirements. The definition has failed to acknowledge this polarity.
For example, one of the mechanisms recommended by the Inter-governmental Panel on Climate Change (‘IPCC’) is the ‘offshoot’ method where the temperatures go beyond 1.5-degree Celsius for a few decades, only to come down before 2100. However, SEBI’s definition is unclear as to how such a mechanism will be interpreted. Companies could use it to raise funds for transition but continue their unsustainable business practices for decades without violating the tenets of the definition.
Moreover, considering the outline presented by SEBI, it should be noted that the tangible requirements of the INDCs are subject to change. Any such change by the Government on an international platform may affect the recognition of already transitioning projects and their planned trajectories.
Magnification of the Greenwashing Quandary by Transition Bonds
Coined by Jay Westerweld in 1986, greenwashing is an activity where the companies make unsubstantiated and exaggerated claims on their sustainability to give them an environment conscious image. In addition to the apparent negative effects that these misleading claims will have on ethics, the environment, and society, free riders gain an unfair economic advantage over ethical businesses. The concerns can be better highlighted by Volkswagen’s ‘Clean Diesel’ campaign, where the company claimed that its diesel cars had lower emissions. However, an investigation proved to the contrary. The nitrous oxide emissions were four times more than the permissible limit.
The Circular aims to legitimize the use of transition bonds by mandating additional disclosures. However, it has neglected to address the issue of ‘greenwashing’, which could affect investor confidence and is inconsistent with the current government’s aim for the green economy. In the absence of universally accepted taxonomies, the only regulatory framework that exists on the subject is a greenwashing circular released by SEBI on 6 February 2023. The greenwashing circular places certain compliance burdens on the issuer of green debt securities. The issuers shall not make unsubstantiated claims that create a false impression regarding certification from a third party. The issuers are obligated not to present misleading labels, hide trade-offs or cherry-pick data that is favourable to their cause. In addition to that, the greenwashing circular lays down a continuous disclosure operation to ensure that the steps undertaken by the issuer are realistically contributing to a greener society and not merely existent on paper.
When viewed from the lens of transition bonds, the greenwashing circular fail to prevent greenwashing on several counts. Firstly, the greenwashing circular fails to take into account the suggestions provided in the 2022 G20 sustainable financial report to generate legitimacy behind the commitments made by the financial institutions. At a time where transition bonds suffer from a lack of credibility, SEBI has failed to lay down an institutionalized mechanism to create uniformity regarding the evaluation of transition plans. SEBI’s failure to take cognizance of the same can result in a myriad of inconsistencies given the loose and incomplete definition of transition bonds as discussed above.
Secondly, given that transition bonds come under green debt securities, the growth of this instrument can be hindered by the greenwashing circular as it incorporates arbitrary terms such as ‘cherry picking’ of data and ‘quantifying’ negative externalities. SEBI is silent on what mechanism is to be adopted for the quantification of negative externalities. Furthermore, the lack of restraints on the scope of ‘cherry picking’ can lead to inconsistencies during the evaluation of a disclosure report. This problem is exacerbated when one looks at the sweeping powers of SEBI provided under Chapter 7 of the Regulations. The Board can restrict the market access of the persons concerned. Thus, without a proper framework on greenwashing, such powers may discourage potential issuers under the apprehension of violation of natural justice.
Currently SEBI has merely laid down a general oversight on greenwashing concerns and transitions bonds. Perhaps it can incorporate some tenets from the mechanism adopted by the United States. The latter has a regulatory framework that consists of guidelines not just related to the raising of transition funds but also consumer products. They lay down steps to differentiate between greenwashed and real green products. Furthermore, they also have a dedicated task force for the same.
In conclusion, while the Circular by SEBI demonstrates a step towards promoting sustainable finance through transition bonds, addressing the challenges of international hesitancy, definitional clarity, and combating greenwashing is crucial for ensuring the credibility and effectiveness of these bonds in fulfilling India’s environmental obligations. Furthermore, the Circular places the responsibility of monitoring sustainable actions on the issuer, which leaves room for manipulation and continuation of greenwashing practices. The lack of stringent punitive measures for violations also weakens the enforcement of these guidelines.
To enhance the effectiveness of the Circular and foster the growth of transition bonds, SEBI should consider incorporating suggestions from international frameworks and regulatory practices. Establishing clear and uniform evaluation criteria, adopting a framework to differentiate between greenwashed and genuine green products, and introducing a dedicated task force could strengthen the credibility and acceptance of transition bonds.
– Vatsal Jain & Vedant Bhardwaj Singh