Towards a European Green Bond Standard: What Is Needed to Be Fit for Purpose

Since its debut in 2007, the green bond market has been growing fast. Today, green bonds (defined as traditional bonds whose proceeds are used for projects that pursue specific environmental objectives) are considered the most promising instruments of sustainable finance and the largest sustainable debt category. Nonetheless, despite the significant expansion over the previous years, the green bond market still represents only a very small fraction of the overall bond market.

The transition to a climate-neutral economy and the achievement of the EU’s ambitious targets on the European Green Deal require public and private money to be redirected towards green investments. Therefore, in July 2021, the European Commission submitted a legislative proposal for the introduction of a European Green Bond Standard, which aims to promote sustainable finance and further develop the green bond market by making it easier for market participants to raise large-scale financing for climate and environmentally-friendly investments.

In a recent paper, I examine the Commission’s proposed Regulation on European Green Bonds (EuGBR), which aspires to set a ‘gold standard’ for green bonds through the standardization of market practices and the introduction of high standards both for issuers and external reviewers. The EuGBR aims to address the existing deficiencies in the green bond market pertaining to the lack of a uniform framework for green assets/projects, disclosure requirements and external reviews.

To this end, the EuGBR introduces three (3) innovative elements. Firstly, it links the allocation of proceeds from a European Green Bond (EuGB) to the EU Taxonomy. Proceeds should be used to finance assets and expenditures that are either Taxonomy-aligned or contribute to the transformation of activities to become environmentally sustainable within a defined period, as set out in a taxonomy-alignment plan developed by the issuer. Secondly, the EuGBR introduces enhanced disclosure requirements for issuers based on standardized templates. Issuers should be subject to (pre- and post-issuance) disclosures to ensure full transparency on the allocation of proceeds and the environmental impact of the EuGB. Thirdly, the EuGBR requires issuers’ disclosures to be assessed by external reviewers to ensure compliance with the EuGBR. External reviewers should be registered with and supervised by the European Securities and Markets Authority (ESMA).

Since July 2021, the Commission’s proposal has been discussed at the European Parliament and the Ecofin. The key issues under discussion pertain to (i) the voluntary or mandatory use of the EuGB, (ii) the potential extension of the EuGB requirements to all categories of sustainable bonds (ie green, social, sustainability-linked bonds), (iii) the application of (full or partial) grandfathering approach, (iv) the level of disclosure and verification requirements, and (v) the supervisory and sanctioning powers of national competent authorities in case of issuers’ failure to meet the EuGB requirements.

The Commission’s decision to propose a voluntary (instead of mandatory) green bond standard seems appropriate, at least in the short term, in order to avoid unintended consequences for the green bond market. This mainly refers to a potential migration of issuers to other non-EU markets with less stringent requirements and/or a switch of issuers to other traditional (non-green) funding sources. The phased-in approach proposed by the ECB and the Rapporteur (European Parliament) to make the standard mandatory within a reasonable horizon, once the currently low proportion of Taxonomy-aligned activities has been increased, could be an appropriate end-state for the EuGB standard.

In the meantime, the success of the EuGB (ie whether it will become the market standard in the EU) depends on the extent of take-up among market participants. Issuers may choose to align with the EuGB or follow other market-based practices. Some issuers may decide to not use the EuGB given that compliance with the requirements of the EuGBR, and in particular the EU Taxonomy, will be more onerous and costly for them than the existing industry standards. This would be particularly relevant if the final requirements of the EuGBR (eg disclosures, reporting, external verification) are considerably wider in scope and more stringent than originally set out by the Commission, which would fundamentally change the liability and costs for issuers. Such burdensome requirements along with the risks arising from sanctions in case of failure to adhere to those requirements may discourage issuers from using EuGBs, especially in light of the limited (if any) regulatory or financial incentives to counterbalance this.

It is reasonable to expect that investors would prefer green bonds that carry the EuGB designation due to the enhanced disclosure requirements and the strict verification arrangements. If issuers start to see explicit reference to the EuGB standard in investor mandates (ie only investments in EuGBs permitted), market pressure and lower funding cost might drive them to the EuGB for raising funds for sustainable activities. Against this backdrop, issuers should weigh the benefits of accessing a wider investor base and avoiding the risk of being accused for ‘greenwashing’ against the costs arising from compliance with additional disclosure requirements subject to the scrutiny of ESMA-supervised external reviewers.

Nikos Maragopoulos is an Associate Researcher at the European Banking Institute