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Ulka Bhattacharyya*
I. THE CURRENT STATE OF SUSTAINABLE FINANCE IN INDIA [1]
A. Introduction
The recent World Economic Forum Global Risks Report 2024, has identified extreme weather events as the foremost global risk, in the coming decade. This comes on the heels of the recent Conference of Parties (“COP”) 28 in Dubai, which has seen concerted efforts at addressing climate change under the aegis of the Paris Agreement on Climate Change (“Paris Agreement”) through global measures including a call to accelerate the transition away from fossil fuels to renewable energy, and a global stocktake of efforts to address climate change.
In India too, the frequency of climate change and extreme weather events has been on the rise. In 2023, India reportedly recorded extreme weather events for 318 out of 365 days, pointing to the urgency of taking decisive policy measures against climate change. Although India is aligned to the overall goals of the Paris Agreement, there is still significant ground to cover particularly in relation to green financing requirements. The Reserve Bank of India’s (“RBI”) estimates suggest cumulative expenditure for adapting to climate change reaching 85.6 lakh crore rupees by 2030. This is at the same time when financial sector regulators including the RBI are engaging with policy and regulatory measures surrounding various facets of climate change and sustainable finance.
In this context, where the regulatory framework surrounding sustainable finance is seeing tremendous interest, in India and globally, this article surveys the current regulatory landscape surrounding sustainable finance in India. Further, the article explores an aspect of this regulatory framework, in depth, i.e. India’s upcoming green taxonomy.
Accordingly, the first part of the article sets the context, and discusses sustainable finance and the framework of the Paris Agreement, including an overview of the key decisions reached at the recent COP 28. Building on this, the article surveys the current state of sustainable finance in India, noting key regulatory initiatives. A key gap that emerges in this framework is India’s green taxonomy, which remains in development. The second part of the article, looks at understanding green taxonomy more deeply. The second part also focuses on the trajectory of sustainable finance policy and regulation in India. Considering the importance of developing a robust green taxonomy for India as part of its overall sustainable finance regulatory framework, the way forward for India’s green taxonomy and some suggestions for its development, are also presented.
B. Background
1. The Paris Agreement and global climate change ambitions
The Paris Agreement adopted at the 21st United Nations Climate Change Conference (COP) in 2015, is the single-most important rallying point in organising multilateral efforts, responding to the existential threat of climate change. The central pillar of the Paris Agreement is its goal of capping the increase in global average temperatures to below 2°C above pre-industrial levels, and endeavouring to limit the temperature increase to 1.5°C above pre-industrial levels. Crucially, the Paris Agreement recognizes the need to make finance flows consistent with the pathways towards lower greenhouse gas emissions and climate-resilient development. This ambition of the Paris Agreement is expressed in annual COPs, where State signatories to the Paris Agreement convene to assess progress in relation to stemming climate change.
2. Key outcomes at COP 28
The recently concluded Dubai COP 28 has sustained the momentum on decisive multilateral action on multiple aspects of climate change. The standout achievements of the Dubai COP 28 have been the operationalisation of the Loss & Damage Fund, initiated previously at COP27, and the Global Stocktake.
Specifically, the first Global Stocktake, culminating in a decision at COP 28, is a momentous development, led by findings of the Sixth Assessment Report (“Sixth AR”) of the Intergovernmental Panel on Climate Change (“IPCC”). While emphasising that strong policy and regulatory action will help achieve the overall global transition to low GHG emissions, the Global Stocktake has noted findings of the Sixth AR. One such vital finding is that human actions, primarily green-house gas emissions, have unequivocally caused global warming of 1.1°C, already. However, the Global Stocktake has also noted that there is scope for finance and capital to act as critical enablers of climate action, going ahead.
C. India's Present Regulatory Framework on Sustainable Finance
1. The imperative for policy action on sustainable finance in India
India is one of the most vulnerable regions to the adverse effects of climate change, despite historically low emissions of only 4% of cumulative global emissions from 1850 to 2019. While this raises separate equity-related concerns, it has provided an urgent impetus for India to integrate climate change concerns into policymaking, across all sectors. This reflects in recent climate-change focused policies announced by the Government of India including the National Green Hydrogen Mission, to position India as a comprehensive global hub for production, usage and export of green hydrogen, and the announcement of the Carbon Credit Trading Scheme.
India is a signatory to the Paris Agreement, with its long-term goal to reach Net Zero by 2070. Further, India’s Nationally Determined Contribution (“NDCs”) has been enhanced in August 2022, to reduce emissions intensity of GDP to 45% by 2030; while having already achieved reductions on emissions intensity of GDP by 33% between 2005 and 2019. India’s enhanced NDC also targets non-fossil fuel-based energy resources contributing to 50% of electric power installed capacity, by 2030.
Sufficient and affordable finance is a critical input for facilitating India’s ambitious climate goals. Until now, financing for climate has mostly been domestic, across a mix of government support, market mechanisms, fiscal instruments, and policy measures. Estimates by RBI have indicated India’s green financing requirements to be atleast 2.5% of GDP, to address infrastructure gaps caused by climate events. Resultantly, the importance of regulatory and policy initiatives to bolster climate finance cannot be understated, and financial sector regulators, including the RBI and the Securities and Exchange Board of India (“SEBI”), have been taking steady measures to create a conducive environment for upscaling climate finance.
2. Initiatives by RBI
The RBI’s underlying thinking is that addressing climate change through regulation is a priority, and that economic growth cannot be decoupled from the need to address climate risks. Multiple policy and regulatory measures have been proposed by the RBI, ever since its membership of the Network for Greening the Financial System (2021), and the RBI has steadily increased engagement with various aspects of climate finance.
In 2022, a first-ever survey of scheduled commercial banks was undertaken, to assess their preparedness in engaging with climate risk and sustainable finance. This revealed focus areas for further reform including creating governance and risk-management frameworks and reporting on climate-related financial disclosures. Contemporaneously, the RBI’s discussion paper on Climate Risk and Sustainable Finance set out its regulatory strategy, surrounding key aspects of sustainable and climate finance including climate-related risks in its application to regulated entities (“REs”); broad guidance for boards of REs; stress-testing and climate scenario analysis; and climate-related financial disclosure and reporting.
Capitalising on this, RBI has published a framework for REs to accept green deposits, to advance sustainability, increase credit-flow to green activities and battle greenwashing in 2023. This is vital, in that it proposes definitions, in the Indian context, of key green finance terms such as green projects, green deposits, green finance and greenwashing. Most recently, the RBI has proposed a Draft Disclosure Framework on climate-related financial risks, for REs to act on climate-related financial risk management, along with related disclosures.
3. Initiatives by SEBI
SEBI, alongside RBI, has been undertaking multiple policy and regulatory initiatives to support the transition to a low-carbon economy. SEBI has acknowledged the role of sustainable finance in this changed milieu, and the need to respond to the demand for sustainable investments. This is exemplified in the updation of SEBI’s regulatory framework on issuing green bonds, to reflect global best practice. Changes introduced consequently, include expanding the scope of green debt securities, and introducing blue, yellow and transition bonds, as sub-categories of green debt securities. Related requirements including disclosures for issuing and listing green debt securities, enhanced requirements for issuing transition bonds, and guidelines on greenwashing have also been laid down. Relatedly, local governments (municipal corporations) have also been allowed to issue green debt securities.
4. Initiatives by other regulators
The International Financial Services Centre Authority (“IFSCA”) has focused on strengthening the framework for sustainable finance in relation to international financial services centres (“IFSCs”). The IFSCA has established a guidance framework on sustainability-linked lending by financial institutions in IFSCs, requiring Board-level policies on sustainability-linked lending. Further, an Expert Committee on Sustainable Finance, has suggested multiple policy and regulatory initiatives, to strengthen the sustainable finance landscape in IFSCs including by creating frameworks for transition bonds and other innovative financial instruments, and developing a voluntary carbon market. More recently, the IFSCA has constituted an Expert Committee on Transition Finance, to propose regulatory frameworks for transition finance instruments, inter alia.
Separately, the Ministry of Finance’s (“MoF”) issuance of India’s Sovereign Green Bond framework (November 2022) is a significant milestone, aiming to channel proceeds from their issuance to environmentally sustainable projects. This is an important part of India’s overall architecture for sustainable finance and has been viewed positively by commentators, especially post its successful debut in January 2023. The achievement of India’s NDCs, in a significant measure through sovereign green bonds, is also evidenced by the considerable targets contemplated for issuing such bonds in the near future.
5. India’s sustainable finance taxonomy: A critical piece of the regulatory framework
In January 2021, a Task Force on Sustainable Finance was established by the Ministry of Finance (MoF) to draw up a framework for conceptualising India’s sustainable finance framework, including the critical tasks of proposing a draft taxonomy of sustainable activities and risk assessment by the financial sector. While this remains a work in progress, India’s proposed draft taxonomy particularly, is a critical piece of the regulatory framework surrounding sustainable finance. As India’s sustainable finance ecosystem matures to meet India’s revised NDCs, the pace of new regulatory initiatives is likely going to intensify. Existing regulations are likely to be moulded to meet emergent sustainability needs, rapidly. In this, India’s proposed taxonomy is likely to assume a pivotal role. This aspect is further discussed in the second part of this article.
II. A DEEP DIVE INTO THE INDIAN GREEN TAXONOMY
A. Background
Taxonomies have traversed a wide path, from relative unfamiliarity about a decade back, to intense activity and 2023 being unsurprisingly dubbed the “year of the taxonomy”. In 2023 itself, at least nine countries have undertaken deliberations on developing or updating their taxonomies, including the United Kingdom, Australia, Brazil and Singapore.[2] Adding to the momentum, Singapore and Rwanda launched their taxonomies, closely following the recent COP 28.
With the rapid rise of sustainable finance and importantly, the mainstreaming of sustainability concerns in financial sector, common terminology to ensure coherence and consistency, and assist stakeholders in identifying which investments can be labelled “green”, is essential. While taxonomies are intended mainly for the financial sector and financial sector regulators, being highly technical and granular, their potential user base is extremely wide and covers multiple financial sector participants including banks and financial institutions, investors, sustainability bond issuers and policymakers.
B. What is a Taxonomy?
The International Capital Markets Association defines taxonomies as classification systems which identify activities, assets and/or project categories, which deliver on key climate, green, social or sustainable objectives with reference to identified thresholds and targets, in the context of sustainable finance. There exist both official taxonomies, developed by various nations, as well as by unions including the EU and ASEAN, and private industry-led taxonomies, notably the Climate Bond Initiative’s Climate Bond Taxonomy, which is a taxonomy of climate-aligned assets and initiatives.
1. Objectives and benefits
While taxonomies vary across jurisdictions, their defining characteristics encompass its objectives; scope; target and output. Formulating effective taxonomies also requires considering certain core principles, such as alignment with high-level policy objectives (an example of this would be the Paris Agreement goals); focus on a single objective; and sufficient granularity. When so designed, such taxonomies facilitate comparability across jurisdictions, and greatly assist all stakeholders.
Crucially, taxonomies enable signalling, by identifying information needed to identify sustainability benefits, and then categorising assets according to how it contributes to sustainability goals. Resultantly, taxonomies enhance identification of green investments, thus directing capital to sustainability, broadly speaking. Taxonomies, when well-designed, contribute immensely to market integrity and sustain long-term interest in sustainable finance markers, both for investors, as well as firms.
Risks of greenwashing, or claiming non-existent sustainability benefits, are minimised when taxonomies are present. Illustratively, taxonomies that contain clear definitions of what constitutes green assets, may facilitate verification of mislabelling, and thus make false green claims or greenwashing more easily detectable. This is a particularly important aspect considering the role of external review or verification in taxonomy design; for example, the Chinese taxonomy proposes voluntary independent review/verification. The IPCC in its recent Sixth AR has also noted that a common basis for understanding green labels could minimise greenwashing-related concerns, further buttressing the rationale for taxonomies. Additionally, well-designed taxonomies improve market clarity and allow investors assurance and confidence on what investments are considered green or sustainable. Tracking sustainable finance capital flows is also greatly eased in its presence.
2. Taxonomies in action: The example of the EU taxonomy
The EU’s Taxonomy for sustainable finance (“EU taxonomy”), is possibly the most wide-ranging taxonomy, and has been inspirational for many taxonomies under development. The EU taxonomy is part of the EU’s overall framework on sustainable finance, and defines criteria for economic activities aligned with a Net Zero goal by 2050, aiming to channelise investment to economic activities which support the EU’s larger green objectives.
The EU taxonomy is described as ambitious, complex and comprehensive. It is also inter-linked with other EU sustainable finance regulations. Briefly, certain entities are required to report information re alignment of their activities under disclosure requirements in the EU Non-Financial Reporting Directive and the Sustainable Finance Disclosure Regulation. The EU taxonomy, in a nutshell, requires economic activities to satisfy the four criteria specified under Article 3 of the Taxonomy regulation. However, despite its extensive detail, usability challenges have been noted. These include addressing an absence of granular data in some situations; and complexities in assessing interoperability and comparability with other non-EU taxonomies.[3] Nonetheless, the EU taxonomy, is a comprehensive and structured system to develop taxonomy-centred regulation, generally.
C. India's Green Taxonomy
As highlighted in the first part, India’s official taxonomy of sustainable activities, is an important aspect of the mandate of the Task Force on Sustainable Finance, established by the MoF, in 2021. However, as on date, this is a work in progress, still under consideration. In the absence of this dedicated taxonomy, a dispersed landscape of listing certain green assets/securities exist at present. This includes listing of eligible categories of projects under India’s Sovereign Green Bond framework; eligible projects under the RBI’s green deposit acceptance framework; and the definition of green debt security under SEBI’s revised green bond issuance framework.
There has been a surge of regulatory initiatives surrounding sustainable finance globally as well as in India, and amidst this, the necessity of India’s dedicated taxonomy cannot be understated. Indian financial sector regulators particularly have also expressed support for a taxonomy. The RBI, in particular has viewed that a well-functioning sustainable finance regulatory framework includes a consistent and comparable taxonomy, being essential for further developing India’s green bond ecosystems, inter alia. The IFSCA too, has backed an internationally aligned taxonomy for IFSCs.
1. The way ahead
While India’s taxonomy currently remains under consideration, it is an important catalyst for further development of India’s green bond markets and the adoption of other mitigation tools, while addressing the challenges of greenwashing. Accordingly, certain broad considerations, if incorporated, will bolster its strength further.
First, given the inter-relatedness of taxonomies across jurisdictions, India’s upcoming taxonomy should assist ease of use and aid compliance, by being interoperable with major national taxonomies. [4] A de novo approach to India’s taxonomy may increase confusion and impede its utility to investors and other users. A first step to doing so would be designing its broad contours around the core principles, mentioned earlier. Examples of such core principles would be alignment with high-level policy objectives (such as the Paris Agreement goals), and sufficient granularity.
Second, the upcoming Indian taxonomy should aim to integrate the existing classification of green activities/assets being followed by financial sector regulators in India. Any drastic upending of current norms around green activities/assets, such as eligible projects under India’s Sovereign Green Bond; the RBI’s green deposit acceptance framework; or SEBI’s revised green bond issuance framework, should be avoided, to maintain regulatory continuity and investor confidence, and to avoid any inadvertent slippages re specific activities/assets, in the transitional process.
Third, departing from the existing classification of green activities/assets being followed by Indian financial sector regulators, in the upcoming Indian taxonomy, in light of practice in other jurisdictions, should be evaluated carefully. This is important given the controversy in the EU surrounding the inclusion of natural gas and nuclear energy in the EU taxonomy framework, setting off concerns of greenwashing and reportedly sparking legal challenge to the EU taxonomy itself. Interestingly, under India’s Sovereign Green Bond framework and the RBI’s green deposit acceptance framework, activities/projects involving fossil-fuels as a core energy source, and nuclear power-generation are expressly excluded from being considered as green. Thus, any departure from existing classification of green activities/assets, under the upcoming taxonomy must be carefully evaluated, and not adopted without evaluating incremental benefits in the Indian context.
Finally, the relevance of the upcoming Indian taxonomy would be enhanced manifold, if there is a focus on defining transition activities, alongside green and non-green activities, under its overall framework. An example to draw from, for this, is the recent Singapore-Asia taxonomy, developed by the Monetary Authority of Singapore. This taxonomy introduces a traffic-light system defining green, transition and ineligible activities across eight sectors, and is the first taxonomy to engage distinctly with transition activities. A just transition also aligns with policy priorities in India, both at the national and State level. Further, financing for a just transition has also taken on an unprecedented role, especially post COP-28. Given this a transition-focus should be imperative for developing a responsive and updated taxonomy, for India.
Given that the upcoming COP 29 at Azerbaijan will likely see a climate finance focus, the passage of India’s taxonomy will not only be a critical addition to its regulatory arsenal surrounding sustainable finance, in the broadest sense, but will also showcase its commitment to sustainability. Hence, the Government of India and policymakers ought to prioritise its passage, at the earliest.
[1] The focus of this article is on green finance primarily aimed at climate change mitigation, within the general framework of sustainable finance. Accordingly, the references in this article while generally referring to sustainable finance, should be read keeping in mind the specific sub-focus on green finance aimed at climate change.
[2] These countries are Australia; China; Singapore; the United Kingdom; Philippines; Brazil, Rwanda; Thailand and Mexico.
[3] For the EU taxonomy, it has been noted that assessing its alignment with one of the four main criteria for environmental sustainability set out in Article 3 of the EU Taxonomy Regulation (i.e. the Do No Significant Harm or DNSH criteria) requires extensive granular data, which approach has its limitations, chiefly due to the shortcomings of a strict DNSH approach. For instance, due to unavailability of granular data at the level of individual projects, the DNSH technical screening criteria (TSC) becomes difficult to assess, and investors end up relying on proxy measures and third-party maintained data, to determine compliance. Further, certain DNSH TSC criteria, such as for climate change adaptation, have been noted as a source of significant data gaps.
The EU taxonomy’s interoperability with other taxonomies is also a source of concern. The EU taxonomy is heavily dependent on extant EU legislation, notably on labelling and certification schemes. For example, the DNSH TSC is dependent on EU environmental laws. While this dependence is a design feature of the EU taxonomy, it poses significant challenges owing to high degree of internalisation of operations of European companies. There are problems for EU companies to disclose the alignment of their non-EU businesses with the EU taxonomy. Additionally, it has been observed that referring to local/regional norms, poses a usability problem for the EU taxonomy vis-à-vis international comparability. An example of this is the unavailability of Energy Performance Certificates across the world, while being common in the EU. Further, uniform safeguards are not used across taxonomies, and therefore comparability issues arise. Thus, the EU taxonomy has been noted as not being “transposable internationally”. See, Nicholas Pfaff and Ozgur Altun, Ensuring the usability of the EU Taxonomy (February 2022, International Capital Market Association)
[4] It may be noted that taxonomies primarily comprise extensive schemes/classifications, which are based either completely on national standards or in a way that considers the need to create a degree of consistency, across jurisdictions. Given that industrial classification systems often differ across nations, a lack of harmonization or interoperability may raise transaction costs for investors and issuers of green financial assets (such as green bonds). Thus, interoperability of national taxonomies may be considered a desirable goal for policymakers and regulators. See, Torsten Ehlers, Diwen (Nicole) Gao and Frank Packer, ‘A taxonomy of sustainable finance taxonomies’ (Bank for International Settlements, BIS Papers No 118, October 2021) <https://www.bis.org/publ/bppdf/bispap118.pdf>.
*Research Fellow, Policy Research Group, Shardul Amarchand Mangaldas & Co, New Delhi, India. The author would like to thank Mr. Nawneet Vibhaw, Partner at Shardul Amarchand Mangaldas & Co., for his valuable inputs on earlier drafts. All views expressed are personal.