EU Green Bond Standard
Paving the way for the development of transition finance
At a glance:
- COP28 reiterated the need to channel private finance towards the climate transition. One of the flagship EU initiatives designed to help to achieve this is the recently finalised European Green Bonds (EuGB) Regulation. The EuGB Regulation entered into force at the end of November and issuers will be able to utilise its EuGB Standard from December 2024.
- Although the green bonds market has been growing rapidly (global issuance exceeded $300bn in the first half of 2023), some fundamental impediments to scaling the market further remain. The EuGB Regulation seeks to resolve these issues by setting more prescriptive rules for firms choosing to use its EUGB Standard to ensure environmentally sustainable allocation of funds, adequate visibility of the allocation process, and appropriate external assessment of an issuer’s claims.
- Although usage of the standard is voluntary, if issuers choose to issue bonds under the EuGB Regulation then they must comply with all the elements of the EuGB Standard to claim the EuGB label by law.
- In particular, key elements of the EuGB Standard include: a requirement to allocate at least 85% of proceeds to EU taxonomy-aligned activities; an array of new templates for disclosures; and a requirement to obtain external certification from designated EuGB reviewers.
- When benchmarked against existing green bonds standards, the EuGB Standard has several benefits for issuers and investors, in particular, around increasing comparability across bonds and reducing greenwashing risk. On the flip side, the requirements increase costs and will be operationally challenging to meet, in particular whilst the availability of data to support the assessment of EU taxonomy-alignment is limited.
- The EuGB Standard is the EU latest initiative to increase transition financing to be finalised. In December, the European Banking Authority (EBA) also proposed the introduction of an EU Green Loan standard. Existing EU regulations already target green investment management products.
Introduction
As the world continues to grapple with the challenges of climate change, one of the key areas of focus currently is transition finance i.e. the financing of initiatives that will help to transition economies and businesses to a more environmentally sustainable future. At COP28, the need to accelerate transition finance was a major theme. While progress has been made in this area, financial market capacity for green financing is still relatively underdeveloped. By some estimates, existing annual transition finance flows (inclusive of both mitigation and adaption) stands at just 20-25% of the $4.3 trillion required by 2030.
Governments, regulators and financial services firms globally are looking at how in practice to fill the transition financing gap. For example, at COP28, the UK Government announced the Climate Investment Funds Capital Market Mechanism (with an ambition to generate up to $50 billion in co-financing annually). In the private sector, companies can issue green loans and green bonds. The green bond market is growing rapidly: global issuance of new green bonds reached around $310 billion in H1 2023, a record half-year for the sector.
However, impediments to scaling the green bond market further persist. In particular, investors can struggle to understand the underlying value of a green bond or to compare two different bonds because of the limitations of existing disclosures. Greenwashing is also a risk.
To address these issues, the EU recently finalised the EuGB regulation. According to the European Council, this new regulation is “a further step in implementing the EU’s strategy on financing sustainable growth and the transition to a climate-neutral, resource-efficient economy”.
What is the EuGB Regulation?
As an “integral part of the European Green Deal”, the regulation establishes the EuGB standard. Usage of the standard is completely voluntary, meaning that firms can continue to issue in any format they choose – although they must follow the requirements laid out in the regulation, including full compliance with all the elements of the standard, if they want to claim the EuGB label. Almost all firms and public entities can issue green bonds under the EuGB tag (even those outside of Europe). The regulation has already entered into force and the standard will be available for use from December 2024.
Compared to other commonly used standards – for example, ICMA’s Green Bond Principles or the CBI’s Climate Bond Standard – the EuGB Standard aims to be more prescriptive in order to ensure: the environmentally-sustainable allocation of the funds, adequate visibility of the allocation process and appropriate external assessment of an issuer’s claims.
| Standard | EuGB | ICMA | Confederation of British Industry |
|---|---|---|---|
| Use of proceeds from capital raised | At least 85% must be allocated to EU taxonomy-aligned activities, and all proceeds must be invested in activities that contribute towards the EU Taxonomy's environmental objectives and meet the relevant Do No Significant Harm criteria. | “Should provide clear environmental benefits”, Issuers are recommended to comply with various green taxonomies (including the EU taxonomy). | Projects must be new and contribute to climate mitigation, adaption or conservation, as well as be consistent with achieving the goals of the Paris Climate Agreement. |
| Pre-Issuance disclosures | Must communicate, via the EuGB factsheet: environmental strategy of bond issuance (and link to transition plans where appropriate); intended allocation of bond proceeds; environmental impact of bond proceeds; information on reporting; and CapEx plan (where applicable). | Must communicate: the sustainability objectives of the eligible green projects; the process by which the issuer determines how projects are sustainable; and processes the issuer has in-place to manage social and environmental risks. | Must communicate via “Green Finance Framework”: the impact of the eligible green projects; the process by which the issuer monitors how projects are sustainable; and the financial soundness of the projects. |
| Post-issuance disclosures | Must communicate via an “allocation report” every 12 months and produce an impact report at least once during the lifetime of the bond and after full allocation. Allocation report should include much of the same information as the factsheet. | Must publish an annual report listing allocations of capital, descriptions of the underlying projects themselves and their expected impact. | Must publish an annual report on the environmental impact of the projects and a periodic report on the financial performance of the projects. |
| Assessment from external reviewer | Required to have an independent designated reviewer. | Recommended but not required. | Required to have an assessment made by an external reviewer approved by the CBI. |
| Regulatory oversight | National Competent Authority responsible for supervising compliance with disclosure and reporting requirements. | N\A | N\A |
Key considerations for green bond issuers and investors
The EuGB Standard principally requires issuers to allocate at least 85% of a bond’s net proceeds to activities covered by the EU Taxonomy. This allows for a 15% “flexibility pocket”, available for activities not yet covered by the taxonomy (e.g. agriculture) provided the activities contribute towards the EU Taxonomy's environmental objectives and meet the “Do no significant harm” criteria. Issuers can invest the proceeds in taxonomy-aligned capital expenditures, operating expenditures (incurred more recently than three years prior to bond issuance), fixed assets, financial assets (created no later than five years after issuance and to be re-invested to a maximum of three subsequent financial assets) or a combination of those. An advantage, therefore, for issuers and investors is that EuGB bonds will align with funds’ EU taxonomy obligations under SFDR as well as some clients’ MiFID sustainability preferences, which can be defined in terms of EU taxonomy alignment.
In addition to prescriptive criteria for allocation of proceeds, the EuGB Standard focuses on transparency and credibility of disclosures. To ensure transparency over use of funds, the framework mandates a series of disclosures using pro forma templates. Issuers must also have both pre-issuance and post-issuance reviews assessed by an independent, designated EuGB reviewer. As for other capital market products, EuGB issuers must also comply with the EU Prospectus Regulation.
The requirements for green bonds issued under the EuGB Standard will add additional costs and cause some compliance challenge as compared to other green bond standards. Issuers that are complying with existing green bonds standards may find it challenging to reshape their processes or to source the necessary data to comply, in particular, with the taxonomy-alignment assessment and “do no significant harm” criteria. Some smaller issuers may find the EuGB Standard requirements more challenging considering their size.
Next steps
The ambition of the EU is that that the EuGB Standard and Regulation will enable investors to “trust that their investments are sustainable, thereby reducing the risks posed by greenwashing”. These considerations are central to the broader set of sustainable finance initiatives being championed by the European Union and address directly a core area of concern of investors – both retail and professional. On balance, despite the costs and challenges of adopting the standard, for these reasons we expect the standard will be taken up.
Firms that have already issued green bonds or are considering doing so in the future should consider how adopting the EuGB Standard would support their strategy. This assessment needs to consider whether/when market access might become easier for issuance under the EuGB Standard as compared to other options. Most firms are also already investing significant resources to meet reporting requirements such as the EU Corporate Sustainability Reporting Directive (CSRD) and consideration needs to be given to how alignment with these projects could help accelerate and simplify the data challenges presented by the EuGB standard.
More broadly, it seems that likely policymakers will continue to drive transition finance forward, which is likely to result in further development of regulatory standards in this area. The EU has stated that the EuGB Standard may “serve as inspiration for any future sustainability-related disclosures under Union law”. The EBA recently recommended a future EU-endorsed voluntary green loan definition that mirrors the features of the EuGB Regulation. As such – it is likely that a wider EU sustainable finance and capital markets regulatory ecosystem will emerge for a broader range of capital market products. It may be beneficial for firms looking to finance their transition to leverage the EuGB Standard now in order to get to grips with the underlying concepts including data and management information to prepare better for the future of transition finance.
