The outlook on sustainable bonds issuance in the context of the Green Deal

1. What are Sustainable Bonds, Green Bonds & Social Bonds?

2. Outlook on Sustainable Bond Issuance

3. The European Green Deal

4. The Impact of the new Taxonomy Regulation on Green Bonds

5. European Green Bond Standard

6. Transition Financing

1. What are Sustainable Bonds, Green Bonds & Social Bonds?

“Sustainable bond” is the generic term used for a bond that pursues social and/or green goals. The term consequently includes green bonds, which are instruments that raise funds for projects with environmental benefits such as renewable energy, green buildings and sustainable agriculture. Social bonds on the other hand use generated funds for projects that address social issues or seek to achieve positive social outcomes.

One of the challenges that these bonds face is using the right key performance indicators and thus also the measurement of success. Green bonds usually have emission reduction plans but are increasingly becoming more diverse. Due to the rapid development of sustainable finance frameworks and increasing transparency, sustainable bonds continue to improve their sustainability performance.

2. Outlook on Sustainable Bond Issuance

Sustainable bonds are in high demand. While the international bond market stagnates in general, the sustainable bond market is expected to make up 17% of the total issuance of bonds in 2022 and consequently have a 65% growth in comparison to 2021 (11%). The international sustainable bond market would then amount to USD 1.5 trillion in 2022.

The European bond market shows that the demand for sustainable instruments is greatest in this region of the world and that the market is still growing rapidly. In Germany alone, the market for sustainable bonds is expected to almost double to 50% of the market volume in 2022, having already tripled in the previous year. The introduction of manifold key performance indicators and continued innovation in transaction structures offer opportunities for further growth.

3. The European Green Deal

To fight climate change and meet their commitments under the Paris Agreement, the European Union has set itself the goal of becoming climate neutral by 2050. This requires social and economic transformation in Europe, which must be cost-efficient, fair and socially balanced. The European Green Deal is the European strategy to achieve this goal. It consists of several policy initiatives to enable a holistic and cross-sectoral approach. Thus, the package includes initiatives that cover multiple closely intertwined policy areas such as climate, the environment, energy, transport, industry, agriculture and sustainable finance.

In every case, the aim is to adapt the EU’s legislation to climate targets. In order to steer private investments into activities and sectors that are necessary to achieve climate neutrality, the EU taxonomy was created. It intends to provide the necessary clarity and transparency for green investments. Finally, the European Green Bond Standard should also contribute to this.

4. The Impact of the new Taxonomy Regulation on Green Bonds

The EU taxonomy aims to provide investors and banks with a guideline as to which technology is to be classified as sustainable. As a rapidly growing number of investors want to invest in green technologies, the taxonomy is of great importance for the financial sector.

The European Commission now envisages temporarily including certain natural gas-fired power plants and nuclear power in the taxonomy. This inclusion has been met with fierce criticism regarding climate targets. Green bonds, and especially their transparency and credibility, are also seen as being at risk.

However, as companies will be subject to disclosure obligations, the EU Commission ensures that investors will be able to identify precisely whether and to what extent natural gas or nuclear activities are included in green bonds. In addition, green bonds usually categorically forbid investments in nuclear energy. Ultimately, the customer will decide whether investments in natural gas and nuclear energy are “green” and can be part of green bonds. Going forward, transparency and clear communication of the contents of green bonds will be even more important.

5. European Green Bond Standard

In order to enable and raise ambitions for sustainable financing, the European Commission decided on establishing the European Green Bond Standard (EUGBS), which is a part of the European Green Deal. Once adopted by co-legislators, this instrument will set a gold standard on how green bonds can be used to raise funds to finance sustainable investments.

Issuers will have a robust tool for showing what they are funding and the projects’ alignment with the EU taxonomy while investors can assess, compare and trust that their investment is used for sustainability linked matters. Ultimately, the standard enhances the effectiveness, transparency, comparability and credibility of the green bond market.

6. Transition Financing

In recent years green bonds have experienced a great level of growth and innovation as a financing instrument. These bonds focus on using their proceeds on projects on climate and environmental activities, such as wind farms and solar panels.

Consequently, efforts towards more sustainability in the bulk of the real-world economy are still limited, as green financing traditionally does not include heavy industry and manufacturing. Transition financing wants to change that by financing ventures that strive for more sustainable business practices, no matter in which industry.

However, such instruments are not yet being utilised, as the role of transition financing in the green bond market is controversial, especially because of its potential to be used for greenwashing. For the transition financing market to grow and have the desired effects, investors need to have a better understanding of the market, which includes more information on projects like its financial return and its environmental benefits.

Ultimately, the fast-growing green bond market could also finance industries with historically very unsustainable business practices and help them transition their business models and activities towards a more sustainable approach.