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Anticipating the Inevitable: What to Expect from the European Green Bonds Regulation

Posted on April 26, 2023

Arthur Carabia
Arthur Carabia
Director, ESG Policy Research
Lili Hocke
Lili Hocke
Director, Commercialization Corporate Solutions

On February 28, 2023, the European Union Parliament and Council reached a provisional agreement on the European Green Bonds Regulation. The purpose of this regulation is to create a voluntary label to reinforce the sustainable ambitions of the green bond market. It is designed to help direct capital flows to Europe’s sustainable objectives as described in the EU Sustainable Action Plan, promoting transparency, and supporting integrity of the market. 

While the details of the agreement have yet to emerge, market participants are unsure about what this will mean for issuers and investors alike. Based on our experience, we cover the key anticipated requirements that should be considered once the regulation is ratified.

Anticipation One: Alignment of Proceeds with the EU Taxonomy

At least 85% of a European Green Bond (EU GB) proceeds will need to be aligned with the EU Taxonomy. The remaining proceeds constitute what's known as "the flexibility pocket." The flexibility pocket refers to the 15% of proceeds from a green bond to be invested in economic activity that contributes to the EU environmental objectives, but are outside of the scope of the EU Taxonomy until the taxonomy framework is fully realized. This implies that this so-called “flexibility pocket” of 15% only applies to activities not yet covered by the EU Taxonomy. With the increasing expansion of the EU Taxonomy, the activities to which the flexibility pocket can be applied will be reduced over time. As a precursor, the recently published draft of additional activities has already expanded the EU Taxonomy and its influence.

Anticipation Two: Grandfathering of Proceeds

Grandfathering is a provision by which an old rule continues to apply to specific existing situations while a new rule will apply to future cases. This is meant to provide legal certainty for EU GB issuers and ensure that they would be allowed to use the EU GB label, despite EU Taxonomy criteria being updated. Our understanding is that the grandfathering of proceeds already allocated would be unlimited and that grandfathering of unallocated proceeds could be limited to seven years.

Anticipation Three: Expected Disclosure Types

Issuers of EU GBs will be expected to disclose detailed information about the use of proceeds (e.g., intended timeline/realized allocation, taxonomy alignment, estimation of positive impacts) via various templates (e.g., factsheets, allocation, and impact reports). Companies adopting the EU Green Bond Standard are asked to disclose how the EU GB issued contributes to its transition strategy.

Previous drafts of the regulation indicated potential disclosure requirements for all green bonds issued in the EU. But the final agreement focuses on those issuers that want to use the label and only encourage issuers of other green bonds to make use of the EU GB disclosure templates.

Anticipation Four: Conducting External Reviews

Pre- and post-issuance reviews will need to be performed by external verifiers which will be supervised by the European Securities Market Association (ESMA). Issuers will be overseen by their National Competent Authorities.

Anticipation Five: Equivalence for Non-EU Taxonomies

The prospect of granting equivalence to non-EU Taxonomies by the European Parliament, making it easier for non-EU issuers and projects to align with the standard, was not retained in the final agreement. This will only be considered years down the road in the context of regulation review.

What This Means for Issuers and Investors

The EU GB label aims to be the next gold standard in the market, offering increased transparency and quality assurance to investors. This may be particularly useful for funds seeking to make sustainable investments as per the Sustainable Finance Disclosure Regulation and are hoping to achieve a certain level of EU Taxonomy alignment. Although the regulation sets a high bar for issuers, we anticipate that the demand for EU GBs will be significant. Issuers can showcase early leadership through transparency of their bond’s EU Taxonomy alignment and at a later stage adopt the EU GB label.

What Are the Next Steps?

The provisional agreement now needs to be formally adopted by the European Parliament and Council. The regulation will take effect 12 months and 20 days after its publication in the Official Journal of the EU, estimated for Q3/Q4 2023.

How We Can Help

With more than 1000 Second-Party Opinions (SPOs) delivered, Morningstar Sustainalytics is the leader of green bond SPOs. With financial market participants being required to disclose degrees of EU Taxonomy alignment at product and entity level, Sustainalytics is already providing SPOs featuring an EU Taxonomy Alignment Assessment, helping issuers to demonstrate credibility and stand out in the market. Building on our overall expertise, Sustainalytics intends to apply to become an External Verifier of EU green bonds.

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