The European Green Bond Standard: a future gold standard for green bond issuance?
On 6 July 2021, the European Commission unveiled its Proposal for a Regulation on the European Green Bond Standard (EU GBS). Most of its requirements follow market practices. To bring more discipline, the Commission’s Proposal includes two distinct features that could bring further stringency and integrity on the green bond market. First, under this Standard, issuers would have to allocate 100% of the proceeds to economic activities aligned with the European green taxonomy requirements (technical screening criteria, DNSH , social minimum safeguards). Second, a new supervisory regime would be created for external reviewers to ensure that issuers using the Standard are following the Regulation requirements. It is noteworthy that the EU GBS proposal includes its use as voluntary. However, the ECB called to make it compulsory within three to five years .
At this stage, the EU GBS is still a Proposal and must be adopted by the Commission, the European Parliament and the European Council as part of the co-legislative process to enter into force. The current form of the Proposal is likely to change. Still, some issuers are already actively trying to be “EU GBS” or “Taxonomy” compliant . As of now, some blurred areas, especially regarding ESMA’s overall governance, interpretation and exercise of its role, makes predictions an erratic exercise.
As the induced stringency of the EU GBS is high as a result of the taxonomy criteria alignment requirement, will issuers embrace it or give it a cold shoulder? Will it be really possible for issuers to stay away from it? We believe they will not be in a position to steer clear of it and so regardless of the Taxonomy or Standard flaws. This holds especially true for Sovereigns because of “lead-by example” pressure from civil society and market participants. What will really change for issuers? Greater coordination between funding teams and other departments will be crucial because ex post taxonomy alignment assessment will be too painstaking and unreliable. It indeed requires upstream internal harmonization to embed the taxonomy criteria in the day-to-day activities and strategic planning and investment decisions of entities. How will the Standard affect the overall green bond market? We foresee ambivalent effects, with more discipline and practices reshaping. Will market-based Standards’ influence vanish? Our take is that there will be a coexistence before a gradual convergence of market sub-pockets between EU Green Bonds and Green Bonds aligned with ICMA GBP, with huge discrepancies among sectors depending on the Taxonomy stringency and usability. How will the Standard affect the external reviewers’ landscape? Hugely, as the critical input and decisive tasks to be carried by external verifiers will tilt from pre-issuance to post-issuance and be more of a granular auditing style. Are some institutions, especially supervisory ones, going to anchor their Sustainable Finance initiatives into the Standard? The “Taxonomy-EU GBS nexus” provides the legal ground to do so. This could happen, with for instance ECB’ green tilted asset purchasing programs. Will investors prefer EU GBS-compliant green bonds? It is likely, as it could help them hedge against greenwashing risks and ease the reporting burdens under EU regulations.
On the occasion of a webinar organized by the International Capital Markets Association (ICMA) and a discussion with representatives from the European Commission  on the EU GBS, this article assesses the potential impacts of the EU GBS on the Green Bond Markets and on the financing of sustainable activities more broadly. Natixis’ GSH have been actively monitoring the development of the EU GBS since its premises, in particular through the publication of the study “TEG 101 - The EU green bond Standard”. We welcome the main features of the upcoming Regulation, but several blurred areas must be clarified.
I. An ambition to set a global gold standard
Leading by example and/or forcing adoption?
The EU GBS enters a landscape made of market practices, labels, guidelines, and Standards for green bonds. Some market participants already criticized the lack of flexibility on taxonomy alignment. Others speculate that the EU GBS will struggle to impose itself on the green bond market. Indeed, non-EU market participants may be reluctant using the EU-centric Standard except if the bulk of their fixed-income investor basis is European and committed to some EU GBS portfolios targets. With taxonomies popping up worldwide (see our study “The New Geography of Taxonomies”) and the uncertainties related to the equivalences between national legislations on the “do no significant harm” criteria, the EU GBS might struggle to impose itself on the global scene.
But as far as the European Commission hopes for market uptake, the upcoming Standard is not designed to replace current market-based Standards. The European Commission advocates a voluntary use. The mandatory aspect was discarded in the impact assessment accompanying the Proposal. However, the European Central Bank recently recommended to make the standard mandatory within 3 to 5 years for new green bonds in order to create certainty for markets.
Making the standard compulsory on the short term is neither realistic nor desirable. We expect the EU GBS to coexist with incumbents, notably the well-used Green Bond Principles (GBP) of the ICMA and the Climate Bond Standard (CBS) of the Climate Bond Initiative in the short and medium term. In the long term, Standards might converge under the EU GBS. Existing market Standards are already trying to close the gap by incorporating elements of the EU GBS, as seen in the 2021 Edition of the GBP now encouraging issuers to disclose their degree of alignment with taxonomies and reinforce their disclosure related to management of environmental and social externalities.
The use of the Standard depends on a nexus of incentives and whether it actually addresses needs. As often in Sustainable Finance, the market is to be moved by the demand from investors.
II. Carrots for issuers….
The Proposal by the European Commission is designed to be inclusive: it would be open to all European as well as non-European bond issuers. The same requirements should apply for assets outside and inside the European Union. Corporates, Public Sector (including Sovereigns) and Financial Institutions will be allowed to use it across all formats (including as well covered bonds, asset-backed securities and project bonds). We expect European sovereign issuers to align with the EU GBS as the political pressure will push them to “lead by example” regardless of the inadequacy of some criteria and that many public policies are not designed at activity level. Several have committed to do so in their Framework (e.g., Germany, Luxembourg, Italy, Spain). To accommodate their uniqueness, specific flexibilities are envisionned. They can prove relevant but it is essential that these flexibilities remain limited, notably in terms of technical screening criteria alignment.
- Ability to use State auditors or other public entities instead of registered external reviewers to review the allocation report (i.e., the post-issuance review).
State auditors or other public entities mandated by sovereign issuers are not subject to the ESMA registration and supervision requirements of this Regulation, as they are statutory entities with responsibility for oversight over public spending and typically have legally guaranteed independence.
- Exemption from having to demonstrate project-level EU Taxonomy-alignment for certain public expenditure programmes, such as funding or subsidy programmes and tax relief schemes. Sovereign issuers can use the proceeds of EU GBS to indirectly finance economic activities that are aligned with the taxonomy requirements through the use of programmes of tax expenditures or programmes of transfers, including subsidies. In those cases (for example a subsidy-scheme for homeowners to install solar panels), it will be enough for the sovereign to show that the funding programme itself is Taxonomy-aligned in its terms and conditions.”
“Forced” investor’s appetite and supply and demand mismatch
Because of the demanding thresholds of the Taxonomy for certain activities, EU GBS will likely be a relatively rare sub-asset in the short term as few issuers will be able to demonstrate 100% alignment. This is why some market participants advocate a lower alignment threshold, for instance 80%, with constraints on the remaining 20%. The EU GBS will be out of reach for the many and could incidentally reduce the pool of eligible assets for those willing to use it and, consequently, undermine their ability to regularly issue in benchmark format. They could therefore be considered as the safest asset (safe haven investment).
First and foremost, according to the article 8 of the Taxonomy Regulation, companies subject to non-financial reporting requirements under the Non-Financial Reporting Directive (NFRD, to be replaced by the Corporate Sustainability Reporting Directive) will have to calculate and disclose the extent to which their capital expenditure (CapEx), operating expenditure (OpEx), and their revenue are Taxonomy-eligible, as of 1 January 2022. Under the Sustainable Finance Disclosure Regulation (SFDR), in force since March 2021, financial market participants are required to report on the share of Taxonomy-alignment of the financial products they market. We therefore expect that investors would, all market and pricing conditions being equal, prefer investing in EU GB, that allow to disclose higher Taxonomy alignment ratios, on which they will be benchmarked. Displaying significant amounts of EU GB in portfolios will likely help them dismissing green or net zero alignment washing accusations (see our article on this topic). Another mighty driver of the demand for EU GBS “compliant” Green Bonds could come from the European System of Central Banks (ESCB), if the ECB ultimately decides to favor EU GBS bonds when purchasing bonds.
Supporting transition plans
To support issuers in their “transition journey” and answering market participants’ concerns about the binarity of the Taxonomy, the Standard allows eligible capital expenditure  that will meet the taxonomy requirements within 5 years from the issuance of the bond, unless a longer period of up to 10 years is justified by the specific features of the economic activities and investments concerned. One example given to illustrate this feature is the conversion of a production facility (like a steel plant) to reduce its emissions and meet the Taxonomy thresholds. Economic activities that will meet the taxonomy requirements must be encompassed in a “taxonomy alignment plan” that will describe the actions and expenditures necessary for the economic activity to meet the taxonomy requirements within a specified period of time. In their annual allocation report, issuers will be required to report on the progress in the implementation of their “taxonomy alignment plan”.
This flexibility has some benefits but is prone to various concerns and may create practical challenges. It will be hard to verify and may reveal unpractical without clear guidance. It will be key do define precisely the information required from the issuer to delineate the expenses underlying the transition plan. External verifiers will need evidence to opine on expenses’ appropriateness to deliver the Technical Screening Criteria performances. On this last point, as the bulk of the Taxonomy still needs to be adopted, there are many uncertainties on the implementation of the “future” alignment characteristic . Then, the Proposal does not specify if and how external reviewers would be required to verify the taxonomy alignment plan of concerned assets, nor develops the structure that such alignment plan would take. Similarly, a list specifying the features of the economic activities and investments that could be “allowed” to meet the taxonomy requirements within ten years is absent in the Proposal. The ECB rightly pinpointed that the current proposed EU GBS regulation does not provide a procedure for the EU Green Bond “label” to be withdrawn from an issuance if the transition action plan is not achieved.
III. …& sticks for external reviewers
Reining in external reviewers
The current proposal tightens the screw on external reviewers. EU GB will be checked by an external reviewer to ensure the compliance with the upcoming regulation. These external reviewers will have to register to the ESMA and to meet the conditions for registration (transparency requirements, professional qualifications, avoiding conflicts of interest) on an ongoing basis. ESMA will be allowed to conduct investigations, on-site inspections, and issue instructions to external reviewers to make them take corrective actions in case of deliberate infringements (non-compliance with the requirements of the Regulation, notably articles 18 to 30; submission of false statements; failure to provide information). If they did not comply, ESMA could impose fines and penalties and ultimately remove their accreditation. As accredited entities will have to provide higher transparency requirements and professional qualifications. We expect external reviews (incl. SPO and third party verificaton) to become more costly. On top of the different nature of the assessment to be carried, this may consolidate Credit Rating Agencies and Big Four’s position as they will be more able to front ESMA registration and supervision scheme (as they are already regulated and/or standardized), to provide both pre and post-issuance external reviews and to absorb the hypothetical increased costs induced by the EU GBS.
As the EU Taxonomy is granularly prescriptive, and that the TSC are to be literally transcribed in green bond issuance Framework, SPOs’ traditional role relevance is fading. The Regulation specifies that they should intervene twice: at pre-issuance (review of the issuer’s green bond factsheet setting out the funding goals and environmental objectives of the bond) and at post-issuance (review of compliance with the requirements of the Regulation after full allocation of the proceeds) . The current expert assessment leading to a gradual level of opinion will be replaced by a verification exercise leading to a confirmation of an alignment or not with a given Standard. The post issuance review is unarguably the most decisive and demanding in terms of work. The Proposal states that external reviewers shall use information of “sufficient quality” and from “reliable sources” when providing pre-issuance or post-issuance reviews. This dimension is key although not thoroughly defined. We believe that ESMA shall be mandated to provide guidance on these concepts. In doing so, it would avoid issuers to arbitrage and prefer external reviewers that are less data demanding and rigorous in their pre-issuance review.
More generally, more guidance on what is expected of external reviewers should be integrated by the ESMA. This includes (but is not limited to) the question of “temporary” opinions; the use of different external reviewers at pre and post issuance and the verification of the impact reporting. We expect ESMA to be the “judge of last resort” when external reviewers will face interpretation issues related to the taxonomy alignment. ESMA will create a discussion arena, collect case laws, and opine on questions from external reviewers.
IV. Blurred areas to be clarified in the upcoming Regulation
Further clarifications on partial or full grandfathering, how it is defined and under what cases are expected. During ICMA’s Conference, Axel Fougner stated that “for the Standard approach (= the gradual approach), the changing TSC is only an issue for proceeds that have not yet been allocated”. The “Q&A” section of the European Green Bonds Regulation mentions that “In the event of a change in the EU Taxonomy Technical Screening Criteria (TSCs) after bond issuance, issuers can make use of pre-existing criteria for five more years”. In our view, once a Green Bond is deemed abiding by the Standard, it should not lose it later on because of new technical screening criteria. We are against any form of retroactivity in order to maintain market stability. A different approach would lead to uncertainty and unpredictability for both issuers and investors. In the case of a partial grandfathering, issuers might fear to lose the Standard in case of changing technical screening criteria. It would create an incentive to issue for shorter maturities and probably, a higher demand from investors for bonds that are very unlikely to lose the Standard before maturity.
The grandfathering will also lead to a mismatch between issuers and distributors: indeed, the amendments to MiFID II and IDD do not specify that distributors can use the latest information communicated by producers when selecting financial products based on retail clients’ preferences. It should be made clear that issuers will not be asked by distributors to communicate data based on the latest Taxonomy criteria when they benefit from a grandfathering clause according to the EU GBS.
Centralized information on EU GBS-compliant bonds
We ignore whether the ESMA will provide market participants with a single portal including all the EU Green Bonds. We boldly suggest it. It could consist in a publicly available database identifying all the Green Bonds allegedly abiding by the Standard (according to the issuers) and for which a positive external review by an accredited entity exists. It could differentiate pre-issuance and post-issuance reviews, with downloadable documents or links towards respective websites, as well as information on proceeds allocation. This portal could also inform about ongoing complaints or enquiries from supervisors on the basis of alleged breaches (“watch list” of Green Bonds and/or external verifiers under investigation). Stakeholders may also use this platform to fill probe when they have a reasonable doubt about the respect of the EUGBS and interest in taking action. Despite the official templates, the heterogeneity of statements and information provided by issuers could maintain market confusion and barriers.
 As part of the alignment with the EU Taxonomy, issuers of EU Green Bonds would need to demonstrate that the investments funded by the bond meet the requirements on do no significant harm (DNSH) and minimum safeguards. The TEG has provided guidance in both its Taxonomy Final Report and the EU GBS user guide on how issuers could show this alignment. However, there is a lack of guidance on this issue in the current proposal. Issuers could use the “Do no significant harm” handbook to ensure that their investments avoid significantly harming any of the environmental objectives, as well as adhere to minimum social safeguards.
 The European Central Bank precised that “Ultimately, the EuGB standard should become mandatory for newly issued green bonds within a reasonable time period, e.g. in three to five years, the exact transition period to be informed by the outcome of the above-mentioned impact assessment.”See the “Opinion of the European Central Bank of 5 November 2021 on a proposal for a regulation on European green bonds”– available here.
 See the frameworks or Second Party Opinions (SPOs) of Cadent, A2A, Diös, E.ON, NRW Bank, ZF Friedrichshafen AG, Landesbank Hessen-Thueringen Girozentrale, and Deutsche Kreditbank AG for financial and non-financial undertakings, and Germany, Luxembourg, Italy, Spain and the European Union for sovereigns.
 The webinar was entitled “EU Green Bond Standard: a big leap forward, or too high a bar?”. The full list of participants included Neil Day, Managing Director at The Covered Bond Report; Ozgur Altun, Sustainable finance Associate at ICMA; Laurie Chesné, Co-head of Green & Sustainable Financing & Advisory, Natixis; Axel Fougner, Policy Officer at DG FISMA European Commission; Eila Kreivi, Director, Head of Capital Markets at European Investment Bank; Bodo Winkler-Viti, Head of Funding & Investor Relation at Berlin Hyp. Our discussion with the European Commission’s policy officers working on the EUGBS included Anne Hauschild, Jonathan Dent, Axel Fougner on November 9.
 Eligible capital expenditures are defined at Article 4 of the proposal – available here.
 So far, only a first delegated act related to the first two objectives of the Taxonomy (climate change adaptation and climate change mitigation) has been adopted in June 2021. As announced in the Renewed strategy, a complementary delegated act will be adopted before the end of the year for the agriculture, nuclear and gas sectors. The criteria for the taxonomy’s remaining four environmental objectives - pollution prevention, biodiversity, circular economy and water - will be adopted in 2022 and expected to be published at the Official Journal in 2023.
 The issuers must follow strict transparency requirements. The template of the factsheet is specified in Annex I; allocations reports’ format is detailed in Annex II, the impact report form is included in Annex III and the content of the pre and post issuance reviews are explained in Annex IV of the Proposal. See the Annexes to the Proposal of the European Commission here.