Sustainable finance: provisional agreement reached on European green bonds

Sustainable finance refers to the process of taking environmental, social and governance (ESG) considerations into account when making investment decisions in the financial sector.

1. Historical background

In 2015, two important international agreements were concluded with the adoption of the UN 2030 agenda and sustainable development goals and the Paris climate agreement, setting out a global framework to avoid climate change.

The Paris climate agreement includes the commitment to align financial flows with a pathway towards low-carbon and climate-resilient development.

In 2018, the Commission presented an action plan on financing sustainable growth. The action plan set out a comprehensive strategy to further connect finance with sustainability.

This action plan includes ten key actions that can be divided into three categories and several sub-categories:

Reorienting capital flows towards a more sustainable economy

  • Establishing a clear and detailed EU taxonomy, a classification system for sustainable activities;
  • Creating an EU Green Bond Standard and labels for green financial products;
  • Fostering investment in sustainable projects;
  • Incorporating sustainability in financial advice;
  • Developing sustainability benchmarks;

Mainstreaming sustainability into risk management

  • Better integrating sustainability in ratings and market research;
  • Clarifying asset managers’ and institutional investors’ duties regarding sustainability;
  • Introducing a ‘green supporting factor’ in the EU prudential rules for banks and insurance companies;

Fostering transparency and long-termism

  • Strengthening sustainability disclosure and accounting rule-making;
  • Fostering sustainable corporate governance and attenuating short-termism in capital markets.

In May 2018, the Commission adopted a package of measures implementing several key actions announced in its action plan on sustainable finance.

The package includes a proposal for an EU taxonomy regulation, a proposal for a regulation on sustainability disclosures and on developing low-carbon benchmarks:

  • A proposal for a regulation on the establishment of a framework to facilitate sustainable investment. This regulation establishes the conditions and the framework to gradually create a unified classification system (‘taxonomy’) on what can be considered an environmentally sustainable economic activity;
  • A proposal for a regulation on disclosures relating to sustainable investments and sustainability risks. This regulation introduces disclosure obligations on how institutional investors and asset managers integrate environmental, social and governance (ESG) factors into their risk management processes;
  • A proposal for a regulation amending the benchmark regulation. The proposed amendment creates a new category of benchmarks comprising low-carbon and positive carbon impact benchmarks, which will provide investors with better information on the carbon footprint of their investments.

In addition, several amendments are made to delegated acts under the Markets in Financial Instruments Directive (MiFID II) and the Insurance Distribution Directive to include ESG considerations into the advice that investment firms and insurance distributors offer to individual clients.

With respect to EU green bonds, the European green deal (the European Union’s response to climate and environmental-related changes and challenges) of 11 December 2019 underlined the need to better direct financial and capital flows to green investments. The European green deal investment plan of 14 January 2020 announced that the Commission would establish an EU green bond standard (EUGBs).

2. European green bond standards

2.1. Context and reasons

According to the Communication for the Commission on sustainable Europe Investment Plan and European Green Deal Investment Plan, investor’s appetite for sustainable opportunities with measurable impact is on the rise.

The green bond market has seen exponential growth since 2007 with annual green bond issuance breaking through the USD half trillion mark for the first time in 2021, a 75% increase on 2020.

Green bonds therefore play an important role in financing the transition to a low-carbon economy, and can help to mobilize the capital needed to achieve climate and sustainability goals.

Indeed, significant investment is required across all sectors of the economy to transition to a climate-neutral economy. A substantial part of these financial flows will have to come from the private sector, hence the need to redirect private capital flows towards more environmentally sustainable investments.

However, there is currently no official green bond standards within the EU.

2.2. Proposal for a Regulation

2.2.1. Objectives of the proposal

In order to address this lack, a proposal for a Regulation of the European Parliament and the Council on European green bonds (EuGB Regulation) has been published.

Such proposal lays the foundation for a common framework of rules regarding the use of the designation “European green bond” or “EuGB” for bonds that pursue environmentally sustainable objectives as defined by the EU Taxonomy Regulation.

It also sets up a system for registering and supervising companies that act as external reviewers for green bonds aligned with the EuGB framework.

The aim of the EuGB Regulation is therefore to facilitate further developing of the European market for green bonds while minimising disruption to existing green bond markets.

The legislative proposal aims to better exploit the potential of the single market and to contribute to meeting the Union’s climate and environmental objectives in accordance with the Paris Agreement on climate change and the European Green Deal.

The EUGBs will set a ‘gold standard’ for how companies and public authorities can use green bonds to raise funds to finance investments, while meeting sustainability requirements and protecting investors from greenwashing.

The new EUGBs will be open to any issuer of green bonds, including issuers located outside of the EU.

There are four key requirements under the proposed framework:

  • The funds raised by the bond should be allocated fully to projects aligned with the EU Taxonomy;
  • There must be full transparency on how bond proceeds are allocated through detailed reporting requirements;
  • All EU green bonds must be checked by an external reviewer to ensure compliance with the Regulation and that funded projects are aligned with the Taxonomy;
  • External reviewers providing services to issuers of EU green bonds must be registered with and supervised by the European Securities Markets Authority. This will ensure the quality and reliability of their services and reviews to protect investors and ensure market integrity. Specific, limited flexibility is foreseen here for sovereign issuers.

Finally, the EuGB Regulation aims to reduce the risk of “greenwashing” by setting high standards for the issuance of green bonds.

2.2.2. Legislative train schedule

On 30 November 2021, a rapporteur appointed by the Committee on Economic and Monetary Affairs published a draft report on the Commission proposal.

On January 2022, amendments to the draft report have been tabled in the Committee on Economic and Monetary Affairs.

On 13 April 2022, the Council agreed on its position on the European Green Bond Standard.

The amended proposal seeks to better regulate the entire green bond market, rather than only establishing the European Green Bond label, and reduce “greenwashing”. For all bonds that are marketed as green, transparency requirements are introduced, including being aligned with the taxonomy legislation on the use of proceeds derived from the bond issuance. This would allow investors to compare EUGBs with other existing green bonds.

To avoid ‘brown’ companies (i.e. with highly polluting industries) using the EuGB label to pretend to be greener than they really are, the amended proposal requires that all EuGBs have verified transition plans. The text also ensures that all issuers of green bonds have processes in place to identify and limit the principal adverse impacts of their activity. Finally, it prohibits all issuers from countries that are on the EU’s grey or blacklist of tax havens from issuing EuGBs.

Besides, supervision is strengthened in various ways. External reviewers who review the EuGB should have fewer conflicts of interest and provisions are included to ensure that the authorities could ban companies from issuing EUGBs if they fail to follow the rules. The adopted text also ensures stronger market-pressure to comply with the rules by ensuring investors have legal recourse if the issuer’s failure to comply leads to the depreciation of a green bond.

On 16 May 2022, the Committee on Economic and Monetary Affairs decided to open interinstitutional negotiations.

Trilogue negotiations started on 12 July 2022 and ended with the provisional agreement reached late February.

2.3. Provisional agreement

On 28 February 2023, the European Union has taken further steps to implement its strategy on financing sustainable growth and the transition to a climate-neutral economy. Negotiators of the Council and the European Parliament reached a provisional agreement on the creation of European green bonds (EuGB).

Under the provisional agreement, all proceeds of EuGBs will need to be invested in economic activities that are aligned with the EU taxonomy, provided the sectors concerned are already covered by it.

For those sectors not yet covered by the EU taxonomy and for certain very specific activities there will be a flexibility pocket of 15%. This is to ensure the usability of the European green bond standard from the start of its existence.

The use and the need for this flexibility pocket will be re-evaluated as Europe’s transition towards climate neutrality progresses and with the ever increasing number of attractive and green investment opportunities that are expected to become available in the coming years.

As regards supervision, the national competent authorities of the home member state designated (in line with the Prospectus Regulation) shall supervise that issuers comply with their obligations under the new standard.

3. Next steps

The agreement is provisional as it needs to be confirmed by the Council and the European Parliament, and adopted by both institutions before it is final.

It will start applying 12 months after its entry into force.

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par Anders Noren.

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