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New EU green bonds standard may fuel greenwash concerns

© Shutterstock / ZolnierekPost Thumbnail

The European Union plans to create a standard for issuing green bonds, but it may fall short of its aims to mitigate greenwash.

  • EU negotiators have agreed to create a European Green Bonds Standard (EUGBS) intended to promote transparency and tackle greenwash.
  • Green bond proceeds will have to be invested in green activities aligned with the EU’s taxonomy, but 15% of them can go to activities with undefined sustainability criteria.
  • As such, the EUGBS may add to issuer and investor concerns, which may require further refinement or changes to the standards themselves.

The European Commission first presented a proposal to the EU Parliament (EP) to develop regulations for European green bonds in July 2021. The intention was to establish a European framework to qualify funding for environmentally sustainable activities. A further aim was to establish a system by which external reviewers could be registered and supervised, which would in turn oversee green bond issuers and verify the sustainability of the bonds.

Negotiations between the Commission, the EP and the European Council began in July 2022 and resulted in a provisional agreement at the end of February 2023. For it to become regulation it needs to be confirmed and adopted by both the Council and the EP, and will apply 12 months after it is entered into force.

What is part of the EUGBS framework?

The main aim of the Commission in proposing the EUGBS was to improve transparency in the European sustainable finance market while also clarifying the definition of sustainable activities, reducing incidences and claims of greenwash. 

Bond proceeds have to be invested in activities that are aligned with the EU taxonomy to be considered environmentally sustainable. Issuers choosing to use the EUGBS will have to disclose how bond proceeds will be used, and how the investment activities enable the transition plans of the company receiving the capital. 

Templates for disclosure requirements can also be used by issuers of bonds which do not fulfil all the requirements to qualify for the EUGBS. By using these templates, companies may enhance their standing with investors.

The EUGBS will also enable independent external review of the bonds and their stated use of proceeds, by devising guidelines and processes for their selection. These independent entities will be charged with ensuring that a green bond is being used for sustainable activities. 

The EUGBS also sets boundaries to establish potential conflicts of interest, including the need to develop technical standards and mechanisms to ensure that any such conflicts are appropriately identified, and managed with transparency.

Paul Tang, a member of EU parliament and sponsor of the regulation, said: “With €100 trillion in annual trades, the European bond market is the single most popular option for businesses and governments to raise finances.”

How do the EUGBSs differ from ICMA’s Green Bond Principles and the CBI Standard?

The green, social, sustainable and sustainability-linked (GSSS) bond market is expected to grow by 5-17% in 2023, based on forecasts by S&P Global Ratings. It expects green bonds to remain the dominant category of issuance, with Europe, Middle East and Africa as the leading market.

According to S&P, the major drivers for green bond issuance in Europe will be the European Central Bank’s intent to decarbonise its balance sheet, the implementation of the EU taxonomy and the establishment of the EU green bond standards.

Thus far, the de facto global standard for green bond issuance has been the Green Bond Principles (GBPs) developed and monitored by the International Capital Market Association (ICMA). The NextGenerationEU green bonds, issued by the Commission to provide €250 billion for the bloc’s post-pandemic recovery plan, are also aligned with the GBPs.

Although the GBPs clearly define the criteria for selecting sustainable or green projects, according to the Commission they lack a clear definition of green activities and recommend, but do not require, a second-party opinion. The Commission said these are important distinctions between the GBPs and the EUGBSs.

The Climate Bond Initiative Standards, developed by the Climate Bonds Initiative (CBI), clearly define green activities and require certification of green bonds by external reviewers. They do, however, specify requirements that are more stringent than either the GBPs or the EUGBS, which is why the Commission believes fewer issuers use them.

The CBI standards also include their own taxonomy with screening criteria to define green economic activities, and require external reviewers to certify green bonds, which makes them similar to the EUGBS standard, and different from the GBPs.

What does this mean for future green bond issuance in Europe?

The EUGBS regulation will not enter into force for another 12 months, during which it is likely to invite scrutiny and debate around its validity and whether it can stay true to its intended purpose. For example, it may draw criticism for aligning with the EU taxonomy, which has already created controversy by defining natural gas as a sustainable fuel.

This is likely to raise concern among investors and cause confusion among issuers, especially since the EUGBS is being presented as the first global green bond standard to tackle greenwash. It does, however, provide the flexibility to invest 15% of a green bond’s proceeds in activities that have no criteria defining their sustainability attributes, which could add to this confusion.

The EUGBS requires issuers to show how bond proceeds will also be used to invest in their transition plans, and is therefore requiring these companies to actively engage in transitioning to green energy. While this may help finance the transition for companies, it appears contrary to the general understanding under which green bond issuance has been occurring thus far.

Whether following the GBP framework or the CBI standards, green bonds are classified as use of proceeds bonds, which means the entire net proceeds from the issuance must be directed towards a defined and pre-determined green, such as renewable energy, energy efficiency, clean transportation, sustainable water management and green buildings.

In fact, sustainability-linked bonds (SLBs) have been widely acknowledged as the GSSS instrument best suited for transition finance. As SLB proceeds are eligible for general corporate purposes, the use of proceeds is not confined to a specific green project with clearly identified sustainable objectives. They have, however, attracted criticism for their own lax standards, which in certain cases has led to accusations of greenwash.

The resolution of what seem to be glaring flaws may result in the refinement of the standards before they become law. If the apparent confusion is resolved, the sustainable finance space will benefit from a new set of standards that mitigate greenwash.

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