EU Taxonomy: The period of misalignment for sustainable finance

First-year EU Taxonomy reporting and implications for the green bond market

Since the introduction of the EU Taxonomy, along with the subsequent proposal of the EUGBS, there has been considerable ongoing debate in the sustainable finance market about the alignment of green bond frameworks with the EU Taxonomy. Last year we conducted an analysis on EU Taxonomy eligibility and were taken aback by the relatively low eligibility figures of certain sectors, such as construction and real estate. This year, Nordea ESG Research followed up with an analysis on the EU Taxonomy alignment for Nordic-listed companies, based on ~210 companies in Nordea’s universe, and the alignment figures gave no further encouragement compared to what we reported last year.

Taking a closer look at green bond issuers in Nordea’s company universe, 34 green bond issuers reported on EU Taxonomy capital expenditure (capex) alignment. Of these, 35% of issuers reported no degree of alignment with the EU Taxonomy, while not a single issuer reported 100% capex alignment. 

Source: Nordea, company data, Bloomberg

Given that the basis for green bonds is investments made by the company and assets on the balance sheet, the analysis of alignment should focus on capex. The data from Nordea ESG Research shows that the average EU Taxonomy alignment of capex in the Nordic company universe was 8% by market cap, and, excluding the companies reporting 0% alignment, the number reached 21%. This means that only 8% of total capex reported for 2022 for the companies in scope can be financed by green debt if we were to use the EU Taxonomy definitions to define green investments and assets.

In light of our findings, if all companies were to align their green bond frameworks and subsequent green bond issuances with the EU Taxonomy, there would be a substantial decrease in green bond supply. Although the EUGBS does offer a provision for companies to issue green bonds based on 10-year capex plans, Nordea finds it unlikely that the EUGBS will be widely adopted in the coming years.

Consequently, this predicament could result in two potential scenarios in the short-term: either a diluted format of the EUGBS or the coexistence of two parallel green bond formats (EUGBS and ICMA Green Bond Principles) moving forward. With the latter, we could expect a mid-way step of issuers more often declaring their green use-of-proceeds EU Taxonomy alignment in their "regular" green bond frameworks.

The low alignment shares underscore the need for further improvement to bridge the gap and ensure that sustainable financing is truly contributing to EU’s Sustainable Finance Framework. Furthermore, we see current interpretation on EU Taxonomy reporting to be on the conservative side, something that’s likely to continue for the coming years. We do anticipate a period of “misalignment,” as companies get more comfortable with reporting on EU Taxonomy eligibility and alignment after the first years and as the EU Taxonomy regulation develops further with the inclusion of additional sectors. But until then, there will be a recurring challenge of aligning green bond frameworks with the EU Taxonomy.

Until there’s a coherent definition of ‘green’: Opportunities with the sustainability-linked format

The aforementioned challenge with low alignment numbers could lead some issuers to hesitate over the green bond format until they have higher alignment of their capex. Here, the sustainability-linked bond (SLB) format can have an interesting role to play as the format is focused on overall sustainability-related transition measured by sustainability KPIs rather than sustainably-defined use of proceeds.

12 SLB issuers in Nordea’s company universe reported on their EU Taxonomy alignment and eligibility in 2022, of which 7 reported no degree (0%) of capex alignment and only 1 reported an alignment higher than 25%. The majority of the diverse set of sectors in our company universe issuing SLBs have not been covered or fully had their operations covered by the EU Taxonomy, indicating challenges supplying green use of proceeds. All of the companies, excluding one, had key performance indicators (KPIs) linked to reducing emissions. This reveals companies’ willingness to transition towards a greener tomorrow via greenhouse gas reductions, despite the lack of green capex.  

The uncertainty around green definitions and how aligned they should be with the EU Taxonomy poses an opportunity for the sustainability-linked format until underlying definitions are more clear. In addition, the low EU Taxonomy alignment numbers suggest that relevant KPIs for companies to consider for sustainability-linked bonds include the “share of Taxonomy-aligned capex,” “share of revenues from EU Taxonomy-aligned products or services” or similar. As previously mentioned, for some sectors in the Nordics, the issue might be that the EU Taxonomy definitions don’t cover the products or services offered, or that the criteria are too vague to be used currently. Until the issue is solved for those sectors, it will not be relevant to align the SLB and green format with the EU Taxonomy.