‘Missing the forest for the trees’: Cicero’s Christa Clapp on a possible EU Green Bond Standard

Responsible Investor’s latest instalment of The EU Action Plan: What Matters To Me

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This is the first in RI’s ‘The EU Action Plan: What Matters To Me’ series, providing insights from market experts on the implications of the current EU Action Plan on Sustainable Finance. Today, Cicero’s Christa Clapp, who has been reviewing green bonds since the market started in 2007, shares her thoughts on the potential for an EU Green Bond Standard.

How can investment in green and sustainable activities be increased? The green bond market today is characterised by a limited supply of new issuances to meet growing investor demand. At the same time, there are various interpretations of the definition of green and sustainable projects even with the common practice of aligning bonds with the voluntary Green Bond Principles (GBP). A common language on green could help facilitate growth in the green bond market and guard against greenwashing.

Not only is this approach cumbersome, but it can also provide misleading incentives on green projects.

The EU Sustainable Finance Action Plan notes the key role that the financial sector can play in re-orienting investments towards more sustainable activities and contribute to the creation of a low-carbon climate resilient economy. As part of the Action Plan, the proposal for establishing a framework to facilitate sustainable investment is rooted in the development of a taxonomy classification to establish market clarity on ‘green’ and ‘sustainable’, which forms the basis for the Green Bond Standard.
On the surface, this approach seems supportive of further sustainable investment, but digging into the details reveals challenges for usability and potentially misleading signals that could limit the transition to a low carbon climate-resilient economy.

Missing the forest for the trees

The development of the taxonomy took root from the bottom-up, grounded in NACE codes. While this may be an effective way to analyse emissions across the economy, it does not provide a practical approach to green labelling. Mapping project categories currently used in the market with specific NACE codes, separately for mitigation and adaptation, is a cumbersome way to assess if a bond is financing green activities. Not only is this approach cumbersome, but it can also provide misleading incentives on green projects.

Separate silos for mitigation and adaptation do not support the best examples of low-carbon and climate-resilient infrastructure projects that are funded by proceeds in the green bond market today. Some of greenest buildings include energy efficiency targets, sustainable material use, emission reduction during the construction phase, and resiliency features like flood planning.But to comply with the Green Bond Standard, a green building project would only need to be reviewed against an energy efficiency threshold, and ‘do no harm’ for adaptation.
Issuers may choose the thresholds that are easiest to achieve, which could have unintended consequences. For example, in the draft taxonomy the threshold for energy efficiency in new building construction may be easier to achieve than the threshold for renovation of existing buildings. Encouraging new construction over renovation could be counterproductive in an environmental lifecycle perspective.

To facilitate increased investment in infrastructure that is both low-carbon and climate resilient, a more comprehensive approach that does not increase the burden for green issuers is needed.

Limiting the green transition

Determining compliance with the Green Bond Standard will increase the organisational burden for issuers and increase the cost of external reviews. For some sectors, compliance involves considering avoided emissions calculated from a baseline, where both the baseline methodology and the emission reductions methodology need to be well understood. For other sectors, this involves calculating an emissions factor that may not be calculated from some pure play issuers. And some green bond project categories may have aspects that fall across several different NACE codes, requiring multiple threshold analyses.

To solve the climate challenge, we need transformation to begin today in all sectors. Early actions that are careful to avoid locking in further greenhouse gas emissions are an important part of the solution. Binary thresholds in the taxonomy can rule out important early actions that need to be taken today, for example in efficiency improvements. Over time, some of these early steps can be deepened with good governance policies of the issuer.

A simpler approach to facilitate sustainable investment

Creating a simple and flexible common language for market clarity on green that supports increased sustainable finance flows while at the same time protects against green washing is possible. A more usable approach that encourages further sustainable financing could be built on the GBP with simple, flexible green criteria and exclusions to avoid locking-in fossil fuel use. A further focus on transparency and comparable impact reporting could keep external review costs relatively low. Such an enhanced version of the GBP at the EU level could then also be compatible with the GBP that are used to guide best practice in the global market today.

Christa Clapp is Research Director for Climate Finance at Norway-based research foundation Cicero, the Centre for International Climate and Environmental Research. She is also a Managing Partner at CICERO Shades of Green.