Milestone reached for the EU Green Bond Standard
A final text regarding regulation of the EU Green Bond Standard has been agreed and could become effective in the second half 2024 or early 2025. The EU GBS is likely to result in more fragmentation than harmonisation at the start. But over time, fragmentation is likely to diminish, as EU GBS should support investments in taxonomy-aligned activities, while we see larger greeniums for green bonds aligned with the EU GBS.
EU regulators have agreed on a final text regarding regulation of the EU Green Bond Standard
This paves the way for standards to become effective in the second half 2024 or early 2025
Final agreement includes 15% flexibility pocket to finance activities not yet fully aligned with EU Taxonomy
It also contains a 7y grandfathering period and establishes a registration system and supervisory framework for external reviewers
EU GBS is likely to result in more fragmentation than harmonisation at the start, as limited share of green bonds as well as eligible economic activities comply with taxonomy
But over time, fragmentation is likely to diminish, as EU GBS should support investments in taxonomy-aligned activities, while we see larger greeniums for green bonds aligned with the EU GBS
The EU authorities have reached a provisional agreement on the final text regarding the regulation of the EU Green Bond Standard (EU GBS). This marks a new milestone on the road to get to the first official piece of legislation/regulation on how to define green bonds. The journey started in 2018 when the establishment of green bond standards was part of the European Commission’s (EC) 2018 action plan on sustainable growth (). The first milestone was the publication of the EC’s legislative proposal on EU GBS in July 2021 (), which then had to be agreed by the EC, the European Parliament, and the EU Council during their trilogue discussion. On 28 February, an agreement was reached (), although the agreed text still needs to be confirmed by the Council and Parliament. Once adopted, the EU GBS will set a golden standard for what green bonds can be deemed in the EU (called European green bonds or EuGB). It will offer clarity to both issuers as well as to investors, as it will provide a strong quality label. Meanwhile, it should support transparency and comparability of green bonds, also preventing greenwashing.
The EU GBS key ingredients are based on four requirements, of which the first is that the proceeds of the green bonds are used to (re)finance projects/activities that are aligned with the EU Taxonomy. The others include regulations related to transparency (i.e., reporting requirements), external reviewers (second party opinion providers), and supervision of external reviewers by the European Securities Markets Authority (ESMA). We have previously reported (see ) what the main discussion points between the European Commission, the Parliament and the Council were. Below, we have therefore analysed what discussion points were left out and which ones were agreed upon.
Flexibility pocket of 15%
The Council, led by the Slovenian Presidency (SI PCY), had previously proposed that the EU GBS would have a flexibility pocket - that is, that a certain share of the proceeds raised under EU green bonds that would not necessarily need to be invested in activities that are fully aligned with the EU taxonomy. While SI PCY had proposed a 20% flexibility pocket, the final agreement was to have a 15% threshold. Furthermore, the final text includes flexibility only towards economic activities that comply with the EU taxonomy requirements but for which no criteria would have yet been established to determine if that activity contributes to a green objective (technical screening criteria). That is mainly because the EU Taxonomy for four out of the six environmental objectives is still under development. On top of this, the 15% pocket can be used to finance certain very specific activities outside the scope of the EU Taxonomy (but no further details were released). The use and need of a flexibility pocket will be re-valuated over time, which was also previously proposed by some member states such as Austria and the Netherlands.
Financing of gas and nuclear energy
The Parliament, led by rapporteur Paul Tang (S&D, NL), had previously proposed that European green bonds should not fund fossil gas- or nuclear-powered energy plants, despite those activities already being included in the Complementary Delegated Act for the EU taxonomy. This was however not included in the final agreements, meaning that a European green bond could still finance those transitional activities. There are also no additional disclosure requirements for European green bonds financing gas/nuclear, which was initially proposed by the Parliament.
Disclosure on transition plans
Still, in order to increase transparency and allow investors to judge themselves whether they would like to invest in European green bonds, the final proposal of the EU GBS includes mandatory requirements for detailed disclosure on how bond proceeds are used. Furthermore, the final agreement obliges companies “to show how those investments feed into the transition plans of the company as a whole”. This would allow the EU GBS to be used by companies that engage also in transitional activities (mainly gas/nuclear) and offers investors more insights in whether they would like to invest in these bonds.
Grandfathering
The initial legislative proposal by the Commission included a five year grandfathering period – that is, European green bond issuers would have five years to re-allocate proceeds if there would be changes in the EU taxonomy. Later, the Parliament had proposed excluding this clause, with the justification that ‘this would provide greater certainty and financial stability for issuers making medium and long-term investments in the real economy and for investors in green bonds issued on the basis of criteria predefined in the Taxonomy’. However, the final proposal includes now a seven year grandfathering period. There will also be an additional clause included, which stipulates that the Commission will publish a report by the end of 2024 and every three years to inform issuers on the review conducted.
External reviewers
There were also disagreements between the three parties about the external reviewers of European green bonds. The Council had previously argued that there needed to be a “binary choice” between whether European Securities Market Authority (ESMA) or National Competent Authorities (NCA) would act as supervisors of external reviewers. The final proposal however has stipulated that the NCA “of the home member state designated (in line with the Prospectus Regulation) shall supervise that issuers comply with their obligations under the new standard.” ESMA will, on the other hand, have the role of supervising external reviewers, ultimately making sure that “potential conflicts of interest are properly identified, eliminated or managed, and disclosed in a transparent manner.”
No mandatory disclosure requirements for all green bonds
The Parliament had previously proposed to introduce mandatory disclosure requirements for all green bond issuers, whether they are considered European green bonds or not. This however has not been included in the final proposal. Nevertheless, both the Parliament and the Council have highlighted in their press releases that the disclosure requirements are also open to be used by companies that cannot fulfil the requirements to qualify for the EU GBS, that is, on a voluntary basis. This should, according to the Parliament, help companies to ‘subject themselves to ambitious transparency requirements and, as a result benefit from better trust among investors’.
Next steps
The provisional agreement still needs to be put in the form of a final text, which will also provide more clarity with regards to other details on the EU GBS (read our previous piece on some of these discussion details ). The final text needs then to be voted on by EU regulators, after which it will become effective 12 months later. Some media reports suggest that the final approval is likely to take place by the summer, which would imply that the EU GBS will become effective in the second half of 2024. However, we do not rule out that this can be delayed to the start of 2025. Furthermore, authorities still need to develop technical standards addressing conflicts of interest for external reviewers. ESMA has also previously stated that it would require some time until the accreditation scheme for external reviewers is fully in place. Finally, we understand that the EC will publish a legislative proposal about sustainability-linked bonds within three years of the EU GBS becoming effective.
Verdict
We welcome the final agreement on the EU GBS, as it will set a clear standard for issuers as well as investors in green bonds. However, at first, the EU GBS is likely to result in a fragmented market, given that only a small share of green bonds will qualify the EU GBS. We estimate that only 10-30% of the outstanding green bonds fully comply with the EU Taxonomy. As shown in the chart below, there also seems to be a natural skew towards Financials and Corporates, with only a very small share of sovereigns & SSA green bonds that would potentially align with the proposed EU GBS. Moreover, less than 3% of global economic activity is aligned with the taxonomy, according to a report last October by the EU’s Platform on Sustainable Finance. Hence, for now, the EU GBS applicability also remains an issue, keeping the size of the market limited.
The fragmentation will likely consist of three layers of green bonds once the regulation will be effective: European green bonds, green bonds that use the disclosure requirements of the EU GBS but that do not (yet) comply fully with the standards, and green bonds issued under the Green Bond Principles of the ICMA. This is likely to create quite some confusion for investors, leading to fragmentation rather than harmonisation (which in the end is also one of the final aims of the EU GBS). Still, this issue will probably be solved in the medium term, as the EU GBS is likely to support investment towards EU taxonomy-aligned activities to foster (among others) the energy transition (which is of course a key objective of the regulation). This will increase the available amount of loans to projects aligned with the EU GBS, which will result in growth of the European green bonds market.
Furthermore, we expect demand for European green bonds to be relatively large, as the quality label will provide some security towards investors with disclosure requirements under the SFDR, in particular those with funds classified as Article 8 or 9. European green bonds should naturally be classified as sustainable investments, and will therefore alleviate any fears of greenwashing (several Article 9 funds have recently been downgraded to Article 8 given opaque definitions of what sustainable investments entail). As a result, we think that European green bonds will likely benefit from a larger ‘greenium’ than green bonds not carrying the label. This, in turn, will be an incentive for issuers to align with the EU GBS. Finally, the EU GBS can be used as a blueprint for other countries that would like to establish regulations for green bonds.