Current developments in capital markets - Green Bonds

On 6 July 2021, the European Commission published a legislative proposal for a regulation on European green bonds (the EU Green Bond Proposal), which is supposed to become the high quality voluntary European Green Bond Standard. Its intention is to use the potential of the single market for achieving the EU’s climate and environmental goals in a more efficient way. Shortly before, the ICMA updated its Green Bond Principles, last revised in 2018, to reflect the record growth of the market for green bonds. Consequently, the changes that will be brought by the EU Regulation compared to the ICMA Green Bond Principles are of major interest for practitioners.

The IMCA Green Bond Principles 2021

The framework established by the ICMA Green Bond Principles is the set standard for green bonds. The new version of the Green Bond Principles contains further recommendations for even higher transparency requirements at issuer level. In particular, the external reviews shall be made in accordance with the ICMA Guidelines for External Reviews provided for this purpose according to which the results shall be made publicly available to everyone and the scope of the reviews shall be disclosed. Furthermore, the heightened transparency at issuer level shall be achieved by providing information on (i) sustainability strategies and commitments and if applicable on (ii) the degree of alignment of projects with official or market based taxonomies.

The new version of the ICMA Green Bond Principles also expands the eligible green projects in the category "Climate change adaptation" to include projects that make infrastructure more resilient to impacts of climate change. In addition, the so called Blue Bonds with the objective of emphasising the importance of the sustainable use of maritime resources and of the promotion of related sustainable economic activities are included in Annex I and are also captured as green bonds going forward.

Overall, a concretisation takes place through references to supplementary guidelines (Climate Transition Finance Handbook, Harmonised Framework for Impact Reporting, Guidelines for External Reviews), which are completed by the Guidance Handbook.

The EU Green Bond Proposal

The EU Green Bond Proposal published by the European Commission, which is also a cornerstone of the Commission’s Action Plan on Financing Sustainable Growth announced in March 2018, is overall closely aligned with the Paris Agreement of 2015 and the sector specific criteria of the EU Taxonomy.

The aim is to simplify the future issuance of green bonds through the alignment of definitions and harmonisation of external review processes. This should result in a faster transition of the European economy to carbon neutral and overall less polluting technologies and production processes. At the same time, compliance with this EU Regulation would prove that the green projects are aligned with the EU Taxonomy and as a result of the high transparency requirements it would be easier for investors to identify environmentally sustainable investments. This should reduce the risk of greenwashing while ensuring market integrity. Furthermore, a consistent regulation at EU level is also supposed to lead to a risk reduction regarding the fragmentation of the single market for environmentally sustainable bonds and bond related external review services, and ensure that there are uniform conditions for the issuer of such bonds.

The further development of the market for high quality green bonds is intended to maximise the potential of the single market for achieving the EU’s climate and environmental goals. For this purpose, the EU Green Bond Proposal establishes a new gold standard for European green bonds, consisting of four key requirements against which other market standards can be compared and adapted:

1. Taxonomy-alignment: the funds raised by the bonds should be allocated fully to projects that are aligned with the EU Taxonomy;
2. Transparency: full transparency on how the bond proceeds are allocated through detailed reporting in an EU Green Bond Factsheet;
3. External review: all European green bonds must be checked by an external reviewer to ensure compliance with the Regulation and taxonomy alignment of the funded projects; and
4. Supervision of reviewers by ESMA: external reviewers providing services to issuers of European green bonds must be registered with and supervised by the ESMA.

Consequently, the EU Green Bond Proposal sets higher requirements for the sustainability of the funded projects and, through increased transparency, provides stronger protection of investors against greenwashing. In addition, the EU Green Bond Proposal is also intended to simplify the financing of transition technologies.

Comparison of the EU Green Bond Proposal with the ICMA Green Bond Principles

The new European Green Bond Standard proposed by the Commission is based on best market practice and designed to be compatible with existing market standards for green bonds. However, by specifying the full alignment of the funded projects with the EU Taxonomy and developing a system for the registration and supervision of external reviewers, the new European Green Bond Standard goes beyond existing market standards in certain key aspects. In particular, the preservation of the voluntary nature of the label as recommended by the Technical Expert Group (TEG) should be emphasised, which in turn is very much welcomed by ICMA as a member of the TEG.

Outlook

As shown in the EU Green Bond Proposal, there are no major differences to the current market standards of the ICMA Green Bond Principles; after all, the goal is compatibility with existing market standards. As a result of the planned EU Regulation, the rapidly growing market for green bonds is likely to become even bigger, probably also as a consequence of better transparency and risk evaluation for investors in the future. However, the continuing danger that investments in gas fired plants or nuclear energy can still be considered climate friendly is meanwhile justified by the Commission with the indispensability of such transitional technologies for achieving the climate turnaround. Now it remains to be seen, what the regulation on European green bonds will actually look like, once it has gone through the EU legislative procedure.