15 February 2022

Jacques Delors Centre: Turning green into gold - How to make the European green bond standard fit for purpose

Green bonds can play an important role when it comes to financing a more sustainable European economy. However, lack of transparency in today’s market for them prevents green bonds from achieving their full potential.

To establish the EuGBS as the new gold standard, the European Parliament and EU Council should improve it in three respects. They should (i) strengthen its environmental credentials, (ii) regulate the entire green bond market and not just the EuGBS niche, and (iii) ensure the enforceability of investor rights. That way, a credible EU public standard can become the new benchmark on financial markets and make a positive impact on the environment.

The market for green bonds is growing at breathtaking pace. In 2021, banks for the first time earned more fees arranging green-related bond sales and loans than they did helping fossil-fuel companies raise money in the debt markets. Green bonds work like conventional bonds, but the money raised from investors is used exclusively to finance projects that make a positive environmental – aka ‘green’ – contribution, such as in renewable energy or energy-efficient buildings. More and more companies and sovereigns want to reap the reputational and financial benefits associated with the issuance of green bonds. Since demand has been outstripping supply, they trade at a premium compared to regular bonds – it is cheaper for companies to issue green bonds. This is good news as green bonds are meant to finance a substantial part of the transition towards a more sustainable European economy. Yet, there remains a problem in clearly measuring and comparing the contribution of green bonds towards improving the environment.

To date, the green bond market is entirely based on privately developed labels. They set out high-level guidelines or give process-based recommendations, but the underlying definitions of green projects lack standardisation and enforceability. Standards also vary regarding the information provided on the use of proceeds, making it impossible for investors to compare the environmental performance of different green bonds. As they cannot be certain that their money is being used for legitimately green investment purposes, greenwashing is now the biggest challenge for investors. But this uncertainty about which economic activities can be rated green also creates difficulties for green bond issuers who are keen to avoid any accusation of greenwashing, especially in transitional sectors. Altogether, this opacity is preventing green bonds from growing to their full potential and creates the serious risk that large sums of private money is financing projects that do little or nothing for the green transition. The lack of high-quality green bonds is thus a drag on Europe’s plan to become the world’s first climate neutral region.

To shed light on the true ‘greenness’ of green bonds and foster investor confidence, the Commission proposed a European green bond standard (EuGBS) in July 2021. At the time of writing, the European Parliament and EU Council are debating the draft legal text and potential amendments. The Commission proposal is supposed to help investors identify, compare and trust in environmentally sustainable bonds and it does indeed raise the bar for green bond issuances. However, this paper argues that the proposal will fall short of establishing the new gold standard for several reasons. It has weak environmental credentials and therefore undermines its own credibility. It misses out on raising environmental ambitions for the entire green bond market by leaving untouched private labels that remain unregulated. And it is poor on creditor rights protection regarding the ‘greenness’ of how proceeds are used.

To establish the EuGBS as the new gold standard, EU member states and MEPs should improve the Commission proposal in three respects. First, the EuGBS should be split into two labels to allow for the introduction of a truly green “EuGBS+” that excludes not only nuclear power and natural gas investment, but any transitional activity. Second, the legislation should require all green bond issuers to provide comparable information on the ‘greenness’ of their use of the proceeds before the EuGBS becomes the mandatory standard over the medium term. Third, the EuGBS should come with an effective enforcement mechanism relying on national authorities and a minimum of actionable rights. A credible EU public standard could then become the new benchmark on financial markets and ensure that green bonds genuinely contribute to greening the European economy.

Jacques Delors Centre

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