The Green Bond Paradox: Why Money Isn’t Flowing Where It Should

As concerns around climate change intensify, investors are increasingly looking for opportunities that allow them to support the environment without compromising on returns. Among various financial instruments, green bonds have emerged as a distinct avenue to direct capital toward environmentally sustainable projects. There are also mutual funds that invest in companies that meet environmental, social, and governance (ESG) criteria, providing a broader range of sustainable investment opportunities.

Green bonds carved out a unique space as far as investing in the green economy was concerned. However, high entry barriers and modest returns have led to other investing instruments gaining traction of late. It begs the question then, are green bonds worth investing in?

UNDERSTANDING GREEN BONDS

At their core, green bonds are like traditional bonds. They are debt instruments issued by corporations, financial institutions, or the government to raise money from investors, with the promise of repayment at maturity along with periodic interest.

However, what distinguishes a green bond is the specific use of proceeds, which must be allocated exclusively to environmentally beneficial projects. These could include investments in renewable energy, clean transportation, energy efficiency, biodiversity conservation, or climate change mitigation.

“Green bonds are similar to traditional bonds and differ only in their purpose and use of proceeds,” says Niranjan Banodkar, Group CFO at YES Bank. “Compared to traditional bonds, green bonds provide investors with an added opportunity to generate positive environmental impact out of their investments.”

The range of sustainable financing tools has expanded since 2017, when the Securities and Exchange Board of India (Sebi) formalised guidelines for issuing and listing green debt securities for the first time.

As of March, 22 Indian companies had collectively raised Rs 6,953 crore through 31 onshore green bond issuances. A major milestone came in 2023 when the central government entered the fray with its first sovereign green bonds, raising Rs 16,000 crore.

With green bonds gaining popularity, several projects have been funded through this route. In December 2024, DME Development Ltd (DMEDL), a subsidiary of the National Highways Authority of India (NHAI), raised Rs 775 crore through green bonds for the roads and highways sector. Similarly, in January 2024, REC Limited, a Maharatna government-owned company under the Ministry of Power, raised JPY 61.1 billion by issuing its first-ever green bonds in Japanese Yen.

While the number of issuances of these bonds and the projects financed indicate a promising future, the investor experience has a different story to tell.

Performance AS AN INVESTMENT OPTION

Green bonds in India are primarily targeted at institutional investors. The minimum ticket size is usually around Rs 10 lakh, making direct access difficult for most retail investors. Liquidity is another concern. Most investors choose to hold them until maturity. Since they do not trade as frequently, there aren’t enough of these bonds in circulation.

“The secondary market for green bonds is underdeveloped, making it difficult to exit before maturity,” notes Nikhil Aggarwal, Founder and Group CEO of Grip Invest.

Then there are concerns regarding returns. Contrary to expectations, green bonds do not offer significantly higher yields than their conventional counterparts. In India, the average yield stands at around 6.2%, although one-year returns in certain periods have reached as high as 10.1%. The so-called greenium—or green premium—is still weak in India. Currently, the yield of a 10-year government bond is at 6.3%.

While green bonds are intended to help governments raise capital for clean energy and infrastructure because of the low borrowing costs associated with such instruments, India’s issuances have struggled to attract a meaningful greenium. As a result, planned funding for key initiatives, including grid-scale solar projects, has been reduced.

“Although the headline yields may not be significantly higher than conventional bonds,” Aggarwal explains, “green bonds benefit from strong credit profiles and policy support, which can enhance risk-adjusted returns.”

Despite lower yields, a key driver of interest in green bonds is the global push for ESG-aligned investing. But that has given rise to other concerns associated with it.

GREENWASHING

Investors today are not only looking at financial returns but also at the impact their money creates, and with that comes the risk of greenwashing. Bonds are labelled “green” without truly contributing to environmental goals. For instance, in the early days of China’s green bond market, some bonds funded ‘clean coal’ projects, which experts found would not qualify as green, highlighting inconsistencies.

“To address greenwashing risks, whereby the use of proceeds raised through green bonds are misallocated to environmentally unsustainable activities, the International Capital Market Association (ICMA) has published Green Bond Principles (GBP) that provide a standardised approach for issuance of green bonds with clear guidelines for transparency, disclosure, and reporting, thereby promoting integrity in the development of the green bond market, globally,” says Banodkar.

In India, Sebi has made it mandatory for issuers of green debt to disclose the environmental objectives of the bond and the use of proceeds, verified by external auditors. India also released its Sovereign Green Bond Framework in 2022, which outlines transparency mechanisms and project eligibility criteria.

All these concerns, therefore, necessitate looking at other investment options, that not just meet ESG goals but also provide investors with higher returns.

ESG MUTUAL FUNDS

Among other popular ESG-oriented investment options are ESG mutual funds, which have seen broader adoption, particularly among retail investors. Funds like Invesco India ESG Integration Strategy Fund, ICICI Prudential ESG Exclusionary Strategy Fund, and SBI ESG Exclusionary Strategy Fund, among others, offer low entry barriers, better liquidity, and diversified exposure to companies with strong ESG credentials. “In developed markets like the US and Europe, ESG-themed funds have seen broader adoption due to better visibility and accessibility,” Aggarwal points out. “In India, ESG equity funds currently see more traction, while green bond investments are largely dominated by institutional investors such as pension funds and insurance companies.”

From a structural standpoint, ESG funds and green bonds serve different purposes. ESG funds screen companies based on environmental and social criteria and invest accordingly, often in equities. Green bonds, on the other hand, are fixed-income instruments with a direct link to specific green projects. While ESG funds provide diversified market exposure with the potential for capital appreciation, green bonds offer stable, predictable returns and are less volatile. For conservative investors or institutions seeking to match liabilities with steady income, green bonds can be an effective tool.

That said, green bonds lack a deep and active secondary market, which makes it essential for investors to be cautious and well-informed.

The rise of green bonds marks a shift in investor mindset—from maximising returns at any cost to investing with purpose and responsibility. 

@teena_kaushal