EU goes green: the EU Green Deal and current considerations to issue green bonds
From Morrisons and Waitrose recently announcing their decision to ditch glitter in this year’s Christmas products due to their ecologically hazardous nature, to British Airways backing the development of a green jet fuel refinery, and BP and Royal Dutch Shell turning their focus to a green energy overhaul; the cry for environmental sustainability and de-carbonisation is only getting louder.
Following on from the European Green Deal Investment Plan (EGDIP), which underlined the need for bold signals to direct financial and capital flows to green investments, the European Commission is considering a move towards issuing green bonds for the first time as part of its coronavirus recovery plan. The EU’s consideration of “green” investments therefore has a twofold aproach; raising of sustainable debt as part of the EU’s €750bn borrowing spree, and the EGDIP, both analysed below.
Before plunging into what these two approaches entail and how it may be a driver of big change in Financial Markets, let’s have a quick run-through as to what green bonds are.
What are green bonds?
Generally, ‘traditional’ bonds are issued by an entity with the aim of raising finance, whereby an investor purchases debt and the issuer promises to pay an annual return until the bond’s maturity. Simply put, they are an IOU with a serial number, which can then be traded in Capital Markets.
Instead, green bonds are differentiated from regular bonds by their label, which signifies a commitment to earmarking the funds raised and exclusively using them to finance ‘green’ projects, assets or business activities. Specifically, they are usually aimed at inter alia energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, and sustainable water management. They can be issued by governments, banks, local governments or corporations, while their first introduction was back in 2007 with a AAA-rate.
It should be borne in mind however that, although investing in green bonds is decentralising investment and attracting more financial activity in sustainable projects, its success is measured in coupon and capital repayments and still depends on the financial health of the issuer. As long as the EU’s green bonds have an attractive yield and maturity profile, the issuance could introduce much-needed flexibility for Member States’ recovery plans, facilitate investment alignment with the Green Deal, support the flourishing of a green bond market and allow for an opportunity to enhance sustainability in portfolios.
Green Bond Issuing
In what has been one of the deepest recessions in the history of the bloc, the EU is set to borrow €750bn on the international financial markets with the aim of lifting the economy. The European Parliament’s environmental committee hinted at the possibility of €200bn of the borrowed money being in the form of green bonds, while the investor appetite for sustainable bonds could mean green bonds may match conventional sovereign debt trading.
The move is set to ensure overall investment coherence with the Green Deal, while it follows last month’s issuance of green bonds from Germany, Sweden, France, Poland, Ireland and the Netherlands. Considering that the climate crisis is becoming more pressing day by day, investors are looking to invest into more sustainable products such as renewable energy, clean water and energy efficiency, making green bonds among the fastest-growing financial assets in recent years. Last year saw a total of $263bn being sold globally, up from $1bn in the previous decade.
The current opportunity to use €200bn of the borrowed money into sustainable bonds could also see use of the EU’s upcoming Green Bonds Standard, analysed below, and subsequently call on others to do the same. Ethical considerations such as Environmental, social and governance (ESG), socially responsible investing (SRI) and impact investing, integrated in the investment process can help meet social impact goals and align the borrowing with the Green Deal.
The EU Green Deal
Following its 2030 climate and energy target of a 40% cut in greenhouse gas emissions, coupled with the tripling of annual global issuance of green bonds since 2016 (€225 billion), the EU has set out to set up a framework to bridge the gap between policy objectives and private financial resources. This includes mobilisation of at least €1 trillion of sustainable investments over the next decade through the EU budget, by crowding in of private funding through guarantees and facilitating public sector investments.
The Green Deal is looking to establish an EU Green Bond Standard, which will set out clearly which assets and projects the money can be used for. This Standard could also strengthen the international role of the euro and help to establish the EU as a global hub for green finance. A lack of such a standard could lead to cross-sector divergences, hinder economies of scale and subsequently make green bond issuance costlier and less lucrative. Although the initial introduction of the standard will set off one-off costs, including authorisation of validators, the increased level of standardisation will gradually lower them.
The plan is designed to eliminate greenwashing, improve the harmonisation of standards across states, sectors and financial services, and increase market awareness of sustainability. It plans to balance the current information asymmetry by applying uniform rules on how market participants can inform investors on compliance with the integration of ESG risks and opportunities. An example of this, are polluting assets, which under the new regulation would have to be disclosed by market participants to potential and existing investors.
This move has certainly signalled a big step for environmental sustainability investment, while one of its notable aims is to make it easier for investors to identify sustainable investments, ensure their credibility and subsequently construct green portfolios. The green angle can certainly help diversify the investor base, by attracting a new subset of responsible investing, or even younger environmentally conscious investors looking to make a positive impact.
The EU’s Green Deal Investment Plan and its consideration of issuing green bonds further cement the gradual transformation towards the 2050 carbon-neutral and sustainable world, by mobilising capital for green investments, and finally getting the ball rolling.