Green bonds and prevention of greenwashing
Green bonds are becoming an increasingly promising means to fill the gap in the financing of the climate transition that has been identified by the European Union (‘EU’). These bonds became part of the overall bond market from the year 2007 onwards. When the Intergovernmental Panel on Climate Change announced that global warming was most likely related to human activities, both the European Investment Bank and the World Bank soon started to issue special bonds designed to contribute to the climate. Although the green bond market is still quite small compared to the regular bond market, it is experiencing tremendous growth every year. The current market uses various voluntary standards, including the Climate Bond Standards and the Green Bond Principles. The requirements that the green bonds must meet under the various standards vary considerably, which means that not all green bonds are equally sustainable. The lack of a uniform framework for green bonds creates an opportunity for ‘cherry picking’ by bond issuers to make them appear more sustainable than they are. Therefore, in practice, there is a need for transparency for investors so that it is easier for them to determine which bonds actually make a significant contribution to the environment and which do not. To meet this need, the Technical Expert Group of the EU has proposed a European voluntary framework for “European Green Bonds”. This framework works as an indicator that investors can rely on. This article explains this proposal and how it can help prevent greenwashing.
Alignment with the Taxonomy Regulation: a clear definition of sustainability
The market need for more transparency in the field of sustainable investments is mainly due to the fact that a clear definition of sustainability has been lacking until now. The EU proposal tries to solve this by aligning with the Taxonomy Regulation. This regulation, which will enter into force in 2022, sets out various goals to which a sustainable investment can contribute. These are:
- combating climate change;
- adaptation to climate change;
- sustainable use and protection of water and marine resources;
- the transition to a circular economy;
- prevention of pollution and protection;
- restoring ecosystems.
An investment does not have to contribute to every goal, but it must not impede the other goals. In addition, there are minimum certain international standards, including in the field of labour, that must be met. Certain technical criteria are also designed for each of the goals. The integration with the Taxonomy Regulation will certainly improve the transparency regarding the green character of sustainable bonds. Bonds that will carry the label of a European Green Bond Standard will be guaranteed to comply with this extended characterisation of the concept of sustainability. Therefore, investors can be sufficiently sure of the green character of the bonds carrying this label.
Verification and reporting
This confidence is all the more enhanced by the fact that the proposal also imposes extensive verification and reporting obligations. In the case of the European Green Bond Standard, it will be compulsory to provide a description of the activity financed, how it fits in with the company’s strategy, how the Taxonomy Regulation is applied and how the income is managed. With regard to the latter, it must then also publicly report on how this revenue is used and what the impact of this is. The reporting on the use of the revenue should then also be verified by an independent accredited party, the outcome of which should also be publicly available. These obligations are a good addition to the current reporting practice, which is characterised by different forms, frequencies and reliability of information. Utilisation of a common framework ensures low transaction costs for comparing the different bonds and can make the market more attractive to new entrants. This is further reinforced by verification by accredited third parties. Attempts at greenwashing can be detected more quickly by the verifiers and the public accessibility of the reliable reporting also helps investors. Because the information is made public, the associated reputation risk provides more incentive for the issuers of the bonds to actually make a fair contribution to the climate.
Is the European Green Bond Standard an effective tool in preventing greenwashing?
As described above, the standard proposed to the European Union can therefore make a positive contribution to the prevention of greenwashing. Firstly, because the link to the Taxonomy Regulation makes it impossible for non-sustainable bonds to carry the label ‘European Green Bond Standard’. In addition, the reporting and verification obligations increase the reliability of the green character of the bonds. Because a standardised procedure is proposed for this, it becomes easier for investors to compare the green bonds and therefore to distinguish the dark green from the light green bonds. In addition, the transparency due to public reporting and verification creates an incentive for issuers of green bonds to make a sincere contribution to the climate and complicates their options for greenwashing due to the reputational risk they run. Nevertheless, its effectiveness depends on how the proposed standard is embraced by the green bond market. After all, the European standard remains a voluntary standard and the question remains to what extent the market is open to this, also because the stricter obligations could result in a (temporary) increase of transaction costs. Nevertheless, the advantages seem to outweigh this disadvantage, mainly because there is a strong demand for more transparency within the green bond market. Moreover, it still remains possible for the EU to make the standard mandatory if the market does not take it on voluntarily. Overall, therefore, it can be said that the proposal for the European Green Bond Standard seems at first sight a promising means of creating more unity, transparency and sustainability in the fast-growing green bond market. If sufficiently exploited by the market, this voluntary standard will contribute greatly to the effectiveness of green bonds in improving the climate.
Do you still have questions about green bonds after reading this article? Then please contact Law & More. Our lawyers are specialised in the field of financial law and sustainability and will be happy to help you.