THE EU Green Bond Standard

Green bonds constitute one of the most important sources of funds for the transition to a low carbon society, bringing about substantial reallocation of resources within the economy. In 2021, the global volume of outstanding green bonds amounted to more than USD 1.2 trillion, highlighting a shift from a niche financial asset to an asset class that financial market participants can no longer ignore. Nonetheless, considering that the overall market size of the global bond market is estimated to be at USD 128 trillion1, the market for green bonds still offers significant growth potential.

Currently the bond market lacks a common framework that defines what constitutes a green bond, which hinders further growth. The principles of the International Capital Markets Association (ICMA) or the Climate Bonds Initiative provide some guidance on what characteristics bond issues should fulfil in this area, but they remain voluntary and do not make use of a uniform definition for environmentally sustainable economic activities.

What is the main difference between Conventional and a Green bond?

The ICMA defines green bonds in the Green Bond Principles as “any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible Green Projects.

Therefore, the key differentiator between a conventional and a green bond issue is the exclusive use of proceeds for investments in green projects, which needs to be laid down in the legal documentation of the issue. Besides that, green bonds are structured in the same way as a conventional issue by an entity and are thus exposed to the same level of credit risk.

How did the market for the Green bonds develop?

In 2007, the European Investment Bank (EIB) laid the foundation for the green bond market by issuing a Climate Awareness Bond, with the proceeds earmarked for projects in the fields of renewable energy and energy efficiency. Since then, the market has seen significant growth, facilitated by the emergence of frameworks providing guidance for the issuance of green bonds, but also by an increasing investor demand. With the publication of the first iteration of the Green Bond Principles in 2014, the ICMA established a market consensus for the issuance of green bonds, providing guidance on the use of proceeds, project selection, management of proceeds and transparency. Besides the Green Bond.

Principles, the ICMA today also offers voluntary guidelines for social, sustainability and sustainability-linked bonds, and thus constitutes a major facilitator for the progressive integration of sustainability considerations in the bond market.

Why is an EU Green bond Standard needed?

The absence of a common definition of environmentally sustainable activities among market-based frameworks, such as the principles provided by the ICMA or the Climate Bonds Initiative, creates uncertainty among investors regarding potential greenwashing and associated reputational risks. By using the EU Taxonomy10 as a reference, the EU GBS resolves this issue and supports issuers of green bonds to credibly demonstrate their sustainability claims. Moreover, the current fragmentation of the green bond market creates additional confusion among investors, limiting the funds invested. Thus, if the EU GBS becomes the gold standard for green bonds in the EU, this will certainly facilitate future growth.

Which investment criteria must a European Green Bond fulfil?

The designation as European green bond or EuGB is voluntary, meaning that only those issuers willing to label their issue as EuGB must comply with the requirements laid down in the EU GBS. Most importantly, the use of proceeds must relate to economic activities aligned with the EU Taxonomy or activities that will be aligned with the Taxonomy within five years from bond issuance, unless the specific features of the activity justify a prolonged period of up to ten years.

What are the transparency requirements of the EU GBS?

Prior to issuing a European green bond, issuers must submit the so-called EuGB factsheet, which, inter alia, includes information on the intended allocation of bond proceeds, the process for selecting green projects and their estimated environmental impact. Importantly, the factsheet must be verified by an external reviewer.

In addition, issuers must prepare an annual allocation report until the EuGB proceeds are fully allocated, demonstrating that funds have been invested in accordance with the requirements of the EU GBS. Once the proceeds have been fully allocated, a certified third-party must conduct a review, assessing whether the issuer has allocated proceeds in accordance with the EU GBS and whether the issuer has complied with the intended.

use of the proceeds as set out in the previously described green bond factsheet. Finally, issuers must report on the environmental impact of the use of proceeds after the proceeds have been fully allocated and at least once during the life of the bond.

What are the requirements for external reviewers of European Green Bonds?

The EU GBS foresee that all bonds issued under the designation as EuGB or European green bond need to be checked by an external reviewer in order to ensure compliance with the regulation and Taxonomy-alignment of the investment project.

External reviewers for European green bonds must be registered with the European Securities and Markets Authority (ESMA) and meet certain qualification requirements, relating to the expertise of senior management, but also to the experience and training of analysts. Most importantly, external reviewers must have control mechanisms in place to ensure that the assessment performed is independent and accurate, eliminating actual or potential conflicts of interest.

The supervision of reviewers by ESMA will certainly increase the credibility of the EuGB label, and thus further contribute to the attractiveness of the label for investors and issuers.

Conclusion: The integration of the EU GBS into the EU sustainable finance framework will certainly be beneficial for the green bond market within the EU. The multitude of frameworks currently used in the green bond market creates confusion for investors, but also among issuers, as it becomes increasingly difficult to determine whether an activity can be considered environmentally sustainable. Aligning the EU GBS with the Taxonomy will improve the understanding of what constitutes a sustainable project underlying a European green bond.

As a result, the regulation will help direct capital flows to environmentally sustainable investment projects, supporting the transition to a net-zero carbon economy as envisaged by the EU and further advancing the market for sustainable financial products within the EU.