Trust, Transparency and Transition: the European Green Bonds Regulation

Trust, Transparency and Transition

Keynote at ESG in Fixed Income EMEA 2023

Introduction

It’s hard to imagine now, but when in the 18th?century, the Russian Tsar Catharina was touring newly annexed Ukraine, she expected to see thriving villages and healthy peasants.

It’s a far way off from Putin’s inhumane actions, but what is not so far off is the ability of civil servants to construct a fake reality.

Not the health of the Russian army was exaggerated, but the prosperity of annexed Ukraine.

The governor of the region, Grigory Potemkin, went so far in this that, the story goes, he constructed fake villages everywhere Catharina went.?

He would build them, light some fires, ask his men to walk around, and as soon as the boat with the Tsar had passed, they would disassemble the village and build it again further downstream.

When drafting the European Green Bond standard and with everything happening in the world, I was reminded of this.

Because are we, in our wish to see a rapid greening of our economy, constructing Potemkin villages? Creating fake green financial products to satisfy demands by investors and the public??

All the while not actually bringing the change we need?

The sustainable bond market has been booming, and has survived the recent downturn of the bond market resaonably well.

But are they an essential element in the transition towards sustainability Or are they the Potemkin villages in the era of global warming??

Greenwashing concerns

“The jury is out” as your former Prime Minister would say.?

No doubt some green bonds or even sustainability linked bonds are doing great things

Helping car-manufacturers build electric cars. Or I pleasantly surprised by Enel’s sustainability linked bond, which has as KPI an 85% taxonomy alignment of capital expenditure.

But at the same time, greenwashing is rife.

And by that I do not just mean clearcut lies – saying you’ll do green, but doing the exact opposite.?

Sure, misleading may be taken place, and we should guard against that.

But often greenwashing is more subtle than that.

The lack of a clearcut definition of ‘green’ means that the term is prone to inflation.?

This means green bonds may actually be quite grey. And in some cases even simply brown. I’ve seen them finance new railroads to a coal-mine. Or a new energy efficient terminal for an airport….

But even if your investment is in a fully green project, greenwashing can still take place.

When people think of greenwashing they probably think of advertisements that are perfectly true, but do not tell the whole story.

Calling pesticide-covered fruit sustainable because they’re not sold in plastic packaging; or a t-shirt with highly polluting paint because its cotton is organic.

The same is true for green bonds. True, Shell can build a windfarm, but as long as they keep investing in new fossil fuel explorations, they’re simply not green.?

They might pool together the green things they would do anyways, tell everyone how green they are for issuing a green bond, and continue business as usual.

It is in this context that the European Green Bond Regulation was created.?

It tries to solve these three aspects of greenwashing – deception, greenflation and windowdressing.

And it does so by improving the current market in three key ways:

It brings trust, transparency and transition plans into the market for green bonds.

The hope is that by addressing these aspects, we can ensure that all green bonds are more than a fa?ade, and really make a substantive contribution to our transition.

Trust

Let’s start with the first aspect, trust.

Of course, many bonds are issued with the best of intentions and fund good, interesting projects

But the lack of clarity and the proliferation of greenwashing claims harms trust in the market.

Investors are spending significant resources scrutinizing green bonds, and even then, their interpretation of greenwashing might differ from that of their clients, or that of NGOs.

The European Green Bond Regulation deals with this in two ways

Firstly, following an EU standard will insulate a bond against criticisms.?

Of course, the EU does not have an unblemished track record here – calling gas and nuclear energy green is not exactly uncontroversial – but it still brings an authoritative seal of approval.

Secondly, the regulation gives external reviewers the central place they deserve.?

We audit financial data, so why not financially relevant ESG data??

To reduce the possibility of deception – our first type of greenwashing - investors should always demand an external review of green bond documentation.?

For European Green Bonds this is now obligatory.

But also for other green bonds, the Green Bond Regulation can be of great help.

It provides the first regulatory framework for external reviewers – what conflict of interest policies they should employ, their outsourcing practices, their governance structure, etc.?

And it gives ESMA the power to supervise them.

This can bring benefits to all investors. For they can demand that all green bonds - also those not following the EUGB standard - are scrutinized by ESMA-supervised entities.?

It will become a badge of approval the market needs.

Transparency

But obviously, external verification alone is not enough. We need to have clear standards as to what these parties should verify. Or said differently, what issuers should disclose.

This brings me to my second point – transparency.

Because of course ICMA and CBI have made great progress on standardizing the disclosures of green bonds.

But there’s only so much you can do with a voluntary initiative. The risk remains of issuers pick-and-choosing what makes them look good, and hiding what makes them look bad.

This makes it hard for investors to assess the greenness of a bond, and compare them with each other.

Because for that, you need to have a clear understanding of what it is you are comparing.

And after long and difficult work, the EU now has the Taxonomy to do just that.

Of course, the Taxonomy is not perfect yet.

It’s incomplete for a start, with non-climate environmental objectives still being developed.

And data issues remain.

But it is a start. An important one, and should be used as much as possible.?

Because it will remove our second greenwashing concern – greenflation.

For European Green Bonds, the taxonomy alignment needs to be near total. There is a ‘flexibility pocket’, but for the 15% of the proceeds that can use it, there are strict requirements on Do No Significant Harm.

Of course, achieving this level may not be possible for all issuers.

For them, the European Commission will draft ‘opt-in’ templates. Where, amongst other things, the degree of taxonomy alignment can be disclosed.

These provide supervised templates that can be used by issuers who are serious in showing the greenness of their bond.?

And investors should demand their use. To know the greenness of their investment, and to make accurate calculation of the taxonomy alignment of any fund including the bond.

So the Green Bond Regulation establishes three categories of green bonds

• we have the top in class European Green Bond with near full taxonomy alignment
• we have the middle category of bonds being transparent about their taxonomy alignment
• And we have the business as usual category

I hope investors will push for at least the middle category, and that issuers will use the opt-in templates to get ready for using the European Green Bond label as soon as they have sufficient project available.

Transition Plans

That leaves us with the final type of greenwashing I want to discuss here – windowdressing.

Because we want green bonds to make a material difference to the economy. Not just look good on the outside but make a substantive difference.

And the way to do that, is by putting transition plans center stage.

The question should not just be: are the proceeds of this green bond spent correctly? But: does this green bond help the company’s Paris-aligned transition?

Transition plans will already become obligatory for larger companies under the EU’s Corporate Sustainability Reporting Directive.?

For both the European green bond documentation and the opt-in templates, we want issuers to link their bonds to those transition plans.

How does the bond help reduce scope 1, 2 or 3 emissions??

That is ultimately what matters

And of course, the transition is not just about climate, it is also about other environmental objectives, such as circular economy and resource use, water pollution, etc.

That is why it’s also key to ask whether the bond will help a company increase its share of taxonomy aligned turnover?

These points are of course relevant for green bonds, but also for sustainability-linked bonds.

That is why, even though we didn’t negotiate a full-scale regulation for these bonds, the opt-in templates can be used.

I expect issuers in this market to be very keen to show that their sustainability linked bond is serious about its green credentials. These templates are a perfect tool to show this.

Conclusion

When drafting and negotiating the law, I did become skeptical at times. Lobbyists and issuers I spoke to had many examples of green bonds of various levels of ambition. But they frequently failed to convince me that these bonds were used to truly transform the company.?

Was I being presented with a substantive tool to speed up the transition, or were they simply Potemkin villages on the river bank?

Do green bond have an added value? Or is a sizable share of them, if not misleading, then at least inflating their green credentials or simply window-dressing?

It convinced me that legislation in this market is key.?

To create trust and strengthen the role of external reviewers

To ensure the Taxonomy, the EU definition of sustainability, is used to anchor all green bonds and create a single language to talk about sustainability in the market.

And to put the transition center place.?

It provides an outlook of what the European Union believes green bonds should look like

And aims at maintaining Europe’s leadership in this market, while raising the quality of green bonds around the world.

So that all, politicians, investors and the public, can be convinced that they’re not being taken for a Russian Tsar and that the green bond boom is indeed good news for our planet.

Thank you!