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Sustainable finance

What are green bonds? And why does Europe need its own green bond standard?

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By Axel Fougner

With the European green deal, the EU embarked on a transformation. The aim is to become a climate-neutral economy, setting an example for the rest of the world to follow. However, this cannot be a success without substantial investment across all sectors of the economy. This has implications for both financial markets and investors. Significant amounts of public and private money must be redirected towards green investments in order for this transformation to happen. The good news is that investors are ready and willing to play their part. One of the clearest signs of this is in the booming market demand for green bonds, which has expanded to five times its former size over the last five years. In this context, the European Commission adopted a Regulation proposal for European Green Bonds on 6 July 2021. So, what are green bonds? And why does Europe need a green bond standard?

Green bonds

Green bonds are a tool to raise financing for large-scale climate-related investments such as energy-efficiency measures, renewable energy production and distribution, zero-carbon transportation, and more. These bonds are increasingly popular with sustainability-minded investors, mainly because they provide transparency on how the company selling the bond will make use of the funds raised. 

So, if an investor wants to support projects that contribute to tackling climate change, how should they go about it? For instance, how do they identify which investment opportunities are in line with the goals laid out in the Paris Agreement? How do they know that the organisation or company they are investing in will stick to their green commitments? This is where the Commission’s recent proposal for a European green bond standard comes in.

A new standard

Today, the EU leads the green bond market, with 51% of global issuance in 2020. On top of that, the euro is the most popular currency for green bonds, with 49% of global issuance denominated in euro. In this context, the European green bond standard (EU GBS) will be an opportunity for Europe to keep raising its game and further develop sustainable finance. Furthermore, providing a trusted regulated environment for green bonds will help to promote the international role of the euro and strengthen Europe’s leadership in this area.

Based on its close alignment with the EU taxonomy and its strong focus on market integrity and investor protection, the European green bond standard will set a new benchmark for green bonds.  With this standard, the Commission wants to position Europe firmly as the world leader on green bonds, while setting the stage for continued growth in this market based on high environmental ambitions and the protection of investors.

The standard was developed using recommendations by experts from the financial sector, environmental NGOs, green bond issuers, and representatives of existing green bond standard-setting bodies.  According to the Commission’s proposal, the new European green bond standard will be a voluntary standard open to any bond issuer, including those located outside of the EU. It is based on four key requirements: 

  1. First, the funds raised by the bond should be allocated fully and exclusively to projects that are aligned with the EU taxonomy. So, when an investor buys a European green bond, they know the funds will be allocated according to strict sustainability requirements.
  2. Second, there are disclosure requirements to ensure full transparency on how issuers allocate the money raised by the bond, and the environmental impact of that money.
  3. Third, all European green bonds must be checked by an external reviewer. This company will check that the issuer is complying with the requirements of the standard, and in particular the taxonomy-alignment of the funded projects. Analysis by the Joint Research Centre shows that bonds subject to external review are likely to attract higher demand from investors.
  4. Finally, external reviewers providing services to issuers of European green bonds must be registered with and supervised by the European Securities and Markets Authority (ESMA). This will ensure the quality of their services and the reliability of their reviews to protect investors and ensure market integrity. At the same time, this will provide some standardisation of external review practices for green bonds, which could hopefully help both issuers and investors to better navigate the landscape of external review services.

If issuers make use of the standard, they will be giving investors the assurance they need that their investments are making a real contribution to the environment, and allow them to better identify that contribution. For issuers of green bonds, the standard will provide a robust tool to demonstrate their environmental commitment and their contribution to reaching the Paris Agreement targets. 

Read more on the European green bond standard

Axel Fougner is a policy expert at the European Commission