The European Commission this summer released its proposed voluntary standard for European green bonds. Now the European Central Bank argues that the standard should be made mandatory. Nordea’s Sustainable Finance Advisory team takes a closer look at the ECB’s view on risks, benefits and practical implementation.
Key ECB recommendations on the potential implementation of mandatory regulation:
- The implications of setting firm timelines are not clear; further clarity on the treatment of previously issued green bonds would be beneficial.
- A “balanced approach” to regulation shift is recommended in order to mitigate potential disruptions to the existing green bond market.
- Although three to five years appears to be a reasonable time period, further fine-tuning is recommended.
- In the meantime, voluntary adoption of the EuGBS should be encouraged.
In July 2021, the European Commission proposed a European Green Bond Standard (EuGBS), which has the potential to become the new “gold standard” for green bonds, while increasing convergence internationally. The proposed EuGBS requires supervision of external reviews, to be carried out by the European Securities Markets Authority (ESMA), and for the use of proceeds to be fully taxonomy aligned.
In a public opinion response to the European Parliament this November, the European Central Bank (ECB) has recommended that the new European Green Bond Standard “should become mandatory for newly issued green bonds within a reasonable time period” in order to further enhance market functioning, foster financial stability and strengthen the green credibility and reliability of the EU green bond market. The green bond market represents a highly visible segment that is rapidly growing, paving the way for significant appetite for high-transparency green bonds.
Article 3 in the Taxonomy regulation describes the ‘Taxonomy requirements’ and activities defined as sustainable must:
- Environmental objectives contribution set out by Article 9 (one, or several)
- Principle of “not significantly harm of environmental objectives”
- Compliance with social safeguards activities
- Compliance with the Commission’s technical screening criteria
Taxonomy alignment: significant benefits but unmitigated risks remain
In setting the requirements for EuGBs, the proposed new regulations take the perspective of bond issuers from both the public and private sectors. Use of proceeds under the new regulations should be related to economic activities that currently meet taxonomy requirements, or will do so within a defined period of time up to ten years from issuance.
The ECB supports the promotion of all EuGBs as fully taxonomy-aligned, citing increased transparency as one of the central benefits. Although the guarantee of taxonomy-alignment without the need for a dedicated assessment of underlying investments helps both issuers and investors at initiation, longer-term compliance and potential “greenwashing” risks remain.
While the proposed regulation does currently require progress on taxonomy alignment plans to be detailed in yearly progress reports, it lacks sufficient teeth to effectively sanction non-compliance over time. In particular, the ECB has flagged the absence of a procedure for withdrawing an EuGB “label” from a bond that does not fulfil the requirements of taxonomy-alignment.
While this is a legitimate risk, we do not view it as a barrier to widespread use of the EuGB standard as the transparency requirements, when applied appropriately, are likely to result in any non-compliance being reflected in the price of the associated bond.
The ECB has flagged the absence of a procedure for withdrawing an EuGB “label” from a bond that does not fulfil the requirements of taxonomy-alignment.
Implications for the established green bond market
In its opinion statement, the ECB contends that the current green bond market suffers from some shortcomings, specifically a lack of sufficient standardisation and common definitions relating to underlying green projects. The absence of common reporting frameworks could reduce the economic attractiveness of green bond instruments and increase transaction costs compared to conventional financing tools. As such, the ECB welcomes ESMA to supervise external reviewers of European green bonds at the EU level, as proposed.
The scope of the proposed regulation is voluntary, which implies that existing standards for the industry regarding green bonds are still applicable. The ECB views it as “necessary” that outstanding bonds continue to maintain their “green bond” designation. At present, industry standards for the green bond market refer to the International Capital Markets Association’s (ICMA) Green Bond Principles.
It is likely that significant efforts will be made to preserve the integrity and reputation of existing standards and the green bond market as a whole, with the grandfathering in of previously labelled “green bonds” an open possibility.
Timelines for mandatory alignment remain tentative
In order to mitigate potential sudden divestments from non-taxonomy-aligned green bonds and green bond issuance, the ECB emphasises a “balanced approach” in the short-term. The ECB recognises that setting a concrete timeline for when the new proposition should become mandatory is not straightforward. The risks associated with a potential regulation shift, principally market volatility and disruptions, must first be considered.
The ECB initially suggests three to five years as a reasonable time period for the EuGBS to become mandatory for newly issued green bonds, with transition periods to be fine-tuned following a proposed impact analysis.
As seen in the practical implementation of other mechanisms aimed at increasing transparency and best practice relating to sustainability impacts, voluntary adoption of the new standard is both expected and encouraged well ahead of any mandatory requirements.
David Ray, Sustainable Finance Advisory, Nordea
Lea Gamsjäger, Sustainable Finance Advisory, Nordea
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