Green Bonds vs. Sustainability-Linked Bonds: How the Structures Differ

Same Label, Opposite Designs

Labelled bonds have become a large part of sustainable finance. The two most common types are green bonds and sustainability-linked bonds (SLBs). Both are sold as "sustainable," and both appear in ESG fund portfolios. But they are built in opposite ways, and an investor needs to know which one they are holding.

Green Bonds: Rules on the Money

A green bond is a normal bond with one extra promise: the money raised will be spent only on eligible green projects, such as renewable energy, clean transport, energy efficiency or water management.

The ICMA Green Bond Principles, the most widely used global standard, set four core components:

1. Use of proceeds for eligible green projects.
2. A process for evaluating and selecting projects.
3. Management of proceeds, so the money can be tracked.
4. Reporting on how the money was used and, ideally, its impact.

The coupon and repayment work like any other bond from the same issuer. If the issuer defaults, green bondholders rank like other creditors of the same kind.

India issued its first sovereign green bonds in January 2023, with proceeds earmarked for green public projects. SEBI has had rules for green debt securities for listed issuers since 2017, revised since then.

Sustainability-Linked Bonds: Rules on the Results

An SLB does not restrict how the money is used. The issuer can spend it on anything. Instead, the issuer commits to reach specific sustainability targets by set dates, and the bond's terms change if it does not.

The ICMA Sustainability-Linked Bond Principles set five components:

1. Key performance indicators (KPIs) that are relevant and measurable, such as emissions intensity.
2. Sustainability performance targets (SPTs) for each KPI, which should be ambitious.
3. Bond characteristics that change if targets are missed, usually a higher coupon.
4. Reporting on progress.
5. Independent verification of performance.

A Worked Example: The Coupon Step-Up

Illustrative example. A company issues a ₹1,000 crore five-year SLB at a 8.0% coupon. It commits to cut emissions intensity by 25% by the end of year three. If it misses, the coupon rises by 0.25 percentage points for the last two years.

• Target met: interest of ₹80 crore a year for five years.
• Target missed: ₹80 crore for three years, then ₹82.5 crore for two years. Extra cost: ₹5 crore in total.

The penalty is ₹5 crore on a ₹1,000 crore bond. That is small for a large company, which is one of the main criticisms of SLBs: the step-up may be too small to change behaviour.

Common Weak Points

For green bonds:

• Weak projects. Projects labelled green may have little real benefit.
• Money is fungible. A company can fund green projects with the bond while its other spending stays carbon-heavy.
• Thin reporting after issue.

For SLBs:

• Easy targets. A target the company would have reached anyway adds nothing.
• Small penalties, as in the example above.
• Call features that let the issuer repay the bond before the target date, avoiding the step-up.

India's Sovereign Green Bonds

The Government of India published its Sovereign Green Bonds Framework in November 2022 and held its first auctions in early 2023, raising ₹16,000 crore over two auctions in January and February that year. Proceeds are allocated to eligible public sector projects in areas such as renewable energy, clean transport and climate adaptation, and the framework excludes certain activities, such as fossil fuel projects.

Sovereign green bonds matter beyond their size. They give the market a benchmark for pricing green debt in India, and they show how a use-of-proceeds framework works in practice, including allocation and impact reporting.

The Buyers of Labelled Bonds

Buyers include dedicated ESG funds, foreign investors with sustainability mandates, insurers and banks. Dedicated demand is what creates any greenium. Where most buyers are ordinary bond investors who care mainly about yield and credit quality, labelled bonds trade much like unlabelled ones.

Regulation in India

SEBI regulates green debt securities and, since June 2025, has had an operational framework for other ESG debt securities, covering social bonds, sustainability bonds and sustainability-linked bonds. Issuers must appoint an independent third-party reviewer or certifier, make disclosures in the offer document, and keep reporting after issue. Proceeds from use-of-proceeds bonds must go only to the stated purpose.

Pricing and the Greenium

A greenium is the lower yield investors accept on a labelled bond compared with a similar unlabelled bond from the same issuer. Where it exists, it gives issuers a reason to label their bonds. Evidence from many markets suggests greeniums are usually small, a few basis points, and they vary with demand from dedicated ESG funds. For Indian sovereign green bonds, any premium has generally been modest.

Habits for Reading Labelled Bonds

1. Identify the structure: use of proceeds or performance-linked.
2. For green bonds, read the eligible project list and the post-issue allocation report.
3. For SLBs, compare the target with the issuer's own trend. Is it really a stretch?
4. Check the size of the step-up and any call options before the target date.
5. Read the third-party review, not just the label.

The Reframe

A green bond tells you where the money goes. A sustainability-linked bond tells you what happens if the promise is broken. Neither label is a guarantee. Both are contracts, and the details decide what they are worth.