At their core, green bonds are debt instruments where the capital raised is exclusively used to fund environmentally beneficial projects, ranging from renewable energy and clean transportation to sustainable agriculture and pollution control.
These bonds work like traditional fixed-income securities in terms of return, risk, and maturity. However, the point of difference is the “use of proceeds” clause.

In 2007, the Intergovernmental Panel on Climate Change (IPCC) warned that humans are degrading the Earth’s climate. As a result, some Swedish pension funds wanted to invest in projects that help the climate rather than deteriorate it. Thus, the European Investment Bank (EIB) became one of the earliest to issue a climate awareness bond in 2007. The World Bank soon followed. What began as a niche innovation has since grown into a mainstream asset class. In 2024, green bond issuance outperformed the conventional bond market by ~2%.

This explosive growth has been supported by the development of globally accepted standards like:

• Green Bond Principles (GBP) by the International Capital Market Association (ICMA)
• Climate Bonds Standard by the Climate Bonds Initiative (CBI)
• ASEAN’s Green Bond Standards for emerging markets
• SEBI’s green debt regulations in India

According to ICMA’s Green Bond Principles, a credible green bond is built on four pillars:

1. Use of Proceeds: Funds must be allocated to green projects, clearly defined in the bond documentation.
2. Process for Project Evaluation and Selection: Issuers must disclose their sustainability objectives, project eligibility criteria, and decision-making processes.
3. Management of Proceeds: Funds should be ring-fenced or tracked using internal processes to ensure transparency and traceability.
4. Reporting: Issuers must provide annual updates on use of proceeds, project progress, and expected environmental impact.

Many issuers also seek an external review, such as a Second Party Opinion or a Climate Bonds certification, to validate their green credentials.

Green bonds can take multiple forms, including but not limited to:

• Use of Proceeds Bonds (most common): Backed by the issuer’s entire balance sheet, with proceeds earmarked for green projects.
• Green Revenue Bonds: Secured by the revenues from the green project itself.
• Green Securitised Bonds: Backed by portfolios of green loans or assets.
• Sustainability-Linked Bonds (SLBs): Coupon payments are tied to the issuer meeting certain sustainability KPIs.

Green bonds appeal to a wide range of investors such as:

• Institutional investors (pension funds, insurance companies) with ESG mandates
• Sovereign wealth funds seeking low-carbon portfolios
• Impact-focused investors who want to align returns with climate goals

In some cases, green bonds may even offer a “greenium” (slightly lower yields) because of high demand and investor willingness to trade financial return for environmental impact.

India has emerged as a promising player in the global green bond ecosystem.

• SBI, NTPC, and IRFC have all issued green bonds for clean energy and transportation.
• In 2023, India issued its first Sovereign Green Bond, raising ₹16,000 crore to finance public-sector green projects.
• SEBI’s regulatory framework provides guidance and assurance to both issuers and investors.

However, India’s green bond market is still in its early stages, contributing less than 3% to global issuances. The potential remains vast, particularly in financing the country’s renewable energy targets, urban sustainability, and electric mobility.

Green bonds are promising vehicles for environmental progress, but there are systemic deficiencies that threaten their legitimacy. Green bonds face six major challenges:

1. Greenwashing and Lack of Standardisation

Green bonds have become a common “greenwashing” ground for corporate deception, with issuers exploiting regulatory gaps to project false environmental virtue.

Issuers may label bonds as “green” without meaningful environmental benefit or impact transparency, a practice known as greenwashing. This occurs due to the absence of universally binding standards for what qualifies as a “green” project.

For example, when Repsol, a giant petroleum organisation, can brazenly issue a €500 million “green bond” to optimise its oil and gas infrastructure and receive institutional backing despite a fundamental contradiction, it brings the market’s integrity into question. This systematic greenwashing, enabled by the absence of globally binding standards, represents ethical failure. Additionally, it actively misallocates billions in capital that investors believe is helping climate solutions.

2. Inconsistent Definitions of ‘Green’

The taxonomic differences of green bonds have created regulatory confusion, where what qualifies as “green” in Beijing is condemned as environmentally destructive in Brussels. China’s classification of “clean coal” as sustainable financing stands in exact opposition to European standards. This creates impossible reconciliation challenges for global investors attempting to construct coherent sustainable portfolios. This definitional incoherence creates academic confusion, fundamentally undermines cross-border capital flows, and fractures what should be a unified global response to climate financing.

3. High Costs of Verification and Reporting

The exorbitant economics of green bond verification have created an invisible wall around the market. Municipal governments across India and Southeast Asia, despite having bankable sustainable infrastructure projects that could transform communities, find themselves locked out of green financing simply because third-party verification costs prove prohibitive. This unreasonable dynamic concentrates sustainable capital in wealthy institutions while excluding the developing regions where climate finance could drive the most transformative impact.

4. Limited Transparency and Weak Post-Issuance Disclosure

The accountability deficit in green bond markets threatens to undermine the entire enterprise. The Climate Policy Initiative documents that 40% of issuers provide no meaningful post-issuance reporting whatsoever. Even among those that do, inconsistent methodologies and selective disclosure practices make impact comparison virtually impossible. This transparency failure turns what should be a rigorous environmental financing mechanism into something disturbingly close to a marketing exercise. This lack of transparency leaves investors with no reliable means to verify whether their capital is actually advancing climate goals.

5. Lack of Liquidity in Secondary Markets

The structural illiquidity plaguing green bond markets has transformed these instruments into lock-in mechanisms, easy to enter but nearly impossible to exit. Even blue-chip issuers like the European Investment Bank find their green bonds trade infrequently due to entrenched buy-and-hold patterns. This illiquidity poses a challenge for institutional investors who require portfolio flexibility, forcing them to demand higher yields or avoid green bonds entirely, thereby raising costs for issuers and limiting market development.

6. Fragmented Regulation and Taxonomy Alignment

The fractured regulatory system around the world overseeing green bonds has created a compliance nightmare that increases costs for issuers without delivering better environmental outcomes. Multinational issuers must navigate fundamentally incompatible frameworks; for example, the EU Taxonomy requirements that differ significantly from the ASEAN Green Bond Standards. This forces issuers to create redundant disclosure structures for each jurisdiction. This regulatory fragmentation adds administrative burden as well as creates structural inefficiencies that have prevented the green bond market from achieving the scale and impact its proponents envisioned.

Challenges of Green Bonds in India

India’s sovereign green bond initiative has stumbled from a promising start to a sober reality check. This revealed deep structural challenges in the nation’s push towards climate finance. What began as a promising initiative with January 2023’s oversubscribed auction is now being viewed as a flop auction. RBI’s November 2024 auction saw only 30% subscription rate, i.e., only ₹1,502 crore of the offered ₹5,000 crore found buyers. The remaining ₹3,498 crore (nearly 70% of the issuance) had to be absorbed by primary dealers (financial institutions like banks).

This collapse in investor interest exposes fundamental market disconnects, and the reasons behind this low enthusiasm for SGBs are structural flaws:

1. Persistent “greenium” that depresses yields below what investors find acceptable
2. Secondary market so illiquid that bondholders effectively face long-term lockups
3. Absence of retail participation in a market narrowly focused on institutional players

Unlike global counterparts that have successfully built green bond ecosystems, India offers neither regulatory mandates nor financial incentives to prioritise sustainability over returns. Brazil ties its green bonds to national environmental priorities like Amazon preservation, while European frameworks actively promote ESG investments through regulatory requirements.

India’s approach forces these climate-focused instruments to compete directly with conventional government securities — a competition they are clearly losing.

This market failure comes at a critical time for India. The country faces a staggering climate finance gap, requiring $170 billion annually while receiving only $44 billion. Without significant structural reforms, including tax incentives, improved liquidity mechanisms, mandatory institutional allocations, and broader retail engagement, India’s green bond program risks becoming a symbolic gesture rather than the transformative financing tool the nation’s climate ambitions demand.

Can India Find the Right Balance between Virtues and Yields?

As climate change accelerates and public finance alone falls short, green bonds represent a way forward not just economically, but ethically. They bring markets in service of meaning and capitalism in service of conservation.

While there are multiple structural flaws in both regulation and the creation of incentives to enhance green bond issuance and adoption, there seems to be a positive trend worldwide, with more and more countries issuing sovereign green bonds and institutions from different industries showing increased interest in these bonds.

A comparatively high GDP country like India, with a goal to become Net Zero by 2070, needs more structural overhauling than simple green instrument financial engineering to drive subscription and generate interest in these debt instruments to finance the adaptation and transition needs of different economic sectors.

Any financial instrument, despite having virtues like green use of proceeds, environmental impact, social upliftment, or any other noble underlying mission, will not be successful if it lacks key financial components such as liquidity and yield. Even the most environmentally transformative green bonds can face investor rejection if they fail to deliver on fundamental financial requirements. India’s policymakers must recognise that no amount of green labelling or environmental virtue signalling can overcome structurally inferior financial offerings.

The Good, the Bad, the Opportunities: Green Bonds in 2025, Johann Ple, Axa Investment Managers, https://www.axa-im.com/sustainability/insights/good-bad-opportunities-green-bonds-2025

Green Bond Principles, ICMA, June 2021

Naisha Deora, Observer Research Foundation. https://www.orfonline.org/expert-speak/green-bonds-financing-the-renewable-era

Peter Cribbs, Environmental Finance. https://www.environmental-finance.com/content/analysis/green-bond-comment-june-of-repsol-and-reputation.html

https://www.climatebonds.net/resources/publications/scaling-green-bond-markets-sustainable-development

Post-Issuance Reporting in the Green Bond Markets, Climate Bonds Initiative. https://www.climatebonds.net/files/reports/cbi_post_issuance_2021_02g.pdf

Pricing of Green Bonds: Drivers and Dynamics of the Greenium. https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2728~7baba8097e.en.pdf

Aligning Green Bonds with the Singapore and ASEAN Taxonomies: the Next Level of Ambition and Credibility. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5061602

RBI’s Green Bonds: A Green Dream or a Missed Opportunity? https://yourstory.com/2024/12/rbis-green-bonds-green-dreammissed-opportunity

Upendra

Senior Consultant at Infosys – Finacle Consulting Group

Rajesh Agrawal

Faculty in Finance and Accounting at IIM Udaipur.