The main feature of green bonds is the intention or the commitment to invest the net proceeds of the issue in green projects. Up to date, there is no binding legal framework and therefore no legal definition of green bonds. Nevertheless, voluntary standards have been broadly complied with and provided a basis for the development of the green bond market over the last years.
Voluntary standards inter alia include the International Capital Market Association's (ICMA) Green Bond Principles, which is the preferred standard seen in the market, and the Climate Bonds Initiative's Climate Bonds Standard. On top, issuers do already consider upcoming standards by the European Union. The latter include the proposals of the EU Green Bond Standard and the EU Taxonomy.
ICMA's Green Bond Principles
ICMA's Green Bond Principles are internationally recognized, voluntary guidelines comprising four core components for alignment with the Green Bond Principles:
- Use of Proceeds: the main element of a green bond is the utilization of the net proceeds for eligible green projects from a variety of defined categories, e.g. renewable energy, energy efficiency, clean transport or green buildings;
- Process for project evaluation and selection: Issuers should clearly communicate to investors (i) the environmental sustainability objectives of the green projects and (ii) the process for determining how the projects fit within the eligible green project categories as well as (iii) the method for identifying and managing perceived social and environmental risks associated with the projects;
- Management of proceeds: Monitoring the use of proceeds is essential for being able to check periodically, if necessary, whether the balance of the tracked net proceeds matches the allocations to eligible green projects;
- Reporting: Issuers should report annually the projects to which green bond proceeds have been allocated as well as report the impact the projects have on the environment.
ICMA also recommends establishing a so-called Green Bond Framework, which explains the alignment of the issuer's green bonds with the four core components and summarizes relevant information within the context of the issuer's overarching sustainability strategy. Appointing an independent external reviewer to confirm the alignment of the green bonds with the Green Bond Principles, a so called "Second Party Opinion", is best practice.
The European Green Bond Standard
It is still open whether a mandatory legal framework for green bonds will be enacted by the EU. But labelling a bond as a "environmentally sustainable" or as a "sustainability-linked bond" will most likely trigger additional disclosure requirements for issuers in the future. The level of detail and associated measures will depend on the legislative outcome of the envisaged regulation for European green bonds by creating a so-called European Green Bond Standard (EUGBS).
As part of the European Union's Sustainable Finance Strategy, in July 2021 the European Commission adopted a legislative proposal, which provides for the EUGBS as a voluntary "gold standard" for green bonds. According to the Commission issuers will have a robust tool to demonstrate that they are funding legitimate green projects aligned with the EU Taxonomy. And investors in the bonds will be in an enhanced position for assessing, comparing and trusting that their investments are sustainable, thereby reducing the risk of being exposed to greenwashing.
The EUGBS will use the detailed definitions of green economic activities in the EU Taxonomy Regulation (Regulation (EU) 2020/852) to define what is considered a green investment.
In April 2022, the European Council adopted its position and, in May 2022, the European Parliament’s Committee on Economic and Monetary Affairs published its report on the Commission’s proposal and suggested several quite substantive amendments. In a next step, the European Commission, the European Council and the European Parliament will be entering the trilogue discussions. It remains to be seen which elements of the Commission's proposal or the Committees amendments will finally be enacted.
Key features of the EUGBS
Compared to the Green Bond Principles, the European Commission (EC) aims to provide issuers and investors with a more extensive and uniform regulatory framework based on the EU Taxonomy.
According to the EC's proposal, it will be a voluntary standard setting out uniform requirements for any bond issuers wishing to call their bond a "European green bond" or being in alignment with the EUGBS. However, the amended proposal of the European Parliament’s Committee on Economic and Monetary Affairs suggests that all issuers of bonds marketed as environmentally sustainable or sustainability-linked bonds in the EU should adhere to certain minimum disclosure requirements.
Another key concept is the need to allocate the proceeds raised by a green bond to economic activities that meet the EU Taxonomy requirements. Proceeds are to be used for projects that make a significant contribution to at least one of the environmental goals identified in the EU Taxonomy Regulation, must not harm any of the other environmental goals, have to comply with minimum safeguards laid down in the EU Taxonomy Regulation and with technical screening criteria that have been established by the EC.
Publishing a so-called European Green Bond Factsheet is another key concept reflected in the EC's proposal. It includes information how the allocation of the proceeds of the bonds aligns with the environmental strategy of the issuer and a statement showing that the issuer voluntarily adheres to the requirements of the regulation. Further, the issuer has to provide information on the intended allocation of proceeds including a description of the process how it will select green projects. European green bond factsheets have to be subject to a pre-issuance review by an external reviewer.
If a prospectus is to be published pursuant to the EU Prospectus Regulation (Regulation (EU) 2017/1129), the prospectus or the final terms for a specific issue shall outline information on the use of proceeds and that the European Green Bond is issued according to the EUGBS. The European green bond factsheet shall also be part of the prospectus.
Annual allocation reports will need to be published until the full allocation of the proceeds of the bond. Regarding the environmental impact of the use of proceeds on an aggregated basis, issuers will also need to draw up an impact report.
Even though the Austrian green bond market is still significantly smaller than the market for non-green issuances, several issuers like UNIQA, HYPO NOE, VERBUND or the Republic of Austria have taken first steps towards the trending asset class.
In a challenging market environment following the Russian invasion of Ukraine, the development of a European green bond standard could be slowed down. This important element of the EU's intention to support the development of green bonds has marginally slipped out of the focus of investors. On the one hand, green bonds have already become a relevant investment class and are playing an increasingly important role in financing assets needed for low-carbon transition. On the other hand, recent negative trends on capital markets have also affected the marketability of instruments, including green bonds. As with other bonds, fewer green bond offerings were conducted. For now, the green trend has faced an unexpected slow down, given also the focus on securing energy supply irrespective of a green cause. That being said, the political developments will most likely boost the mid- and long-term pace for energy transition in Europe. Green bonds will play an important part in financing such transition.
Vienna ESG market segment
In May 2022, and even in absence of an Austrian green bond standard or clear market trend, the Vienna Stock Exchange introduced a new Vienna ESG Segment. The admission criteria is based on the ICMA principles. In addition, the Vienna Stock Exchange requires an external review (second-party opinion/verification/certification/rating) together with a letter of commitment from the issuer upon application. The first green bond listed in this new segment was issued by the Republic of Austria.
Conclusion and Outlook
We expect that the EUGBS will follow the same path as existing market standards such as ICMA's Green Bond Principles. Based on the EC's proposal for the EUGBS, a voluntary applicability of the EUGBS for using the EU Green Bond designation is likely to be enacted. It goes without saying that allocation of proceeds is and will remain a key element of green bonds and their attractiveness for green investors.
Labelling a bond as a "sustainable bond", as a "sustainability-linked bond" or as "environmentally sustainable" may trigger additional disclosure requirements for issuers in the future. Relevant changes are expected to be implemented in the EU Prospectus Regulation framework, thereby setting new standards in terms of ESG disclosure.
Codifying a European standard for green bonds will be a relevant tool for increasing transparency in relation to a product class which has seen numerous individual configurations in recent years, not only in Austria. At present, investors cannot compare the different types of instruments in a meaningful way due to the diverse levels of disclosure and presentation. Whether the EUGBS will in fact be the green market standard in Europe and/or Austria is difficult to assess, as the green finance market is still in its growth phase. In the current political environment, the legislative proposals, which exclude the financing of gas and nuclear power generation, may not accurately reflect the current short-term sentiment and the pressure to secure the European gas and power supply. But, ultimately, it will be the investors deciding on the success of the green bond story. We expect that the trend towards green will see an upswing and, in some years, non-green issuances will reflect the minority of deals.