The EU Green Bond Regulation introduces a new benchmark for green bond issuance, with implications for sustainable finance markets around the world, say Florence Devevey, Patrice Cochelin and Christa Clapp of S&P Global Ratings
Environmental Finance: The EU Green Bond (EU GB) Regulation came into force at the end of 2024. What does it introduce?
We believe that the regulation could promote greater transparency, credibility and integrity within the EU's green bond market, in that it requires issuers to disclose more detail on how bond proceeds will be used, as well as post-issuance reporting around allocation and impact. The regulation also introduces the need for external reviews of these green bonds.
EF: What processes should potential EU GB issuers follow when considering issuance?
FD: The bulk of the work issuers need to do is around their alignment with the EU Taxonomy. There are three things the issuer needs to show: that the activities financed by the EU GB proceeds make a substantial contribution to one of the EU's environmental objectives; that they do not do significant harm to any other objective; and that the issuer is aligned with a series of minimum safeguards around human rights, corruption, tax and so on.
We will discuss with the issuer to understand whether they have the processes and policies in place to demonstrate these three things before issuance. Issuers also need to bear in mind that they also commit to post-issuance allocation and impact reporting.
EF: What do you see as its implications for the EU's green bond market?
FD: We see two types of EU green bond in the market. The first will be 'standalone' EU GBs, and those green bonds that are also aligned with the International Capital Market Association's Green Bond Principles (GBPs). And there will be varying degrees of overlap between the two standards, where a proportion of the proceeds fund activities that are aligned with the EU Taxonomy, and some which meet GBP requirements for contributing to an environmental objective, but which are not covered by the EU Taxonomy, such as energy-from-waste or aquaculture projects.
Patrice Cochelin: The EU Taxonomy is very deep, but some will argue it's a bit narrow because of the project types it doesn't cover. It's also somewhat binary – projects are either aligned with the Taxonomy or they are not. Finally, it is very much based on EU regulations and directives, which can make it difficult to apply to projects in other parts of the world. That's why we think it's useful to also apply our Shades of Green methodology to our reviews of EU green bonds.
EF: How does the application of the Shades of Green methodology to EU GBs work?
FD: We apply our Shades of Green methodology to our reviews of all projects to which green bond proceeds are directed, whether EU GBs, those using the GBPs, or those that use different standards or none at all. We assign a shade to every environmental project, and if we believe the project is green, we assign one of our three Shades of Green; light green, medium green or dark green. (We also have three nongreen shades, red, orange and yellow, but for a project to align with the GBPs, it needs to obtain at least a light green shade.) So, within Taxonomy-alignment, a renewable energy project would typically be dark green, whereas other types of project, like the construction of energy efficient buildings or natural gas-fired assets, we would typically view as light green.
- A shading to every project to provide more nuance. This provides investors with a global benchmark: it enables global comparability of projects and green bonds, whether they align with the EU Taxonomy or a local taxonomy or the GBPs.
- A section called Issuer Sustainability Context, which gives context about whether the projects financed by the EU GB are relevant to the issuer's sustainability factors and how the issuer addresses those beyond the green bond projects.
These two elements feature in both our EU GB and second-party opinion reports.
PC: We also apply the Shades of Green methodology to project types that could qualify for the flexibility pocket (Article 5 of the EU GB Regulation), which can account
for up to 15% of an EU GB's proceeds. It's not clear to me how reviewers that don't have an equivalent green analysis methodology will approach these projects, and I think there's a risk that some analysis could be cursory.
EF: S&P Global Ratings is an approved reviewer: what does that mean, and what role do you – and other approved reviewers – play in the issuance process?
FD: We can act as a reviewer on both pre-issuance and the two post-issuance reports. We issue an opinion on these documents, and on whether we think they align with the EU GB regulation.
One thing that's important to understand is that our product is solicited: the issuer asks us to do it. It's what we call an engaged product, in the sense that we speak to the issuer and, when relevant, to their intermediaries. We interact with issuers by asking questions to help us do our analysis. For example, we would ask to understand policies or how the company intends to comply with the EU Taxonomy.
PC: We also add more information about the issuer's broader sustainability context. This is important, because one of the objectives of the EU GB regulation is to reduce greenwashing: an issuer may tick all the boxes in terms of its use of proceeds, but what it does elsewhere in its business might disqualify it in the eyes of some investors. Our research doesn't answer 'yes' or 'no' to that question, but it provides the investor with important context about 'who' issues the debt.
EF: What about post-issuance reporting?
PC: In the grand scheme of things, it's welcome that there is a stronger focus now on impact reporting, given the market's growing maturity. Given the maturities of much existing sustainable debt in the market, there's going to be a lot of refinancing opportunities over the next few years. One of the parameters that investors will be looking at will be what the issuer achieved the first time around with its bonds. If issuers can demonstrate that they had a real-world impact with this reporting, then we would expect investors to be more open to go in for a second round.
EF: How does your approach to corporate and sovereign EU GBs differ?
FD: First of all, the regulation treats corporates and sovereigns differently in some regards. For sovereign categories of EU GBs, the ways that the issuer can use the proceeds are a bit broader: they can use them for tax relief, subsidies or other types of expenditures. For the third criteria of EU Taxonomy alignment, regarding the application of minimum safeguards at the issuer level, we follow the recommendations of the Platform for Sustainable Finance, and limit the analysis to human rights and corruption, whereas we also do some analysis around taxation and fair competition for corporate issuers. Also, we take into consideration that sovereign issuers are usually not the entity that is directly carrying out the project, which means there's a level of detail that will not be available.
EF: What implications does the introduction of EU GBs have for the sustainable bond market in other jurisdictions?
FD: It may be difficult, but not impossible, for global entities with operations outside of the EU to show that financed projects comply with the EU Taxonomy rules.
For example, the do no significant harm criteria are often linked to EU directives, and it can be complex to demonstrate compliance with those criteria outside the EU.
PC: It is doable, and we have cases of non-EU issuers coming to us with projects that we have found to be aligned. If the EU GB standard emerges as a popular one within the market, we could see pick-up from outside Europe. If investors in the EU become fluent in using the EU Taxonomy and the EU GB Standard, then issuers outside the EU looking for liquidity from that pool of investors could see some advantage in speaking the language of the EU GB.
EF: How do you see the EU GB and the EU Taxonomy influencing the evolution of other regional taxonomies?
CC: We have already seen references to the EU Taxonomy in other jurisdictions. For example, Brazil is yet to issue its own taxonomy, so the Brazilian stock exchange came out with green equity principles which reference the EU Taxonomy: its principles don't require alignment, but they mention the EU Taxonomy because it is such a big reference point globally.
We see other taxonomies taking a different approach to the EU, given their specific local contexts. A primary objective of the EU Taxonomy was to guard against potential greenwashing, which meant focusing on very green projects. This left open how to deal with the rest of the economy that didn't meet those high thresholds.
So, in south-east Asia, taxonomies are focusing more on the transition space, and address local considerations such as palm oil or early coal retirement. Canada, meanwhile, is talking about exploiting its resources, which are maybe more fossil-based. There are some very interesting local flavours coming out.
For investors, it will be important to have the transparency and the language to talk across these taxonomies, understand how they relate to each other, and to be able to understand whether they are enabling a good transition, which is the lens we see things through with our Shades of Green methodology.
EF: What other trends do you expect to see in the sustainable bond market this year?
PC: The market's been roughly flat for now the past two or three years. This year, we see the market going back to its roots, to some extent, with green bonds being the most resilient segment of the market, and with supranationals like multilateral development banks being very active in the space, alongside corporate issuers.
We are also watching parts of the market that have been less strong, such as issuance from the banks. They have a dual role in the market, as both issuers of sustainable bonds themselves and as arrangers. We are watching closely in the context of some banks leaving the net-zero alliances.
There are continuing questions over the sustainability-linked bond (SLB) market, which was a very strong part of the market back in 2021 but which has been declining since. It is possible, though, that we have reached the bottom and, on the way, there has been some cleaning up of the market, meaning that issuance in future will now be more credible and investors will be happy to absorb SLBs again.
Recurring questions remain over the transition bond market. Japan has been leading the charge here but, so far, it's been very much a Japanese story only. It remains to be seen if that market pocket will expand to other types of issuers.
Florence Devevey is a Paris-based managing director, head of sustainable finance EMEA, Patrice Cochelin is managing director, sustainability methodology and research, also based in Paris, and Christa Clapp is global head of sustainable finance market analytics, in Oslo, at S&P Global Ratings.
For more information, see: www.spglobal.com/ratings/en/research-insights/special-reports/sustainability-insights
