Sustainable finance
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Sustainable financedate: 31/03/2023
By Axel Fougner
On 28 February 2023, the European Parliament and the Council reached a political agreement on the European Commission's proposal for a European Green Bond Regulation. The regulation, which is an integral part of the EU Green Deal, will create a high-quality, voluntary EU standard that issuers can make use of, either instead of or on top of existing market standards. The ‘European Green Bonds Standard’ will enable investors to orient their investments more easily towards more sustainable technologies and businesses.
Climate-conscious investors
A green bond is a type of bond where the issuing entity – usually a large company or a public institution – commits to using the money raised to support green investments. These bonds give climate-conscious investors an effective way to direct their money towards such investments, while allowing issuers to draw public attention to their sustainability transition.
Given their usefulness for both issuers and investors, it’s not surprising that green bonds are growing in popularity, with cumulative worldwide issuance recently reaching €2 trillion. This is good news, as there is a pressing need for the type of large-scale sustainable investments that such bonds support, such as investments in renewable energy, energy efficient buildings, and zero-carbon transportation, to name but a few.
The current market for green bonds is built on market-based principles and standards. While these mechanisms have provided flexibility for issuers, they have been less successful at harmonising the definitions of green activities and the procedures for providing third-party external review of the green bond. The current situation can lead to additional costs for investors looking for certainty about the green credentials of the bond, but also for issuers wishing to prove the sustainability of their chosen approach to green bond issuance. Given the growing importance that investors attach to sustainability in today’s financial markets, this lack of harmonisation needs to be improved.
This is why, with its legislative proposal in July 2021, the European Commission set out to create a European green bond standard. This standard, which is intended as a gold standard in the green bond market, makes use of the criteria for environmentally sustainable economic activities known as the EU Taxonomy.
Main requirements
The political deal that was reached on 28 February sets out the main requirements for an issuer to be able to use the new standard and call their bond a European Green Bond:
- First of all, most of the funds (85%) raised by the bond must be allocated to projects that are aligned with the criteria of the EU Taxonomy. This way, when an investor buys a European green bond, they will know those funds will be allocated according to strict sustainability requirements.
- Second, there are disclosure requirements to ensure full transparency on how issuers allocate the money raised by the bond, in line with market best practice.
- Third, all European green bonds must be checked by an external reviewer that is registered and supervised by the European Securities Markets Authority (ESMA). External reviewers will check that the issuer is complying with the requirements of the regulation, and in particular the Taxonomy-alignment of the funded projects. The supervision by ESMA will ensure the quality of their services and the reliability of their reviews, to protect investors and ensure market integrity.
In addition to creating a standard, the European Green Bond Regulation will also call for the publication of freely available EU templates for issuers of other bonds with environmental objectives, even if they do not make use of the standard. The use of these templates would be strictly voluntary. The standard and the disclosure templates will be available to use 12 months after the regulation enters into force.
Not all green bonds will be issued using the European Green Bond Standard, not even in Europe. But this standard is intended to set an example for the market to follow, based on high environmental ambitions and the protection of investors. With it, the Commission wants to position Europe firmly as the world leader on green bonds, while setting the stage for continued growth in this market.
Read more on the European Green Bond Standard
Axel Fougner is a policy officer at the European Commission