Green finance: Taxonomy, a clear legal definition keenly awaited

Even as the central bank is drawing up taxonomy for this emerging business, the degree of awareness at bank board level could be the weakest link yet

In January this year, John Kerry said: “Let’s face it, (a) whole bunch of companies in the world have chosen to say, ‘I’m going to be net-zero by 2050’. And you and I, we know they don’t have a clue on how they’re going to get there. And most of them are not on track to get there.” The United States special presidential envoy for climate (and former secretary of state) was addressing an audience at the World Economic Forum in Davos this year.

Kerry may have been exaggerating to get his point across. But the fact is that the approach to green finance and all that is associated with it has little by way of legacy to fall back on. Take the Hong Kong-based Asia Securities Industry & Financial Markets Association’s first “Green Taxonomy Survey” released in December last year: 75 per cent of the respondents said they were using a taxonomy (or scheme of classification) with the “EU Taxonomy of Sustainable Activities” being the dominant. Most anticipate implementing a blended taxonomy model to create an internal standard. But, the survey respondents said, beyond regulatory obligations, issuer, borrower or investor expectations would be key factors in determining which taxonomy they would use. This is basically an “a cut-and-paste” way of going about it.

In India’s context, the Reserve Bank of India’s (RBI’s) taxonomy, which is in the works, and how regulated entities go about it will be critical. That’s because one of the weakest links is the degree of awareness at the lenders’ board level.

In July last year, the RBI’s “Report of the Survey on Climate Risk and Sustainable Finance” noted that in the majority state-run and private banks, the boards had not discussed climate and sustainability-related risks and opportunities. This was in sharp contrast to (the surveyed) foreign banks, which had taken on board the need to raise awareness on these matters; and were aware of the need to enhance lending and investment towards sustainable finance.

At the board level, not all lenders will be in a position to get knowledgeable people. This is because of the intense scrutiny on independent directors in recent times; and the far lower levels of compensation payable to them (when compared with non-banks). The latter aspect is due to the fact that the RBI does not permit part-time directors of banks to be paid remuneration other than sitting fees even though the Companies Act permits up to one per cent of a firm’s profit to be paid as commissions to board members. It’s ironic that shadow banking firms are not hamstrung when they hire independent directors — so much for the central bank’s efforts to bring them on a par with banks in matters of oversight. And “green experts” get paid big for being on the board of companies. There’s also the issue of interconnectedness — according to the Banking Regulation Act, 1949, a director on the board of a bank can’t have anything remotely by way of a relationship with it. It’s time this is relooked at with mandated disclosure of pecuniary relationship between the bank and entities with which a director is involved. The BR Act may also have to be reviewed.

Three transactions — two at the sovereign level (cross-border and domestic), and that of a local body have been in the headlines of late. The Export Import Bank of India raised $1-billion in green bonds priced at 190 basis points over the 10-year US Treasury Bill; the government’s twin green bonds for a cumulative Rs 8,000-crore auction sailed through. And the Rs 244-crore bond issuance by the Indore Municipal Corporation was subscribed 5.91 times and listed on the National Stock Exchange. Having got past these thresholds, the sense is that India is on the cusp of attracting billions of dollars in green finance.

Response to climate change would require intensive capital mobilisation. Emerging markets need around $94.8 trillion to help them transition to a net-zero economy by 2060. India alone would need $17.77 trillion towards this end. If these vast sums are not to be frittered away, a public debate is in order around the command-and-control structures in RBI regulated entities (and also wider India Inc.) Green can turn red in no time.

The central bank’s taxonomy and a legal definition of what’s “green” — one that will hold across industries — is keenly awaited. As Deputy Governor Rajeshwar Rao said: “... it would enable more precise tracking of finance flows to green sectors...” and, in turn, “help design effective policy, regulations and institutional mechanisms directed towards increasing both public and private investments”.

Climate change and green finance is not to be looked at as another health fad — board oversight will be critical.

Now boarding

·         Lenders will need to set up better controls at the board level

·         Green audit committees are key

·         Hiring good hands on bank boards will call for a revisit of compensation

·         Deployment of green credit may call for external ratification

·         RBI’s taxonomy can only be a starting point