European Green Bond Standard: Implications of the provisional agreement

The provisional agreement on European Green Bonds

Last week, a provisional agreement was finally reached between negotiators of the Council and the European Parliament on European Green Bonds. Initial information released about the agreement reveals that issuers seeking the European Green Bond label must allocate the proceeds from bonds to EU Taxonomy-aligned economic activities. In addition to this requirement, issuers will also have to show how the use of proceeds aligns with their overarching company transition plans.

The provisional agreement also includes a 15% “flexibility pocket” for the allocation of proceeds to activities not yet covered by the EU Taxonomy. While this “flexibility pocket” allows for some expenditures that are not explicitly defined under the EU taxonomy, issuers will likely have to demonstrate that those expenditures contribute to environmental objectives and that they meet the generic “Do No Significant Harm to other objectives” and the Minimum Safeguards criteria, meaning that all expenditures may still be tied to the Taxonomy regulation in some way. Although not stated under the provisional agreement, these Taxonomy-related requirements for the 15% pocket suggest that the allowance for flexibility will only tighten in the future.

One key issue widely discussed in the market has been the potential requirements the European Green Bond standard may place on “regular” green bonds as well as environmentally-focused sustainability-linked bonds. In the provisional agreement, any mandatory requirements for other bonds have been dropped. The latest version now includes voluntary disclosure requirements for other sustainable bond formats, with an aim of setting best practices for transparency. 

In the future, other formats will also see the possibility to achieve a EU label, as the European Commission committed to developing a regulatory proposal on sustainability-linked bonds within three years, as part of the agreement.

In a step towards assuring trust in the system as a whole, the European Securities and Markets Authority (ESMA) has been given a supervisory role as the external reviewers (including Second Opinion Providers) of European Green Bonds. Within the proposed supervisory framework and registration system for external reviewers, reviewers will have to identify and disclose any potential conflicts of interest.

The agreement is provisional until formally adopted by the Council and Parliament and is expected to be effective 12 months after adoption.

Implications for issuers and the overall sustainable bond market

The European Green Bond standard brings additional clarity and transparency to the market. This is highly encouraged as investors seek more coherent sustainability-related information about green bond issuers as well as the “greenness” of investments and costs financed by green bonds. As such, we see the intention behind the European Green Bond standard, creating a label that gives more comfort to investors, as positive.

There are still some outstanding questions related to the European Green Bond standard, as well as to the practical usability of the EU Taxonomy, that must be answered in order to fully understand whether the label will be attractive for issuers or not. As the standard is dependent on the application of the EU Taxonomy, the usefulness and scope of the Taxonomy itself will be crucial for the ultimate attractiveness of the standard. Today, many sectors are struggling with interpreting and applying the Do No Significant Harm criteria for their activities, and in some cases also the Technical Screening Criteria. For companies required to make mandatory disclosures on EU Taxonomy alignment in their Annual Report, a best effort approach will be used in cases where there is no clear guidance. However, when using a voluntary standard, like the European Green Bond standard, issuers should be more careful when claiming alignment with the EU Taxonomy to avoid greenwashing accusations.

The 15% “flexibility pocket” will likely not be a decisive point for many industrial/manufacturing issuers, as the size of the pocket will generally not be enough for practical usage in many industries. It is rather the overall coverage of EU Taxonomy to certain sectors and activities that should first expand. This will put pressure on the next delegated act on the EU Taxonomy to i) ensure the remaining four environmental objectives expand the EU Taxonomy’s coverage in a more balanced manner across industries, and ii) broaden the scope of covered activities included for Climate Change Mitigation and Climate Change Adaptation activities.

At the same time, we have already seen cases where the commonly used definition of eligible activities for green bonds in the current market are more ambitious than the EU Taxonomy alignment criteria (e.g. for new buildings in Sweden). Meanwhile, in some other sectors, companies are struggling to meet any of the Technical Screening or Do No Significant Harm criteria. This also puts pressure on the EU Taxonomy to develop balanced criteria to make sure that the European Green Bond standard can be seen as the best-in-class standard while making it equally appealing to issuers from various sectors.

We expect sovereign issuers, as well as first-moving issuers in sectors with clearly defined and long-term definitions of EU Taxonomy alignment, to be the main groups to utilise the European Green Bond standard. For the remaining market, more clarity on the benefits of using the European Green Bond standard will have to materialise. As the benefits of using the European Green Bond Standard are not fully clear and the impacts of potentially losing “EU GBS” status include a degree of uncertainty, issuers may increasingly continue to choose a path of issuing green bonds under existing ICMA principles while communicating their EU Taxonomy alignment separately for each issuance.

While the proposed European Green Bond standard label aims to act as a “gold standard” that provides clarity and assurance to investors, it is investors who will ultimately lead the way in helping the European Green Bond label emerge as an attractive pursuit for issuers. Issuers are only likely to seek the proposed “gold standard” if the benefits from attaining the label are clear. Currently, despite some progress, the close ties to the still immature EU Taxonomy mean that the European Green Bond label is unlikely to provide enough additional certainty to investors for it to lead to the clear price or other measurable benefits that would be required to incentivise issuers to pursue the label.