How could the European Commission’s (EC) proposed Green Bond Standard (GBS) help to lead the low-carbon transition of the global economy?
- The main aims of the EC Green Bond Standard include promoting capital flows into sustainable investments and combating the practice of ‘greenwashing’.
- There remains a degree of uncertainty about how the GBS will be measured or enforced, but some uncertainties are becoming more clear as the EC continues to disclose.
- The GBS will help reassure investors that green bonds are a viable long-term proposition.
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One of the most crucial components of the European Commission’s efforts to promote capital flows into sustainable investments is the development of a Green Bond Standard.
The instruments are one of the most crucial parts of the puzzle that could lead the global – or, at least, European – economy into a low-carbon transition, thanks to their explicit use to raise money for environmentally sound projects, such as green energy infrastructure or clean transport.
The growth of green bonds
The popularity of green bonds is growing around the world, with global issuances in H1 2021 reaching US$529.3bn, according to Refinitiv Deals Intelligence and the Climate Bonds Initiative (CBI).
The EU could become one the world’s largest issuers if its COVID-19 recovery fund – which totals €750bn, 30 percent of which is targeted for climate projects – goes ahead. S&P Global has predicted that if financed via green bonds, the EU would boost the size of the global market by 89 percent.
But the issue of “greenwashing” – over-selling the green credentials of a planned project in order to gain the preferable terms of green bond borrowing – still persists without a universal green bond standard, which the European Commission hopes to create.
In June 2019, a technical expert group (TEG) recommended that the creation of an EU-wide GBS would enhance the “effectiveness, transparency, comparability and credibility of the green bond market” and hopefully go some way to prevent green projects from being mislabelled.
What might the EU Green Bond Standard look like?
In March 2020, the TEG published its final report into what the GBS may look like.
The standards are largely centred on four prongs of attack.
First, the GBS aligns the economic activities that a bond enables with the EU’s green taxonomy project, so projects will be required to contribute towards one of the EU’s six environmental objectives, to not harm those same goals, and to comply with safeguards and screening criteria.
Then, as many bond issuers will already be familiar with, come three more requirements:
- to provide a framework illustrating how proceeds will be deployed and managed
- to publish impact and allocation disclosures on an annual basis
- to have these disclosures verified by a third party.
The GBS also hones in on a “use-of-proceeds” approach focusing on proper impact reporting, in a bid to produce predictable (and green) outcomes from projects, and to allow any company to issue green bonds so long as they are financing appropriate projects.
Investors and market participants had until the beginning of October 2020 to share their thoughts on the creation of this standard, alongside a parallel targeted consultation running with some market makers.
The legislative proposal was announced in Q2 2021 with few of the exact details of the GBS yet to be hammered out.
In the meantime – as with the EU’s green taxonomy – asset managers are required to demonstrate their alignment with the standards by 1 January 2022, with issuers to follow step by the end of 2022. Many bond issuers are already piloting alignment exercises to ensure that they can provide the necessary documentation by next year’s deadline.
The European Securities and Markets Authority (ESMA) has argued for any third-party verifiers of green bond standards to be supervised at a European level, much like debt ratings agencies already are.
In addition – because the GBS is voluntary, rather than legally binding – issuers will not be required to cite compliance with the EU’s framework, and could opt for principles outlined by trade body ICMA, or a planned GBS developed by the International Organization for Standardization.
What will be the impact on investors?
Hiro Mizuno, the former chief investment officer at Japan’s Government Pension Investment Fund, was among the voices to urge caution about the popularity of green bonds.
He argues that they are “costly and complicated and cumbersome” for issuers to arrange and for investors they often do not make sense as a proposition. He added, “there’s still a risk that the green bond will remain a passing fad”, if the problem of greenwashing cannot be addressed.
For investors to be completely at ease, the GBS may go some of the way to addressing those concerns. In the meantime, a careful assessment of potential bond investments is possible using the industry-leading standards that have been developed, such as the CBI’s framework.
As previously mentioned, many issuers are already starting their alignment exercises to meet their 31 December 2022 deadline, and may provide some crucial insights as to how to implement the GBS.
