Bond markets and the EU’s new Sustainability Strategy

EU taps third-party reviews to police GBS, eyes similar standards for transition and sustainability-linked bonds

Prospective bonds aligned to the new EU Green Bond Standard (EU GBS) will need to be approved by EU-registered external reviewers before they can be brought to market.

The requirement is a response to shortcomings in existing proprietary green bond frameworks, the EU said, which it noted: “can be costly and difficult for investors to determine the positive environmental impact of bond based investments”.

The draft EU GBS, released yesterday together with the EU’s renewed strategy on sustainable finance, is the final initiative to be tabled from the 2018 EU Action Plan. It seeks to provide a ‘gold standard’ for companies and public authorities to finance environmentally ambitious projects, while serving as a benchmark for other market standards.

Under the proposals, the European Securities and Markets Authority (ESMA) will be responsible for operating a centralised registration and supervisory regime for third-party reviewers that will service issuers of EU green bonds. Bond issuers will be required to obtain both pre- and post issuance assessments from an accredited reviewer. 

As with other EU Action Plan initiatives, the GBS is aligned with the EU Green Taxonomy, and requires proceeds raised by green bonds to be fully allocated to projects which meet the Taxonomy requirements. In contrast, a similar scheme operated by the Chinese government for ‘carbon neutral bonds’ allows up to 50% of proceeds to be allocated to working capital which has led to fears of greenwashing.

While the GBS is voluntary, national and EU supervisors will have the power to issue a maximum penalty of “twice the amount of the profits gained or losses avoided” in the event of irregularities or infringement by issuers of EU green bonds. 

Issuers will be required to explain how a prospective EU green bond aligns with their broader environmental strategy and the EU Green Taxonomy, in addition to regular use-of-proceeds reporting. Issuers will also need to submit an environmental impact report at least once during the lifetime of an EU green bond.

The success of the EU GBS is likely to be monitored closely by financial markets amid reports of a waning ‘greenium’- referring to the lower cost of capital enjoyed by green bond issuers – caused by demand volatility. In May, the Association for Financial Markets in Europe raised the alarm after finding that the greenium for Euro-denominated corporate green bonds had tightened “closer to virtually 0 bp (basis points) in April 2021”. 

Commenting on the GBS, European Commission Vice President, Valdis Dombrovskis, said that it would help to fight greenwashing and “recognise those bonds that truly represent a sustainable investment”, while EU Commissioner Mairead McGuinness described it as responding “to the needs of investors for a trusted, robust tool when investing sustainably”.

Despite the EU’s ambitions for the GBS, it has indicated that the standard will not apply to its own issue green bonds which will be used to fund 30% of the €750bn flagship EU Coronavirus recovery fund. In March, RI broke the news that the Commission was mulling an alternative ‘light touch’ approach for recovery financing after facing pressure from EU member states. 

Sean Kidney, CEO of bond standard-setter the Climate Bonds Initiative (CBI), described the potential move to RI as “madness”.

“It’s very unfortunate that the EU is considering issuing green bonds without reference to the incoming GBS. While it is true that the standard and the taxonomy will not be operational by the time the EU plans to start issuing green bonds in bulk, we believe there are workarounds, specifically by applying the Do No Significant Harm element on a best-efforts-basis over the transition period,” he said.

“Politically, it would be madness for the EU to issue green bonds which are not aligned to its own standards. It would be like one hand doing something without regard for the other hand. We will be putting our alternative solution to the EU shortly.”

Kidney, who was also a member of the expert advisory group which provided the initial recommendations for the GBS, was largely bullish on the finalised standard, saying “growing the green bond market will require a solid  regulatory regime, and that is what is being proposed”. 

CBI will be reviewing its flagship Climate Bonds Standard with a view to incorporate some elements of the GBS, he added. 

With the publication of the EU GBS, EU lawmakers and member states will have four months to veto the draft – extendable once by 2 months – after which it will enter into law.

Going forward, the GBS could become one of a number of new EU sustainability standards for fixed income products. Under the next phase of the EU’s Sustainable Finance Action Plan, the Commission has indicated that it will commence work on developing additional green labels, which will apply to categories such as transition or sustainability-linked bonds, by 2022.

The Commission said it will also “take action” to ensure that credit ratings and outlooks sufficiently account for ESG risks by Q1 2023. This will be subject to the findings of a study on how credit ratings are currently doing so, which will be conducted by ESMA.