European Standard for Green Bonds: clarity in the market

Research into the effect of the EU Green Bond Standard by Sustainalize in collaboration with Rotterdam School of Management.

One way to contribute to a more sustainable economy is by issuing or investing in a green bond. A green bond is a type of debt instrument to finance environmentally friendly projects. The European Union is developing an EU Green Bond Standard (EU-GBS); this new standard will help to create more standardized, transparent, and comparable information about how ‘green’ a bond is. The green bond market is reaching maturity, due to its rapid growth in the last couple of years. The EU Green Bond Standard should help support green bond market growth even more while reducing the risk of greenwashing. Not insignificant developments, as green finance and consequently green bonds are essential to reach the global climate goals.

Together with Rotterdam School of Management, Sustainalize conducted a study on the impact of the EU GBS. For this research, various interviews were conducted with investors, issuers of green bonds, and experts in the field, such as AFM, PGGM, MN, Alliander, Vesteda, and NWB Bank. In this article we will first discuss green bonds in more detail, followed by the Green Bond Standard and its effect on providing transparent and standardized information.

Sustainable Finance Developments

The European Union has ambitious plans for sustainable development, but money to execute these plans is currently still missing. This is why the EU has developed an EU Action Plan on Sustainable Finance: to create a financial system that can support in creating sustainable growth. This action plan does not only addresses governments but also calls upon businesses to contribute to a more sustainable economy. Without businesses, it will not be possible to close the investment gap predicted at 180 billion EUR per year to achieve the EU 2030 targets that were agreed upon in Paris.

To engage businesses and private finance systematically in this transition, changes in the EU financial system are needed. More ‘green finance’ investments are needed; finance that supports economic growth while reducing pressures on the environment. In its action plan, the EU wants to address the challenges in the green finance market, such as the lack of reliable information. To address this issue, a European classification system for sustainability has been developed: the EU Taxonomy (more information in our webinars). This will help create common definitions of what ‘sustainable investments’ are. Moreover, a standard for ‘green’ financial products (EU Green Bond Standard) is being created with the main goal to give investors certainty and reduce the risk of ‘greenwashing’. This article will elaborate on this EU Green Bond Standard and its potential.

Green Bonds Market

What is a green bond?
A green bond is a type of debt instrument for which the use of proceeds is used to finance environmentally friendly projects. When issuing a green bond, investment money is only used for climate-related programs or assets, such as renewable energy, energy efficiency, or climate adaptation projects. Thus, the green bonds market provides the opportunity to direct (private) finance towards low-carbon investments.

Why issue a green bond?
There are several potential benefits for issuers when issuing a green bond:

  1. investor diversification and engagement,
  2. improved corporate reputation and awareness,
  3. improved internal awareness of sustainability, and
  4. possible financial benefits (e.g., lower interest rates).

The main reason to invest in a green bond is that investors are becoming more and more strict about where they invest their money. Not only the fossil fuel industry is encountering this, but this is becoming a topic of concern for other industries as well, such as aviation, alcoholic beverages, dairy, etc.

Who can issue a green bond?
Issuers are typically supranational institutions, private corporations, banks, or governments.

The first green bond was issued in 2007 by the European Investment Bank (EIB), but the market started to develop quickly around 2014 when EUR 34 billion in green bonds was issued. Ever since, the market has been growing and now represents more than EUR 700 billion in assets, with a record in new issuance in 2019 with the amount of EUR 255 billion. It is expected that 2020 will again be a record year.

Green bond market – real and projected growth in EUR billions
Fig. 1: Green bond market – real and projected growth in EUR billions. (Click on image for full size)
Source: Bloomberg (2019). NN Investment Partners (2019)

Guidelines for issuing green bonds

To create transparency and clarity in the green bond market, two global voluntary standards in addition to the EU-GBS have been created. The Green Bonds Principles (GBP) and the Climate Bonds Standards (CBS).

Voluntary green bond guidelines
Voluntary guidelines have been developed that green bond issuers use as a framework to show the ‘greenness’ of their bond. The Green Bonds Principles (GBP) were established in 2014 and aim to promote integrity in the green bond market by developing guidelines that promote reporting, disclosure, and transparency. These guidelines have established broad market recognition and acceptance by regulators and policymakers.

Following the guidelines of the GBP, the Climate Bonds Standards (CBS) was initiated by the Climate Bonds Initiative (CBI) to create clear criteria to verify the label of a green bond. CBI aims to create more trust and assurance with a certification scheme for its green bond standard. Their aim is to improve the ability of an investor to assess the green credentials of a green bond. The CBI aimed to create more reliability within the market but it seems that in practice, financial institutions themselves still determine what forms of financing they consider as sustainable, which leads to inconsistencies. Even though the green bond market has expanded rapidly in the last years, to reach its potential, it has been argued that a standardized framework or definition is necessary to ensure communication of information and transparency.

The EU Green Bond Standard
Action two of the Action Plan on Sustainable Finance wants to create labels and standards for green financial products, which has been further developed in the EU Green Bond Standard. The EU-GBS aims to tackle current bottlenecks in the green bond market with its new framework and additional recommendations, such as the EU Taxonomy. Consequently, the goal of the new standard is to create more transparency and integrity within the green bond market and to clarify how environmental impact and economic activities can be combined in a measurable and credible way. The EU-GBS is planning to take a two-step approach concerning its legal status: firstly, it will be a non-binding EU act, on a voluntary basis. Secondly, while monitoring the impact of the GBS implementation, it would be possible to include legislation after a period of up to three years. After a public consultation, which is open until 2 October 2020, the European Commission will decide in Q4 2020 how the EU-GBS will be taken forward.

Figure 2: Highlights of the EU Green Bond Standard
Fig. 2: Highlights of the EU Green Bond Standard. (Click on image for full size)
Source: EU Technical Expert Group on Sustainable Finance (2020)

A next level Standard
Although the Green Bond Principles and the Climate Bond Standards have provided guidelines and tried to define what can be seen as ‘green’ in the green bond market, the voluntary standards struggle to create the standardization and maturity the green bond market needs. The EU-GBS has aligned with these best market practices but expects to create more transparency because they have defined what credible ‘Green Projects’ are by linking it to the EU Taxonomy. Also, the EU-GBS has more reporting obligations: allocation reports (how the money has been used) are mandatory annually and an impact report (related to environmental impact) is mandatory at least once, after all the money has been allocated. The allocation report needs to be checked by an external verifier, for the impact report this is recommended. For these verifiers, the EU-GBS has developed a scheme for to become accredited. Currently, there is a wide range of external reviewers that use diverse approaches when verifying a green bond. It is expected that the accreditation scheme of the EU-GBS will lead to more professionalism and independence of verifiers.

“The AFM welcomes proposals (such as those of the EU-GBS) to arrive at more standardization and transparency, as this would benefit this market.” – Jurgen Veenker (AFM)

The effect of the EU Green Bond Standard

As a result of the study, it is found that the EU Green Bond Standard will help to resolve current information imperfections and information asymmetries in the green bond market. This makes it a good tool to determine how ‘sustainable’ or ‘green’ a financial product is.

Until now, there was not enough information available to determine how ‘sustainable’ or ‘green’ a financial product was. This research found that the EU Green Bond Standard will help to resolve current information imperfections and information asymmetries in the green bond market. The leading cause for information imperfections is the lack of an agreed-upon standard on what is green, which is being addressed in the action plan. The EU Taxonomy will create clarity about what green projects are and what aren’t, creating a standard that issuers and investors can follow. Also, the EU-GBS will create more transparency due to more frequent reporting obligations. More importantly, the EU-GBS introduces an accredited verification scheme, which increases the comparability and credibility of external reviewers. This will enhance the quality and comparability of these verifications, which will help provide more transparent information. Consequently, greenwashing can be reduced since the EU Taxonomy defines which investments are ‘sustainable’ and which are not. The results show that the EU-GBS will create more certainty, transparency, and unity in the green bond market since market players (e.g., investors, issuers) no longer have to decide themselves what falls within the scope of ‘green’. Now, they can use the standardized framework. As a result, it will be possible to distinguish between bonds that do or do not comply with the EU Green Bond Standard. All in all, this research discovered that the EU-GBS is expected to be better equipped to limit information imperfections as opposed to voluntary market standards.

“A Green Bond Standard is important for issuers of green bonds. It will contribute to the transparency and credibility of the green bond market.” – Frans Baas (Vesteda)

Even though this research found that the EU-GBS is seen as a positive and necessary development, several concerns and considerations were found as well. There are several considerations to ensure green bond market growth: first, the guidelines of the EU Taxonomy and EU-GBS should not be made too strict and some level of flexibility should remain. Second, it should be monitored whether the standard will be used globally and not become solely a regional standard. Third, the costs of complying to the EU-GBS should be kept as low as possible to be disposable for smaller issuers as well. Moreover, the EU can play a role in standardizing impact measurements and environmental data. This is currently lacking, which is seen as a big obstacle in relation to the credibility of green bonds. Lastly, the EU should consider a way to include the heavier industry that falls outside the current scope of the EU-GBS. This is highly needed for a shift towards a more sustainable economy. Moreover, guidance and standardization are needed for other types of bonds, such as social, sustainability, and SDG bonds. The interest in these types of bonds is rapidly growing as well.

“As long as the guidelines are not too rigid and don’t become an impediment to green market growth for whatever reason, I believe the market should and will warmly embrace one standardized framework.” – Bart Reidsma (PGGM)

Moreover, the results show that not only the ‘use of proceeds’ of a bond needs to be green for a bond to be credible. The sector or industry an issuer operates in, and the (sustainability) strategy of an issuer, is becoming more and more relevant for investors. It is important for the company or organization that issues a green bond, to show investors that they take sustainability seriously and implement this in their long-term strategy or vision.

Action!

By investing in green and sustainable finance, businesses become part of a more sustainable economy. One way of doing this is by issuing a green bond or investing in a green bond. As this research shows, the arrival of the EU Green Bond Standard will increase the reliability of green bonds. With this, the stimulation of growth in the green market is to be expected. An encouraging thought!

Let’s drive business as a catalyst for change. Let’s dare to shape the future!

“The EU Green Bond standard is a promising step towards greater standardization and comparability of green bonds. It will assist investors in distinguishing between greenwashers and those firms who truly want to make their business more sustainable.” – Sem de Moel (MN)

Author: Marleen Blanson Henkemans

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