Everything you need to know about the green bonds market and the efforts to regulate it

Key takeaways

  • Europe was responsible for almost 60% of the global market for green bonds in the first half of 2023
  • Given the importance of this instrument to the green transition and challenges on the market to qualify "green projects", the European Parliament voted in favor of the new European Green Bond Standard (EuGBS)
  • The EuGB will become a voluntary label. Issuers that want to carry the label need to specify the use of bond proceeds and commit to a green transition plan. The bonds will also need to be assessed by an external reviewer

Green bonds have been around for some time, but they are a relatively recent asset class and have experienced tremendous growth in recent years. In this article, we will go over the definition of green bonds and the recent developments in the effort to regulate the instrument.

Definitions of green bonds

A green bond is a specific type of bond, which is a means for companies or public entities (like countries or local governments) to borrow substantial sums from capital markets. What sets it apart as "green" is the commitment by the issuer to allocate the funds raised through these bonds toward environmentally beneficial projects. These projects can encompass a range of initiatives, such as renewable energy, energy efficiency improvements, heating insulation projects, sustainable housing, or sustainable transportation solutions like electric vehicles.

Before the bonds are issued, the issuer publicly announces the specific green projects the funds will support, allowing investors to later hold them accountable. This arrangement proves mutually beneficial for both issuers and investors:

  • Investors benefit from knowing their investment positively impacts the environment, and they gain confidence that the company they invest in takes climate change seriously
  • Issuers benefit by gaining a reputation boost, showcasing their concrete efforts in addressing climate change. In several instances, investors are willing to pay a premium for green bonds due to these reasons

Purchasers of bonds are primarily major financial entities such as asset managers, wealth managers, banks, and pension funds, as bonds usually have a high value and cost. These financial institutions procure the bonds and integrate them into their current funds or other products for resale to other investors, ultimately resulting in green bonds being part of the investment portfolios of individuals.

As the trend of investing in green bonds continues, there is growing consideration of its trajectory. Investors are increasingly selecting companies and directing funds into green bonds,. However, they need reassurance that these projects are indeed “green”. Another challenge faced by investors is that the definition of a “green project” can, at times, be very wide and forgiving.

European Green Bond Standard (EuGBS) and the efforts to regulate the European market

The European Green Bond Standard (EuGBS) steps in to try to solve the challenges encountered by the financial market.

The new regulation was proposed by the European Commission in July 2021 aiming to establish a “gold standard” for green bonds. In summary, it sets clear guidelines to adhere to. In return for compliance, the bonds can be labeled as EUGB. The most important rule requires issuers to allocate all bond-raised funds to these projects in alignment with the EU Taxonomy, a comprehensive list of economic activities that are sustainable or green.

In May 2022, the EU Parliament’s Economic and Monetary Affairs Committee unveiled a series of amendments to significantly widen the scope of new regulations, with rules covering the entire green bond market. The proposals met resistance from industry groups, including the International Capital Markets Association (ICMA), which warned that the stricter regulations could push issuers to turn to other markets and other sources of finance resulting in market contraction, the loss of EU sustainable bond leadership, and fragmentation of the international green bond market with the EU following different rules from an international market.

Finally, earlier this month (October 2023), lawmakers in the European Parliament overwhelmingly voted (418-79) to endorse the introduction of a new European Green Bond label, with the goal of combating greenwashing and providing investors the assurance that their funds are genuinely supporting sustainable activities and technologies.

The impact of EuGBS on issuers

Overall, the adoption of the EuGBS is anticipated to enhance credibility and foster investment in sustainable finance for a greener economy. In practical terms, the issuers, though, will be the most impacted by the regulation. Here’s how:

  1. Companies issuing bonds with the EUGB label must adhere to strict investment and transparency guidelines, including specifying the use of bond proceeds and committing to a green transition plan.
  2. To utilize the EUGB label, issuers must now have their green bonds assessed by an external reviewer registered and overseen by the European Securities and Markets Authority (ESMA). This will ensure that the external reviewers possess the necessary expertise and truly independent opinion, conducting evaluations free from any undue influence. Their assessment will involve aligning the bond's projects with the EU Taxonomy, as previously mentioned.

Nonetheless, the EuGB Standard is voluntary, focusing on green bonds, and it offers a flexible approach, allowing a portion of funds to be allocated to sectors aligning with EU Taxonomy but lacking defined criteria. The rules also encompass regulations for external reviewers of green bonds, emphasizing conflict of interest disclosure and a supervisory framework.

Assessing the size of the green bonds market

According to the international non-profit organization Climate Bonds, capital markets activity during 2022 was globally hit following the invasion of Ukraine which caused energy price strikes, inflation, and rising interest rates. This extended to bonds bearing thematic labels. For example, the number of issuers of green bonds dropped by 24% from 2021 to 2022.

In the same period, the proportion of the total debt occupied by green bonds remained unchanged (5%) and the green label continued to dominate the global thematic debt issuance in 2022.

The cumulative total of the segment by the end of 2022 was USD 2.2 tn. Europe was the most dominant region for the cumulative total of sustainability bonds with USD 1,001.9 bn (46.4% market share), as opposed to Africa with USD 4.7bn (0.2% market share).

Cumulative green bonds issuance by region, by the end of 2022

Despite lower volumes last year amidst a broader issuance market pullback, issuances have rebounded, reaching record volumes in the first half of 2023, with particular strength in the European market, which accounted for nearly 60% of the global market in the same period.  

Issuers no longer tap the market to fund COVID-19 measures, favoring instead the combination of social and environmental use of products under sustainability bonds. Energy, Buildings, and Transport remained the three largest use of products categories, collectively contributing to 77% of the total green debt volume.

Tip: For more information about green bonds, Datia’s team recommends the 16-minute EU Finance Podcast: Episode 9 - The one about the European Green Bond Standard.

How Datia comes in

Datia offers over 200 sustainability KPIs of 36,000+ companies, 210,000+ funds, and 210+ sovereign nations. Thanks to our proprietary instrument-to-issuers mapping, all green bonds issued by a globally traded company or a government are also mapped to the sustainability metrics reported by the company or government and available at Datia.

The different KPIs are then utilized to create sustainability reports for financial products or entities, following the latest frameworks, such as SFDR’s PAI statement and European ESG Template.

To learn more about Datia's solutions for Sustainable Finance, book a call with our team of specialists.