Green bonds: Can the EU really become the world’s largest issuer of climate-conscious finance?

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The European Commission has set its eyes on the rapidly expanding market of green bonds in order to make the EU the dominant leader in climate-conscious finance.

Seizing the economic momentum created by the bloc’s €750-billion recovery fund, the Commission wants to capitalise on its bolstered competencies – raising money directly on the financial market to bankroll the massive fund – with the goal of becoming the world’s largest issuer of green bonds, an increasingly popular instrument among investors.

Over the next five years, the executive could issue up to €250 billion in green bonds in order to help member states carry out their environmentally-friendly initiatives within the scope of the recovery fund. Leaders had previously agreed that at least 37% of the projects subsidised by the COVID package would go into initiatives focused on the sustainable transition.

The Commission has so far raised €45 billion for the recovery fund, with an additional €35 billion expected to be collected before the end of the year, for a total €80 billion across 2021. Some of these funds have already been disbursed to EU countries.

Until now, all this cash has been earned through classic long-term bonds (mainly 20- and 10-year bonds), but, from October onward, the executive plans to collect 30% of this money through green bonds. All borrowing will end in 2026 and must be repaid, at the very latest, by 2058.

If these climate-centred auctions attract the same kind of interest as the previous transactions, the Commission could easily become one of the leading – if not the number one – issuer of green bonds in the world, lending credence to Brussels’ aspirations of being climate leader.

But the green bond market is rapidly changing and expanding, with more international competitors joining the arena and luring investors into the lucrative business of climate action.

A soon-to-be trillion-dollar market

As the urgency to fight climate change increases, governments devote an ever-larger amount of public resources to ambitious projects designed to transform their economies and become carbon neutral. However, the cost of these plans, which tend to be far-reaching and multi-annual, is ballooning, opening a window of opportunity for investors looking for new ventures.

This appetite gave rise to green bonds: financial instruments specifically designed to collect money for climate and environmental projects. They are fixed-income bonds, which means the investor who buys the debt receives interest payments on a stable and predictable schedule.

Green bonds are backed by the credit rating of the company or entity that issues them (the Commission today has a triple AAA credit rating) and are usually accompanied by tax incentives to enhance their commercial appeal.

The market has swollen in recent years. Back in 2014, green bonds issued worldwide were worth $36.8 billion (€31.1 billion). Six years later, in 2020, the market reached $290.1 billion (€245 billion).

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Not even the devastating impact of the pandemic has dented the surge: according to Climate Bonds Initiative, an international organisation that mobiles green capital, the year 2021 will finish with over $450 billion (€380 billion) raised for climate projects. For 2023, the projection is $1 trillion.

Although the United States is the top country in the issuance of green bonds, EU countries are the indisputable forerunners.

Germany, France, the Netherlands, Sweden and Spain are in the top 10 of green bond issuers. Last year, the five countries put out together $120 billion in green bonds, more than 40% of the global total. Meanwhile, the United States and China offered $52.1 billion and $22.4 billion, respectively.

Italy, Finland, Portugal, Denmark, Hungary, Austria, Luxembourg, Belgium, Ireland, Greece and Lithuania have already raised money for their national projects using green bonds, although to a much lesser extent than the top 5 EU countries.

2021 has seen Latvia, Poland and Slovakia join the flourishing market. Outside the bloc, Norway, the United Kingdom, Switzerland, Russia and Iceland are too making significant inroads.

Europe’s commanding presence has made the euro the leading currency for issuing green bonds: out of the $290 billion transactions registered in 2020 around the world, $139 billion were conducted in euros – almost 50% of the global total.

For its part, the US dollar attracted less money – over $82 billion – but reached more countries due to its long-held status as the world’s reserve currency.

The Republic of France is currently the main individual issuer, followed by the American company Fannie Mae and the Federal Republic of Germany.

Projects in the field of energy ($103 billion), buildings ($76 billion) and transport ($66 billion) were the the main destinations of green bonds in 2020. These three areas broadly match the priorities of the European Green Deal and the Fit for 55 roadmap, a bold legislative package that aims to cut the EU’s greenhouse gas emissions by 55% before the end of the decade.

Such monumental effort in such limited period of time requires an extraordinary level of investment that governments can’t simply afford on their own.

“Over this decade, we estimate that Europe will need around €350 billion euros of annual extra investment to meet its 2030 emissions target in energy systems alone. This is in addition to around €130 billion it will need for other environmental goals,” EU Commission Executive Vice-President Dombrovskis said in July.

“We have known for a long time that public money will not be enough. And we have to rely on the private sector. This is why sustainable finance is so important: to generate investment at the scale needed.”

The Commission’s big entrance

When the Commission begins issuing green bonds later this year, it will join a small club of supranational entities already present in the market, such as the World Bank, the European Investment Bank (EIB), the European Bank for Reconstruction and Development (EBRD), the Nordic Investment Bank (NIB), the Africa Finance Corporation and the Asian Development Bank.

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The EIB is the top supranational entity in green bond issuance, with $7.3 billion collected in 2020. Given the expensive price tag of the recovery fund, the Commission will easily exceed that figure in a handful of auctions, immediately trusting the institution into the global top 10.

“I think it’s going to work. [The Commission has] already pioneered a lot of this this work around trying to make make sure that the green bonds that exist actually have the kind of positive impact that we need them to have,” Krista Tukiainen, head of research at Climate Bonds Market, told Euronews.

Tukiainen says the EU’s plan is the largest one ever seen from a supranational actor. And yet, it’s still unclear how far the Commission, as an institution, will go in the market.

The main component of the EU’s €750-billion recovery fund is roughly split between grants and cheap loans. Countries can freely request how much they want from each pool according to their economic needs and circumstances.

Mindful of repayment obligations, most member states have chosen to forgo loans and opt exclusively for grants. This preference has considerably shrunk the original recovery fund, which could eventually amount to €500 or €550 billion. (The Netherlands and Bulgaria are yet to submit their national plans).

The contraction means the Commission will actually issue fewer green bonds than promised and will likely miss the €250-billion mark announced in early September. Johannes Hahn, European Commissioner for budget, underlined Brussels will auction “at least” 30% of its recovery bonds as green, leaving the door open to a higher rate of climate-conscious bonds.

As things stand, the Commission will raise between €80 and €95 billion each year from 2022 to 2026, which will translate into €25 to €30 billion of green bonds (if the 30% rate is regularly applied). This would make the Commission the top individual issuer of green bonds and rank it ahead every single country, except for the US, Germany and France.

Brussels is confident it has all the right tools to make its market entrance a success story. Investors gave the Commission a warm welcome when it offered its social bonds to finance the €100-billion SURE programme, meant to support short-time work and furlough schemes during the pandemic.

In the long run, the EU also plans to establish a voluntary “gold standard” for green bonds to ensure they don’t fall into the the so-called green-washing, a common misleading practice that advertises products and services as eco-friendly when, in fact, they are not.

The regulation underpinning this gold standard is currently under negotiations and won’t be applicable when the Commission enters the green bond market in October. Commissioner Hahn explained that the EU’s first green bonds will try to meet as much as possible the regulation’s strict conditions. The executive will publish public reports about the allocation and impact of its green bonds.

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“[One of the] main criticisms that are levied against green bonds is that it’s hard to ascertain where the money is actually going and, more importantly, what impact it’s having. So there’s a kind of data puzzle to be able to show that in practical terms,” Tukiainen said.

“And then the other main criticism is that any kind of entity, any kind of organisation, technically speaking, can issue a green bond. So they can go to the market and say: ‘This money that I’m ring-fencing for this instrument is green, even if I’m still elsewhere investing in fossil fuel assets’.”

To prevent these duplicitous scenarios from tarnishing the bloc’s green financial market, the Commission has established a technical rule book – the EU taxonomy – to help governments and investors identify which projects respect the Paris Agreement and which ones are in breach of it.

The taxonomy splits investments in two main categories: “sustainable”, like hydrogen, solar power and bio-energy, and those that cause “significant harm” to the environment, like coal and lignite. The criteria cover sectors responsible for almost 80% of direct greenhouse gas emissions in Europe.

But in the rulebook, two energy sources are conspicuous by absence: natural gas and nuclear energy. The Commission has delayed a crucial decision to classify both resources due to profound disagreements between EU countries.

Commissioner Hahn stressed member states are not allowed to subside nuclear plants with money from the recovery fund. Natural gas is also excluded from the upcoming issuance of green bonds, although there’s a small exception to use recovery cash – collected through traditional bonds – to finance gas initiatives that serve as transition to a low-carbon economy.

The question around the future of nuclear, which produces about 25% of the bloc’s electricity, is shaping up to be one of the most intense and divisive debates of the new working year.

On one side, Germany is leading the anti-nuclear cause, together with Austria, Denmark, Luxembourg and Spain. On the other side, France, with great support from Eastern states, is fighting to label nuclear as sustainable under the EU taxonomy.

A report from the Commission’s research unit released earlier this year indicates the executive could eventually side with the pro-nuclear team, arguing greenhouse gas emissions from nuclear plants are comparable to those from hydropower and wind. However, critics say the resulting radioactive waste is harmful to human health and the environment.

The pivotal decision, though, will be up to member states to take. The agreement is expected to arrive in a delicate political juncture, after a new German government is installed and before France takes over the rotating six-month presidency of the EU Council.

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