Although we do not know the final details yet, we can say that the provisional agreement on the EU green bond standard is a good thing. It sets a clear framework for green bonds and connects to the EU taxonomy, a major piece of regulation. The key question though is whether the standard will be an instrumental piece of regulation towards the greening of our economies. The answer is both yes and no.
The green bond market is very well established and now relatively large. To date, around $2.3tn has been issued. Green investors have the tools to verify the credibility of those instruments and identify those that are not up to scratch.
Beyond the International Capital Market Association’s green bond principles and second-party opinion providers, investors use tools such as the Climate Bonds Initiative’s screening database, which screens out green bonds that do not align with its well-established taxonomy.
Good climate credentials are essential for green bonds to do well from a capital market perspective. Anecdotally, it can be observed that ‘darker’ green bonds can command a significant discount in the primary market. Also, in its biannual research on green bond pricing in the primary market, the Climate Bonds Initiative has overall consistently observed that green bonds obtain higher book covers and more aggressive spread revisions on average, compared with matched ‘vanilla’ equivalents.
Launch pad
Green bonds are an excellent starting point. They have demonstrated that it is possible for a bond instrument to target dual objectives: financial and green goals. Financing specific projects and assets, they get the ball rolling on the green transition. It is clear today that green assets are not also simply nice to have from a business perspective. Greener business models have a competitive advantage; think of electric transportation, for example.
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Building on this, we need more powerful tools, frameworks and ultimately finance at the company level, directed towards those who are delivering the necessary transition from brown to green. This is where the real battleground is. In this context, the EU green bond standard’s concept of companies needing to implement a transition plan is where the focus from market participants should be, but not just for use-of-proceeds bonds.
We want to finance companies that are credibly transitioning their business towards a Paris-aligned trajectory. This is especially important for those heavy-emitting industries of which products will still be needed in 2050 (steel, cement and chemicals, for example).
Here, innovative financial solutions including sustainability-linked bonds (and loans) have emerged in the past three years. However, these are facing their moment of truth. Many have been largely criticised and their underlying climate objectives questioned. A gold standard is needed to support credible climate financing at the company level, such as equities, general purpose debt and sustainability-linked debt.
Focus on transition plans
Sustainability-linked bonds’ performance targets need to be linked to a credible and ambitious, company-level transition plan. Here, the UK is well advanced, with the launch in 2022 of the Transition Plan Taskforce and the publication of a first version of its recommendations. It is expected that the final framework and implementation guidance will be finalised by the summer.
Much is also happening in the not-for-profit world. Companies can validate their greenhouse gas emissions targets via the Science-Based Targets initiative, and have their targets and transition plans assessed under the Assessing Low-Carbon Transition initiative. The Climate Bonds Initiative is launching its sustainability-linked debt and company certification scheme shortly. The tools exist.
Now the need is for a concerted effort to use them. Companies need to put further credible capital expenditure plans that underpin their transition plan and greenhouse gas emissions reduction targets. Banks need to incentivise companies to do so by aligning them to banks’ own balance sheet net-zero plans. Investors need to use their power of influence to push corporates.
Second-party opinion providers and ratings agencies need to qualify transition plans. All stakeholders, including the regulators, need to prioritise credible transition.
The EU green bond standard piece of legislation is laudable, but only one step of the journey. Market participants need to focus on the next, complementary part: transition plans and company-level financing. Green bonds are the ‘aperitivo’; it is time for the main course.
Fabrizio Palmucci is senior adviser at the Climate Bonds Initiative.
This article first appeared in Sustainable Views, an ESG policy and regulation service by the Financial Times Group.
