At the end of 2019, the European Union announced its EU Green Deal commitments, aimed at transforming the region into a “modern, resource-efficient and competitive economy”. As part of this, the EU outlines a goal to reach no net emissions of greenhouse gases by 2050.
To do this, the European Commission has announced it will invest €1 trillion by 2030. It’s also estimated that major private sector investments will total €2.5 trillion over the next 10 years. EU ESG regulation will also play a crucial role in meeting these commitments, with a significant impact on business, and on debt financing activity through the capital markets.
A new regulatory paradigm for business
“The EU Taxonomy is the backbone of EU ESG regulation, as it provides a clear reference as to what activities should be considered green and under what conditions. The European Commission is expected to provide its perspective on the extension of the current environmental taxonomy to sectors that are not green, as well as to cover social objectives, after reviewing the recommendations contained in reports prepared by the Platform on Sustainable Finance (PSF),” explains Patrick Bader, representative of BNP Paribas at the PSF and member of the CIB Regulatory Anticipation team.
We can expect the EU Taxonomy to continue to evolve, beyond the short term extension to the four remaining environmental objectives.
Patrick Bader, representative at the PSF and member of the CIB Regulatory Anticipation team, BNP Paribas
Over the coming years, ESG regulations are likely to increase in number and impact as the region acts decisively to achieve its ambitious targets.
“This dynamic we’re seeing will redefine how companies conduct their business, and we expect it to extend beyond the EU,” says Rachida Tournier, Head of Corporate Coverage EMEA, BNP Paribas CIB.
This dynamic we’re seeing will redefine how companies conduct their business, and we expect it to extend beyond the EU.
Rachida Tournier, Head of Corporate Coverage EMEA, BNP Paribas CIB
“The regulatory changes will apply firstly to large companies in the EU, and we can expect them to be progressively extended to smaller companies, eventually encompassing all businesses, including non-EU companies listed on EU regulated markets and EU subsidiaries of non-EU companies,” she adds.
This will have an impact on funding costs, the cost of capital and global markets, and new financing and investing solutions.
The EU ESG regulatory framework
The EU ESG regulatory framework is evolving fast and will become fully embedded into how businesses operate in years to come, involving all market participants. It aims to prevent greenwashing and provide transparency to investors, under three pillars:
EU Taxonomy: a science-based common classification of economic activities that are considered “green”, i.e. by ensuring that they substantially contributing to environmental objectives.
Non-financial disclosures: comprehensive disclosures for both financial and non-financial undertakings, providing investors with transparent and comparable information in their decision-making around sustainable investments.
- Taxonomy Regulation – Article 8
- Non Financial Reporting Disclosure (NFRD) & Corporate Sustainability Reporting Directive (CSRD), meant to replace NFRD by providing a more demanding and robust sustainability reporting framework
- Sustainable Finance Disclosure Regulation (SFDR)
- The proposed Corporate Sustainability Due Diligence Directive (CSDD) is introducing a duty of care for large companies to tackle environmental and social impacts across their value chain.
Products & labels: a broad toolbox for market participants, investors and countries to develop sustainable investment solutions, while preventing greenwashing.
- Regulated label: EU Green Bond Standard (EU GBS), to be approved by European Parliament and Council
- Market principles (e.g. ICMA, LMA): Sustainability-Linked Loans (SLLs), etc.
A new green certification tool
“Why does ESG matter? Because it is linked not only to new risks, but also new opportunities. We are undergoing an ESG revolution driven by an exceptional growing investor demand,” says Jeanne Aing, Head of CIB Regulatory Anticipation, BNP Paribas.
Why does ESG matter? Because it is linked not only to new risks, but also new opportunities. We are undergoing an ESG revolution driven by an exceptional growing investor demand.
Jeanne Aing, Head of CIB Regulatory Anticipation, BNP Paribas
“The EU regulatory framework, which includes the EU taxonomy, is designed to encourage investments to implement this ‘revolution’ and to monitor progress,” she adds. “As such, it’s a game-changer.”
The EU taxonomy works as a green certification tool, and comes with the introduction of a new regulatory label called the European Green Bond Standard (EU GBS). It is designed to be compatible with the existing one, which is based on market best practices such as ICMA bond principles.
As per the European Commission’s proposal, this upcoming EU GBS is a voluntary label for all issuers (EU and non-EU) for financing that will be fully aligned with the EU taxonomy. It is mooted to become the new gold standard while the green bond market grows significantly; although the final text is still undergoing the European legislative process. We can expect to see further developments on the EU GBS between April and end of Q2 2022.
According to the Climate Bonds Initiative, green bond issuance increased by 100% between 2019 and 2021 to US$500 billion, and is expected to reach US$5 trillion by 2025. Clearly, Europe is leading the way: around 50% of green bond issuances are currently denominated in euros.
“However, in the fast-growing green bond market, the European Commission considered that it was still suffering from a lack of clear definitions of green projects, creating uncertainty and added costs for issuers and investors,” adds Aing.
Regulation to tackle greenwashing
That is why the new European Green Bond Standard has been designed to go beyond existing market standards in certain key aspects, by specifying the full alignment of the funded projects with the EU Taxonomy and developing a system for the registration and supervision of an external reviewer.
For example, the EU GBS requires the disclosure of proportion of proceeds used for refining and the publication of external review; elements only recommended by the ICMA principle. Furthermore, the accreditation of external reviewers is not addressed in ICMA principles, while it’s under supervision of the European Securities and Markets Authority (ESMA) in the EU GBS.
“The objective is to avoid further greenwashing to provide investors with useful and relevant information for sustainable investments,” adds Aing.
Close alignment with the EU taxonomy and a focus on market integrity and investor protection means the EU GBS will set a new benchmark for green bonds. In the future, this is unlikely to stop at environmental criteria: the European authorities are also considering extending standards to other bonds (sustainability-linked, social bonds etc.).