Green bonds

Definition

A green bond represents a portion of a loan, the proceeds of which are fully allocated to the financing or refinancing of one or more existing or new sustainable projects or assets.

Remarks:

• As can be seen, the issue of transparency on the use of the funds raised at the time of issue will be at the heart of the concerns of both issuers and investors.
• However, a green bond remains above all a bond, i.e. a security representing a fraction of a loan from the issuer, with all the characteristics, financial or risk, attached to bonds.

Principles and best practices

Back in 2017, the International Capital Market Association (ICMA) published the Green Bond Principles (GBP). This is currently the best known framework.

Faced with the rapid development of the market, and the obvious risks of greenwashing, the European Commission worked in 2021 on a draft European regulation. This regulation, which is based on the European taxonomy of sustainable assets, will constitute a real standard, allowing issuers who comply with it to use the name "EuGB" (European Green Bond) for their green bonds. Before coming into force, it must be adopted by the European Parliament.

Green bond principles (ICMA)

The GBP are a set of “best practices” to which issuers can adhere on a voluntary basis.

Principles

Use of funds

The funds raised must be allocated in full to projects with environmental benefits. These projects must be described and evaluated, if possible quantitatively, in the financial documentation of the bond, therefore prior to issuance (ex ante transparency).

The environmental objectives pursued fall into the following categories:

• mitigation of climate change,
• adaptation to climate change
• preservation of natural resources
• preservation of biodiversity
• pollution control

Issuers are encouraged to refer to existing nomenclatures, such as the European taxonomy.

Selection of funded projects

The issuer follows a selection process for projects and assets financed that takes into account:

• sustainability objectives,
• rules for validating that the project falls into at least one of the above categories,
• identification and management of social and environmental risks associated with the projects,
• positioning of the project within the issuer's overall strategy with respect to sustainability issues,
• possible alignment of the project with existing standards or taxonomies,
• planned mitigation of social and environmental risks.

Ideally, this process should be reviewed by an external auditor but this is not a requirement.

Management of issue proceeds

The funds raised by the issue, or an equivalent amount, are deposited in a dedicated account or portfolio, or tracked in an appropriate manner by the issuer. This account may be specific to each green bond, or managed globally for all the issuer's green bonds. The issuer is committed to a high level of transparency in the management of the funds, and the use of external auditing is encouraged.

Reporting

The issuer shall prepare a report at least annually, and more frequently in the event of a significant event, describing the investments financed until the funds are fully utilised. This reporting should not only describe the investments but also measure their impacts according to a specific methodology and indicators (ex-post transparency).

It is also recommended, but not mandatory, that this reporting be reviewed by an independent auditor.

Limits

The GBPs provide a framework, but their main limitation is that the framework is non-binding. Issuers join on a voluntary basis. In practice, there are significant differences between issues on various aspects:

• clear definition of the "green" character of projects (alignment with the European taxonomy recommended but not mandatory),
• divergence in reporting methods,
• lack of standardisation of the expertise carried out by external auditors,
• environmental impact analysis mainly ex ante.

As the issuer has no legal obligation under the GBP, the investor has no prerogatives to verify the "green" character of the projects financed. China is thus the world's largest issuer of green bonds, which finance, among other things, "clean coal" projects...

Draft European regulation

The future European regulation aims to create a real "green" label, independently audited, which requires to meet objective criteria in order to be obtained and thus avoids greenwashing.

Goals

The main objectives of the regulation are to:

• Facilitate the mobilisation of capital for environmentally sustainable projects. This objective is part of the wider context of the European Commission's actions on sustainable finance, the "Green Deal" for Europe.
• rely on a common definition of sustainable activities as set out in the "taxonomy" regulation
• Harmonize project selection and communication rules for issuers.
• Facilitate access to information and comparison between products for investors.
• Fight against the fragmentation of the European market.

Provisions

Label

The regulation introduces the creation of an "EuGB" (European Green Bond) label with uniform requirements.

Assets financed

Bonds labelled "EuGB" can finance any type of asset as long as it meets the criteria of the taxonomy:

• tangible or intangible assets
• financial assets including household assets
• capital and operating expenditure including household expenditure

Based on the taxonomy

Funded activities are selected according to the criteria defined by the taxonomy, which is by definition intended to evolve. Issuers must therefore rely on the criteria in force at the time of issuance, and have a period of 5 years to adapt their selection process to the new criteria after they have been published.

Similarly, the activities funded are those that meet the criteria of the taxonomy or will meet them within 5 years. The objective is that all funds are allocated to sustainable activities before the bond matures. The issuer must provide a plan for alignment with the taxonomy showing how this objective will be achieved.

Issuers

The label can be obtained by any type of issuer:

• Sovereign issuers: these can use the funds raised to finance projects directly, but also indirectly via tax breaks or subsidies. The control of the use of the funds can be entrusted to public entities empowered to control public accounts.
• Financial issuers: these must demonstrate in their allocation reports that all the funds raised have been used to finance sustainable assets as defined by the taxonomy at the time of their creation. They must also demonstrate that the value of their outstanding green bonds is at least equal to the total amount of sustainable financial assets on their balance sheet.
• Non-financial companies
• Local and regional authorities

Information requirements

There are many! Indeed, the issuer must be able to provide three standard documents:

• The EuGB factsheet contains all the information relevant to the issuer. It is mandatory in all cases, unlike the prospectus, and supplements it when it is required.
• Annual allocation reports must be published until the proceeds of the issue have been fully allocated. They demonstrate that the funds have been allocated in accordance with the requirements of the taxonomy. The external auditor (see below) validates the use of the funds in accordance with the taxonomy but also in accordance with the objectives described in the factsheet.
• The impact report must be produced at least once during the life of the bond. It reflects the actual environmental impact of the green bond.

These documents shall be prepared in accordance with standard plans provided in the annexes to the Regulation (aiming at harmonisation of documentation). The review documents produced by the external reviewers are themselves harmonised.

The documents must be freely available on the issuer's website. They must be transmitted to the national supervisory authority and to the European Securities and Markets Authority (ESMA).

The documents may relate to one or more issues.

External reviewer

The task of the external reviewer is to review the factsheets before the issue and the assignment reports after the issue. The external reviewer produces standardised review documents.

The external reviewer must be registered with ESMA. ESMA publishes the list of registered external reviewers, monitors their activity, including through on-site inspections, and may apply administrative sanctions.

The external reviewer publishes his/her examination documents in an open access manner.

Public auditors (e.g. the Cour des Comptes in France) are not subject to registration with ESMA.

Role of national supervisory authorities

National supervisory authorities (e.g. AMF in France) ensure that issuers publish the requested documents in accordance with and within the deadlines set out in the regulations.

Actors

Issuers

By issuing green bonds, issuers communicate their environmental strategy, diversify their investor base and improve the quality of the dialogue within their organisation between the finance department, the sustainable development department and the operational departments.

Historically, the first issuers of green bonds were the World Bank, the European Investment Bank and the French Development Agency. States, companies and local authorities came next.

The Climate Bond Initiative, an international organisation that promotes green bonds, lists 1,500 issuers at the end of 2020.

French Treasury

In France, the Treasury has been issuing green bonds since 2017. Due to the principle of budgetary universality, the funds cannot be directly allocated to specific projects. But an annual report establishes that the funds raised correspond to at least an equal amount of eligible green expenditure. The issues are supervised by a Green OAT Evaluation Board made up of eight independent experts.

European Union

As part of the Next Generation EU (NGEU) recovery plan, the European Commission will raise €250 billion in green bonds over the next five years, becoming the largest issuer of green bonds.

In parallel, Europe is developing a set of regulatory measures to ensure market transparency and guide investors towards truly green investments.

Investors

Green bonds allow investors to meet the demand of savers for financial products geared towards sustainable assets and to develop and master a management style that integrates environmental criteria.

Market

The green bond market is becoming a strong segment of the bond market, with good liquidity.

In 2021, new issues are estimated at 509 billion dollars compared to 240 in 2020 (source: Climate Bonds Initiative).

The market is also diversifying towards social bonds or sustainable bonds. The latter actually combine social and environmental objectives.

Thus, SLBs (Sustainability Linked Bonds) represent a separate category of green bonds linked not to specific projects but to sustainability indicators: the financial characteristics are linked to the issuer's achievement of certain quantified sustainability objectives.

Discussion

Usefulness

There is no doubt about the usefulness of the green bond market given the urgency of the ecological transition and the need to finance it, provided of course that greenwashing is avoided!

Green bonds are also intended to support the implementation of public transition policies.

Green premium or "greenium"

In principle, the fact that a bond is labelled "green" has no influence on the credit risk associated with the issuer, and therefore on the conditions under which the issuer must find financing on the market. This is all the more true as there is no additional advantage for the investor to hold a green bond rather than a conventional bond from the same issuer.

However, there is a "green premium" or "greenium" that can be as much as 4 basis points (i.e. a 0.04% difference compared to the rate requested for the same issuer for a conventional bond of the same duration).

What is the reason for this green premium? No doubt due to strong investor demand on the one hand, and a message of confidence from the issuing company on the other.

However, some studies show that green bonds have a lower yield to maturity than conventional bonds. This may raise fears of the emergence of a "green bubble". However, investors are also becoming more discerning and are looking primarily at the intrinsic risk of the issuer.

Fighting greenwashing

As with all "green" products, the risk of greenwashing is high, especially in the absence of a common, transparent standard that applies to all. It would be a pity if some opportunistic players tarnished the image of the market as a whole. This is why the draft European regulation is eagerly awaited to define a "level playing field".

Thus, the European Parliament has proposed improvements to the text, including the requirement that all EuGBs have verified transition plans. As the text's rapporteur, Paul Tang, puts it:

"The European Green Bond Standard needs to be fully aligned with the EU taxonomy for it to become the gold standard in the international green bond market. And with transition plans, we put European Green Bonds at the heart of companies’ transitions to a sustainable economy. We are serious about ending greenwashing. When this regulation becomes law, simply saying your firm’s bond is green will no longer be good enough."