Introduction

To align with the United Nations Sustainable Development Goals (SDGs) by 2030, the Securities and Exchange Board of India (SEBI) has increasingly focused on sustainable finance. Achieving these goals requires significant funding and significant changes to the regulatory framework to strengthen capital markets. The bond market plays a crucial role in this process, offering a long-term asset class that aligns well with the objectives of the Sustainable Development Goals (SDGs). Given the scale of bond markets, they have the potential to fill the significant financing gap needed to achieve the SDGs, providing the financial resources needed to support large-scale, long-term sustainable projects.

In response, SEBI introduced innovative financial instruments, such as green bonds, yellow bonds for solar energy and blue bonds for water management, in 2023. Additionally, SEBI set new standards for reporting, including the Business Responsibility and Sustainability Report (BRSR), and published environmental, social and governance (ESG) guidelines for rating agencies. While these efforts demonstrate SEBI’s commitment to sustainability, the current framework primarily addresses the environmental aspect of ESG. Aware of this gap, SEBI has published a Consultation Paper on Expanding the Scope of Sustainable Finance Framework in Indian Securities Market to Expand the Scope of Sustainable Finance (below consultation document).(1) This blog will discuss key points from the SEBI consultation paper and suggest potential ways forward.

ESG debt securities

Based on recommendations from market participants, SEBI aims to expand the regulatory framework for sustainable finance by introducing Social bonds, sustainability bonds and sustainability-related bonds alongside existing green debt securities. This expansion aligns with global sustainable fundraising practices. Collectively, these instruments – green debt securities, social bonds, sustainability bonds and sustainability-linked bonds – are often referred to as ESG debt securities.

ESG debt securities, according to market practices, are generally of two types:

• Use of Product Obligations (UoP) – these are obligations waived for a specific type of projects that aim to deliver particular results or impacts.
• Key Performance Index (KPI) Bonds: Unlike UoP bonds, these bonds are issued to achieve overall sustainability goals instead of focusing on a targeted outcome or outcome through a project.

The existing framework for thematic bonds such as green debt securities are UoP-based bonds. SEBI through Social Bonds and Sustainability Bonds aims to introduce a new class of UoP bonds, while Sustainability Linked Bonds will be a KPI bond.

Due to the nature of these titles, defining and understanding KPIs will become important. Some evocative social responsibilities include causes aimed at ending poverty and other deprivations that go hand in hand with strategies that improve health and education, reduce inequality, and stimulate economic growth. International standards stipulated by the International Capital Market Association (ICMA) suggest that KPIs should be relevant to the issuer’s core business, aligned with its sustainability strategy, measurable and verifiable, and compared to external benchmarks to assess performance ambition. As these obligations are linked to specific sustainability objectives, SEBI’s role in monitoring and enforcing these commitments will become critical to maintaining market transparency and integrity.

Compliance requirements

ICMA suggests that for any thematic obligation, regulators should consider four key elements when formulating regulations to ensure transparency and protect investors’ interests. These components include:

1. Use of profits – Clear guidelines on how funds collected will be allocated to specific projects or initiatives.
2. Project evaluation and selection process – A defined process for selecting and evaluating projects to ensure they meet the thematic objectives.
3. Revenue management – Appropriate mechanisms to track and manage funds to ensure they are used as intended.
4. Reports – Regular and transparent reporting to keep investors informed of the use and impact of funds.

In light of these key considerations, the consultation paper addresses three main aspects relating to these obligations: disclosures (initial and ongoing), external reviews and securitization. It seeks public comment on these areas. The document aims to align with international standards for these bonds and the ICMA benchmark guidelines for ESG debt securities.(2)

Disclosures and reporting

Disclosures are necessary to raise funds from the public, particularly in long-term asset classes such as securitized ESG debt. In addition to the information required under the CRS Regulations (3), the information required for these debt securities must be both initial and ongoing. The consultation paper suggests that this initial information could be included in the offer documents and ongoing information could be included in the Business Responsibility and Sustainability Report (BRSR)(4) stipulated by SEBI for ESG information for listed entities.

International guidelines suggest that initial information contained in offering documents may stipulate information regarding (non-exhaustive list):

• Clear deadlines for achieving goals, including observation dates and triggering events.
• Baseline or verified reference point, with justification for its selection.
• Conditions for recalculation or adjustment of baselines, if applicable.
• Strategy for achieving UoP bond targets, detailing ESG governance, investments and key actions with quantitative contributions where possible.
• Taking into account external factors beyond the control of the issuer and likely to have an impact on the achievement of objectives.
• Recommendation for second-party advice when benchmark indices do not have clear performance thresholds.

Issuers must provide ongoing information through BRSR and may include:

• Up-to-date performance information on selected KPIs, including relevant benchmarks.
• Verification assurance report detailing performance against the Sustainability Performance Targets (SPT) and the impact on the financial and/or structural characteristics of the obligation, including timing.
• Information that allows investors to monitor the level of ambition of SPTs, such as updates to the issuer’s sustainability strategy, KPI/ESG governance and any relevant changes in strategic development plans or policies.

External review

SEBI, in line with international norms, has proposed an external review process to improve transparency in raising green debt securities. This requires the issuer of these securities to appoint an external reviewer/certifier. The consultation document suggests four ways of carrying out such an external review, including:

• Second party opinion
• Verification
• Certifications
• Rating / Rating

However, the consultation document does not specify whether this external review should only be a pre-issuance process or an ongoing process post-issuance, from one year to the next. The international framework recommends carrying out a pre-issuance review to assess the alignment of their ESG debt security with the four components set out above. After issuance, ICMA recommends that issuers appoint an external reviewer to ensure proper monitoring and allocation of proceeds from these securities.(5)

Securitization

Securities securitization refers to the process of converting illiquid financial assets, such as loans or receivables, into marketable securities. These assets are pooled together and sold to investors as securities, usually in the form of bonds or other tradable instruments. This process allows the issuer to raise capital by transferring the risk associated with the underlying assets to investors.

Due to the illiquid nature of these securities, securitization of ESG debt securities also becomes essential to promote the involvement of market participants in the issuance and investment in these securities. The definition of “securitized debt instruments” under the SDI(6) regulations for the creation of a “separate special purpose entity” must be amended to include “sustainable debt instruments” which must include securities of ESG debt as the underlying asset for creation purposes. of the Special Purpose Vehicle (SPV). This will provide opportunities for national and international actors to participate in sustainable financing.

Conclusion

The introduction of sustainable financing opens new opportunities for market participants to strengthen their engagement, reflecting the government’s commitment to fulfilling its international obligations. With the growing focus on sustainability, SEBI’s initiatives in this area are commendable. However, concerns remain regarding the regulatory frameworks surrounding disclosure and reporting, which the market regulator must address to ensure effective implementation and compliance. Overall, while this development is a positive step forward, it requires careful consideration of the regulatory landscape in order to foster a strong and transparent sustainable financial market.

(1) https://www.sebi.gov.in/reports-and-statistics/reports/aug-2024/consultation-paper-on-expanding-the-scope-of-sustainable-finance-framework-in-the -indian-securities-market_85691.html

(2) Green Bond Principles – https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Green-Bond-Principles-June-2022-060623.pdf; Social Bond Principles -https://www.icmagroup.org/assets/documents/Sustainable-finance/2023-updates/Social-Bond-Principles-SBP-June-2023-220623.pdf; Sustainability-Linked Bond Principles https://www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/Sustainability-Bond-Guidelines-June-2021-140621.pdf; Sustainability-Linked Bond Principles https: //www.icmagroup.org/assets/documents/Sustainable-finance/2024-updates/Sustainability-Linked-Bond-Principles-June-2024.pdf; Climate Bonds Standard-https://www.climatebonds.net/files/files/climate-bonds-standard-v4-1-202403.pdf;

(3) Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities) Regulations, 2021 – https://www.sebi.gov.in/legal/regulations/sep-2024/securities-and-exchange-board -of-India-issuance-and-list-of-non-convertible-securities-regulations-2021-last-modified-on-September-18-2024-_86834.html;

(4)https://www.sebi.gov.in/legal/circulars/jul-2023/brsr-core-framework-for-assurance-and-esg-disclosures-for-value-chain_73854.html

(5) https://www.icmagroup.org/assets/documents/Sustainable-finance/2023-updates/Social-Bond-Principles-SBP-June-2023-220623.pdf;

(6) SEBI (Issue and Listing of Securitized Debt Instruments and Securities Receipts) Regulations, 2008; https://www.sebi.gov.in/legal/regulations/aug-2023/sebi-issue-and-listing-of-securitised-debt-instruments-and-security-receipts-regulations-2008-last-amended- on-August-18-2023-_76336.html