The European Parliament has approved its ‘European Green Bond’ label to be used as a new standard aligned with its Green Taxonomy. This will help to address greenwash concerns and help scale the market by providing investor clarity.
- The regulation defines strict uniform standards for issuers who aim to label their bond a ‘European green bond’ or ‘EuGB’ and regulates external reviewers of bonds.
- The EU is the world’s largest issuer of green bonds, which are the main source of investment funding to power the sustainable transition.
- The increased credibility is expected to drive interest among investors and stakeholders to invest in green bonds and avoid greenwashing while supporting the bloc’s green transition.
Standardisation for green bonds is necessary for the market to grow. Even without an agreed standard as to what qualifies as ‘green’, S&P Global Ratings has estimated that in 2023 markets for bonds labelled as green, social and/or sustainable will be 14-16% of global issuance.
Jochen Krimphoff, global lead data, tools and methods, WWF’s Greening Financial Regulation Initiative (GFRI), who is also a former member of the European Commission’s Technical Expert Group on sustainable finance which developed the initial proposal for the EU Green Bond standard in 2019, said: “These new mechanisms will ensure that green bonds meet specific environmental objectives and adhere to established standards, enhancing credibility and transparency in the market. Moreover, it introduces a template for standardised disclosures for bonds marketed as environmentally sustainable – including sustainability-linked bonds. This will provide clarity and consistency and help investors evaluate the environmental impact and sustainability commitments associated with these bonds.”
Green bond market has shown rapid growth
The global green bond market has boomed in the past decade, recording a 75% increase between 2020 and 2021 to $500 billion dollars and hitting a record $350 billion in the first half of 2023. The overall green, social, sustainable and sustainability-linked (GSSS) bond market is expected to grow by 5-17% in 2023. Europe is the world’s largest issuer of green bonds, with over half the global volume in 2021. Amidst the wider bond markets, however, green bonds only constitute a tiny percentage of 3-3.5%.
Despite the surge in demand, the lack of standardised definitions of what constitutes a green bond has led to concern about the potential for greenwashing. Investors have also lacked assurances that the bonds they were investing in actually contributed to environmental objectives under the Paris Agreement, which has lowered confidence.
The European Green Bond Standard (EU GBS) regulation was adopted on 5 October 2023 and requires issuers to disclose how the proceeds of the bonds will be used for environmental benefits, and show that at least 85% of funds are allocated in line with the EU Taxonomy.
“Businesses want to make the green transition. And the European Green Bond gives them the best tool yet to help them finance this shift. It provides a transparent and trustworthy tool to drive a company’s transition plan,” said Paul Tang, rapporteur and member of the Group of the Progressive Alliance of Socialists and Democrats in the European Parliament.
The regulation will be implemented 10 days and 12 months after Council approval and publishing in the Official Journal of the EU. The standard is set to provide clarity for investors and stakeholders looking to fund more sustainable technologies and businesses, and also give companies assurance about the credibility of their green bonds.
The EuGB Regulation, which was adopted in 2021 and underlies the standard, will lay the foundation for a common framework of rules regarding the use of the EuGB label for bonds that pursue environmentally sustainable objectives as defined by the Taxonomy. It also sets up a system for registering and supervising companies that act as external reviewers for green bonds aligned with the framework.
What are green bonds and what standards exist?
Green bonds are a type of debt or financial security issued by public or private entities that raise funds for projects with environmental or climate benefits. They are one of the main means of funnelling investments into environmentally sustainable technologies, infrastructure and resource efficiency to power the sustainable transition.
Greenwash has been a concern for some time, as it is not always clear exactly what funds raised through a green bond are being used for. For example, a 2023 paper studied Chinese A-share companies between 2013 and 2023 and found that many issuers of green bonds, especially in polluting sectors, tended to prioritise the quantity rather than quality of green innovations from green bond funds – suggesting that this resulted in “superficially increasing the number of green patent applications, without actually making substantial improvements to their green innovation capabilities” for an “environmentally conscious image”.
Existing standards for the green bond market include the Green Bond Principles (GBPs) developed and monitored by the International Capital Market Association (ICMA), and the Climate Bonds Standards by the Climate Bonds Initiative (CBI). According to the EU Commission, the GBPs differ from the CBI’s requirements as they do not require a second-party opinion, while the CBI has more stringent requirements as compared to the EU GBS.
MEP Gilles Boyer, Renew Europe’s shadow rapporteur on this file, said: “We need to speed up the environmental transition. With this clear and ambitious standard, Europe is leading the way to provide greater transparency, trust and confidence in a rapidly growing green bond market. Everyone, from individual citizens to large investors, who wishes to, will be able to have clear access to finance that contributes concretely to protecting the planet. We are confident that this European standard will become a global reference for sustainable investments”
Aligning with the EU taxonomy
The EU taxonomy is a classification system that defines criteria for sustainable economic activities that align with environmental goals such as reaching net zero by 2050. The new green bonds are mainly expected to align with the following environmental objectives:
- climate change mitigation;
- climate change adaptation;
- the sustainable use and protection of water and marine resources;
- the transition to a circular economy;
- pollution prevention and control; and
- the protection and restoration of biodiversity and ecosystems;
The Taxonomy has previously been criticised for defining nuclear and natural gas as a sustainable fuel within the Green Taxonomy. It has also presented a range of administrative challenges, according to the International Capital Market Association (ICMA), which highlighted barriers for organisations such as access to relevant data, heavy reliance on EU legislation and criteria that slow assessment of non-EU projects, interpretation issues and the requirement for hard-to-obtain granular data.
The difficulties in usability have resulted in low market alignment: a 2022 study found that Euro Area investor portfolios only aligned by 2.8%.
What does the new standard entail?
The new green bonds label is voluntary, thus companies can choose to apply for the label and undergo the process to confirm that it meets the strict criteria.
As the EU Taxonomy is being updated, issuers of a European Green Bond will be required to ensure that at least 85% of the funds raised by the bond are allocated to economic activities aligned with the EU’s Taxonomy Regulation. There is a level of flexibility however, as for specific activities within sectors not covered by the Taxonomy, the remaining 15% can be allocated to other activities provided the issuer discloses this to comply with regulations including minimum safeguards, under the No Significant Harm (DNSH) principle.
The EuGB label demands more transparency from companies; they will be required to not only disclose detailed information about how the bond’s proceeds will be used in specific ‘template formats’ but also show how these investments are part of the company’s green transition plans. It requires the completion of a Green Bond factsheet, and an allocation and impact report. These templates that include disclosure requirements can also be used as a standardised measure independently by companies that do not qualify for the EU GBS.
It also establishes a registration system and supervisory framework for external reviewers of European green bonds. These independent entities will be responsible for ensuring that a green bond is being used for sustainable activities. It also mandates that any actual or potential conflicts of interest that external reviewers may face are identified and disclosed transparently, then eliminated or managed.
Boosting the sustainable transition
The move is set to boost transparency and enhance investor confidence in EU green bonds as issuers begin to apply for the label and the Commission hopes it will boost Europe’s transition to a sustainable economy.
As companies worldwide increasingly face climate litigation for issues including greenwashing, the standard provides a new assurance for both issuers and investors about the credibility of green bonds and the associated environmental impacts.
Pricewater Cooper (PwC) said in a statement: “We believe that the adoption of the EU Green Bond Regulation introducing the EU GBS will be the turning point for debut and repeat Green Bond issuers who want to apply what has been regarded as the long-awaited golden standard to be used for Green Bonds issuances and to make a clear statement of being frontrunners in and fully committed to a sustainable future.”
Nevertheless, there remains a range of challenges and controversies regarding implementation. The flexibility of 15% allowed can reduce reliability and trust due to non-alignment with environmental objectives. The EU Taxonomy’s usability barriers also pose a hindrance: in April 2023, the ICMA projected that the future uptake of the EuGB as a voluntary label will be linked to resolving the Taxonomy’s usability issues. It expects, however, that renewable energy projects in the bloc are a promising area that will likely be financed with EuGB bonds.
PwC also raised the issue of alignment with the Taxonomy: “To name a few, the requirements for the proceeds being aligned to the EU taxonomy and getting assurance over the DSNH are challenging elements of the EU GBS to be complied with, and it is likely that this voluntary standard will operate alongside ICMA Green Bond Principles and the CBI Climate Bonds Standards for few years to come.”
The EU is now working on the Listing Act, a new legislation which amends the Prospectus Regulation to specify the information that must be disclosed regarding the content of green or sustainable bonds.
A new legal standard for widespread use across the market where half of the world’s green bond transactions take place will help eradicate opacity in green investments and minimise investor risk.
Considering that some estimates suggest up to $200 trillion is required to finance net zero by 2050, encouraging financial investment in sustainability is crucial. The voluntary nature of the standard may, however, constitute a drawback along with the difficulty of using the Taxonomy.