Anticipating the EU Green Bond Standard: The Core Elements of the European Green Bond Regulation

In July 2021, the European Commission submitted a legislative proposal for the introduction of a European Green Bond Standard (EUGBS), aiming to promote sustainable finance by making it easier for market participants to raise large-scale financing for climate and environmentally-friendly investments. Following lengthy negotiations, the co-legislators reached an agreement and the European Green Bond Regulation (EUGBR) is expected to be published in the coming months (an analysis of the Commission’s proposals and the co-legislators’ positions can be found in my paper published last year).

The EUGBS aims both to allow issuers to demonstrate their strong environmental commitment in a credible manner and to provide investors with confidence that their investments are sustainable. The EUGBS aspires to set a new benchmark for green bonds through the standardization of market practices and the introduction of high standards both for issuers and external reviewers. The EUGBR seeks to protect investors from the risk of ‘greenwashing’ by setting high standards for the issuance of green bonds through the removal of the existing barriers to the development of the green bond market, namely the lack of common definitions for green assets and the inconsistent application of disclosure and verification requirements.

The EUGBR introduces three (3) novelties that significantly differentiate the EUGBS from the market-based green bond standards. Firstly, the funds raised through a European Green Bond (EUGB) should be allocated (mostly) to Taxonomy-aligned projects, namely to environmentally sustainable assets and economic activities in line with the Taxonomy Regulation. Secondly, issuers will be subject to enhanced disclosure requirements based on standardized templates to ensure full transparency on the allocation of proceeds and the environmental impact of the EUGB. Thirdly, external reviewers, which should confirm that the aforementioned disclosures comply with the requirements of the EUGBR, have to be registered with and supervised by the European Securities and Markets Authority (ESMA).

The EUGBR intends to align the use of EUGB proceeds with the Green Taxonomy, which is used as a benchmark to define whether an economic activity and the related assets are green and whether full compliance with minimum social safeguards is ensured. Thus, proceeds from an EUGB should be used to finance Taxonomy-aligned environmentally sustainable economic activities or economic activities that contribute to the transformation of activities to become environmentally sustainable within a reasonably short period from the EUGB issuance. Nonetheless, the EUGBR provides issuers with some flexibility, allowing up to 15% of the proceeds to be allocated i) to activities for which there are no technical screening criteria in force at the date of issuance, provided the activities comply with the generic criteria for ‘Do No Significant Harm’, as laid down in Regulation 2021/2139, and/or ii) to activities in the context of international support, provided those activities comply with the relevant technical screening criteria on the best effort basis. This flexibility aims to strike the right balance between the ambitious approach of the EUGBS and the actual applicability of the Green Taxonomy in the short- and medium-term.

Issuers may use the proceeds of an EUGB to finance i) fixed (tangible or intangible) assets that are not financial assets, ii) capital expenditures (CapEx), and/or operating expenditures (OpEx) with a 3-year lookback limitation, iii) financial assets (ie financial claims and equity instruments), created no later than five (5) years after the issuance of the EUGB, iv) assets and expenditures of households, or v) a combination of the aforementioned categories. In addition to the above, sovereigns may allocate the proceeds of an EUGB to indirectly finance economic activities that are aligned with the Green Taxonomy through the use of programs of tax expenditures or transfers.

As regards disclosures, issuers should publish i) pre-issuance EUGB factsheets, ii) post-issuance annual allocation reports, and iii) at least one report on the environmental impact of the EUGB, based on common templates included in the annexes of the EUGBR. A significant novelty of the EUGBR pertains to the mandatory external review of i) the pre-issuance EUGB factsheet and ii) the allocation report published after the full allocation of the proceeds. This obligation aims to ensure that a third party assesses and validates the accuracy of information contained in issuers’ disclosures and their compliance with the EUGBR requirements. Also, the EUGBR introduces a mandate for the European Commission to publish pre-issuance and post-issuance disclosure templates for bonds marketed as environmentally sustainable or sustainability-linked bonds. Issuers of such bonds can publish on a voluntary basis these templates, along with other disclosure documentation.

As regards the prospects of the EUGBS, the voluntary (instead of mandatory) nature of the standard seems appropriate, at least in the medium term, in order to avoid unintended consequences for the green bond market triggered by 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 success of the EUGBS depends on the extent of take-up among market participants. Issuers will have a choice of whether to use the EUGB designation or not. Some issuers may decide to not use it given that compliance with the requirements of the EUGBR, and in particular the Green Taxonomy, will be more burdensome and costly for them than the existing industry standards. Nonetheless, 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 EUGBS in investor mandates, market pressure and lower funding cost are likely to drive them to the EUGBS to raise funds for sustainable activities.

Nikos Maragopoulos is an Associate Researcher at the European Banking Institute.