EU sustainable finance and the green bond standard

EU sustainable finance and the green bond standard

Introduction

The European Green Deal (EUGD) launched in 2020 strives to make Europe the first climate-neutral continent by 2050. As a consequence, the European Commission (EC) has adopted proposals which make the policies regulating climate, energy, transport and taxation fit to reduce net greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels.

The goals set out in the Green Deal come at a cost as well. As a consequence, the European Green Deal Investment Plan came to life, also known as the Sustainable Europe Investment Plan. The goal of the Plan is to mobilize at least 1 trillion euros of private and public sustainable investments made through the current decade (2020-2030) to help transition to a climate-neutral, environmentally friendly economy.

Because of the EU’s ‘no one left behind’ tactic, the Plan includes a Just Transition Mechanism which is supposed to provide at least 100 billion euros of investments in the 2021-2027 period to help regions most affected by the green transition. Another important aspect of the plan is setting a green bond standard at the European level.

So then what is a bond, what is a green bond, why does it need to be standardized and why does it matter?

What is a bond and what is a green bond?

A bond is type of loan made by an investor to a borrower, where the borrower agrees to pay back the ‘debt’ with an extra agreed upon amount. On top of that, the borrower can also agree to pay a certain interest rate every year until the bond reaches ‘maturity’ – the due date of the loan repayment. These types of loans are usually taken out to fund projects and operations and can also be traded before their maturity.
The difference between a regular bond and a green bond is that green bonds are exclusively used for sustainable purposes, such as energy transition.

Why do we need a Green Bond Standard in the EU?

The market for green bonds is growing at a rapid rate, so it attracts more investors. With great power comes great responsibility, meaning the green bonds market is facing some challenges, which is where the Standard comes into play.

As a starting point, the EU Green Bonds Standard is meant to establish clear and consistent criteria on what could be categorized as a ‘green’ project or target. This way, with transparent criteria, greenwashing can be avoided and the confidence of investors in the market increases because having a standard against which projects are evaluated boosts credibility. Further, the Standard aims to increase transparency as to the environmental benefits of the bonds, meaning that the borrower will have to provide complete and reliable information, allowing investors to make an informed decision. Harmonising green bonds provides a more cohesive and easier to manage and navigate market, can facilitate market growth by attracting more issuers, and helps keep track of whether the green bonds help achieve the broader sustainability goals of the EU.

Earlier this year, the final text of the EU Green Bond Standard regulation was agreed between the European Parliament and the European Council and is expected to enter into force in the second half of 2024 or early 2025. According to this provisional agreement, 85% of the proceeds from a green bond must be invested in economic activities that comply with the EU Taxonomy Regulation (a regulation that serves as a classification framework and determines which economic activities are environmentally friendly, based on reports on six environmental goals). The remaining 15% is known as the 'flexibility buffer', which means that some revenues from the green bond can be used for economic activities that contribute to the EU's environmental objectives but are not yet included in the Taxonomy Regulation.

The relation between the two pieces of legislation is a bit tricky, especially since the EU legislative bodies (Parliament, Council and Commission) agreed to label as ‘green’ some fossil gases and nuclear energy sources as long as they meet a certain CO2 emission threshold, therefore including them in the Taxonomy Regulation as ‘transitional’ resources. Transitional resources are resources considered, in this case, less polluting than traditional resources and which are relied upon while the EU is making the transition to climate neutrality. ClientEarth, the WWF European Policy Office, Friends of the Earth Germany and Transport & Environment all filed a case in the Court of Justice of the European Union against the Commission’s decision to label the resources as ‘green’ back in April of 2023.

Conclusion

Many question the EU’s ambitious goal of reaching climate neutrality by 2050, but the legislative measures implemented for this goal also influence private investments by individuals like you and I. Requiring companies, businesses, governments and other actors to be transparent and truthful about the actual impact of projects has a positive impact in the long run because it eliminates greenwashing and builds trust. This way, it is also easier for beginner investors to decide which sustainable funds they want to invest in. If you would like to know more information about the green bond standard, then listen to episode 9 of the EU Finance Podcast – The one about the European Green Bond Standard.