The EU Green Bond Standard: Evolution but not a Revolution

The current EU green bond markets rely mostly on private regulation by way of market self-discipline, via ICMA Green Bond Principles, which is to be complied with by the bond issuers as good practice. However, that has been criticised for not being sufficient, leaving a regulatory vacuum and causing the ‘legitimacy deficit’ problem. Namely, the lack of effective and mandatory prescriptive standards for green bond issuers causes transparency and investor protection concern. To solve the regulatory vacuum, the EU has recently established the landmark EU Green Bond Regulation, which should bring some certainty to define ‘green’ and green safeguard requirements for issuers.

In my forthcoming article (‘The EU Green Bond Standard: Evolution Towards Credible Green Debt Markets’, J.I.B.L.R. 2024, 39(3), 90-108), I attempt to examine the pain points under the current regulatory vacuum, and the inadequacy of the private regulation such as the ICMA Green Bond Principles, and make an assessment of the key aspects of the EU Green Bond Regulation (EuGBR), as well as evaluate related factors and the potential market uptake of it in practice.

The EUGBR is a paradigm shift from market private regulation by ICMA. Undeniably, it is a positive milestone for the green bond market establishing a uniform regulatory framework compared with the private regulation. With sufficient issuers that choose to apply the same European Green Bond (EuGB) label across the EU, that would increase market efficiency by reducing discrepancies and costs for investors assessing such green bonds, tighten the fight against greenwashing, and hence foster further growth of the green bond markets. In addition to the voluntary nature of this regulation, the following factors can be relevant for the potential uptake of the EuGB label.

First, the solutions to any useability challenges of the Taxonomy Regulation (TR) are essential. The TR sets out the conditions for TR assets alignment. But when it comes to compliance, the devil lies in the details. In this regard, the ICMA has identified many challenges in practice, such as the lack of universal standard, the accessibility of granular data for Technical Screen Criteria (TSC) compliance etc. The useability of the TR, and the total target assets with TR alignment in the market by the corporate EU, are essential for the uptake of the EUGBR.

Secondly, the TR policy predictability and stability would be critical for issuers to consider uptake of the EuGB, under the grandfathering provision. The grandfathering of the seven-year period does allow some backward looking in terms of TSC compliance and comfort. To utilise it best, issuers might consider to allocate all proceeds immediately after the issue of the bonds to avoid the impact of any future TSC change. But the question remains—what happens after seven years under the updated new TSC? So, the predictability and stability of the TSC would be essential for the market participants to systemically embrace the new golden label.

Thirdly, from the issuers’ perspective, an economic analysis is important before a decision to apply the EUGBR. In practice, under the ambitious agenda of the EUGBR, each issuer would have to make their own cost-and-benefit assessment as to how costly (including risk factors) it would be to update their existing green bond framework under the golden label, in exchange for some potential rarity benefits (such as Greenium) in the primary market.

Lastly, from an investor protection perspective to counter greenwashing risk, investors would prefer more clarity and standardisation eventually. The European Supervisory Authorities (ESAs) defines greenwashing as ‘a practice whereby sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services’. Such practice can mislead consumers and investors in their investment decisions. To prevent being a victim of greenwashing by other market participants, in the long term the investors may want to push the issuer to use the label, and sooner rather than later.

Given the ambitious plan of the EU agenda under the EUGBR compared with the regulatory vacuum under ICMA private regulation, the uptake of the golden labelling is likely going to be an evolution, but not a revolution.

In the short term, due to the voluntary nature of the EUGBR, and the above-mentioned factors to be considered after the paradigm shift, it is likely to lead to fragmented sections of the green bonds and regulatory pluralism at the starting phase. The existing and new green issuers are bound to be divided by compliance levels of green bonds issue. In the long term, however, the harmonisation might arise after a fragmented period when uncertainty starts to diminish. On the one hand, there would be more clarity and predictability in terms of taxonomy policy making and alignment after the testing phase, and more assets would be TR aligned, as the potential use of proceeds (UOP) target for green bonds issue. On the other hand, arguably when the green bond market is further developed and more transparent, there would be considerable Greenium for green bonds under the EuGB label in the primary market.

Chen Chen Hu is a Senior Legal Counsel at Danske Bank, Denmark. Views in the article represent the opinion of the author and do not represent that of Danske Bank A/S.