Climate change is often tackled only through the lens of risk management. This approach focuses on forecasting the impact of negative events, designing mitigants and enhancing protection. This perspective can be meaningfully complemented by an entrepreneurial search for business opportunity, supported by sustainable investment that includes climate impact in the cost of funds.

The bond market has been quick to look forward in this area: bond issuers, intermediaries and policy-makers have anticipated that investors would gradually integrate climate change in their investment strategies and organically improved the conditions to facilitate this. One example is green use-of-proceeds bonds, which – contrary to general-purpose bonds – raise funds only for economic activities that contribute substantially to environmental objectives, notably climate change mitigation.

These securities have rapidly turned into an instrument that helps issuers kickstart objective classification and report on their most sustainable economic activities, from which they can gradually extend such mapping to the rest of their balance sheet. This process has the potential to make the promotion of sustainability monitorable by markets in all areas of activity.

Ultimately, precise definitions and reliable reporting on the use of capital in the whole economy should enable investors to determine the relative cost of funds more accurately (especially if data prove that higher positive impact is associated with lower transition cost), rewarding investments that enhance sustainability and penalising those that do not, other conditions being equal.

Inaugurated in 2007 by the European Investment Bank, green bonds passed the €3tn mark in March 2024. They have become an important tool in the European Union’s public policies – with ad hoc legislation establishing a voluntary EU green bond standard that can be used as a yardstick for gradual alignment as well as a touchstone to assess relative quality in the market.

There are several core components that have put this type of bond at the service of both environmental and macroeconomic sustainability.

Maximum demand and supply

Policy relevance is a matter of size. Via a reliable notional link between proceeds and allocations, green use-of-proceed bonds rank equally with general-purpose bonds in terms of credit merit, maximising the investor basin.

By enabling issuers to autonomously define the perimeter of activities to be allocated from the proceeds, the green bond market has also been capable of high diversification in terms of issuers, be it by geography (around one half in Europe, one quarter in the Americas and one quarter in Asia Pacific) or type (roughly equal split between public sector, banks and corporates).

Market-driven push for more clarity and comparability

Comparative analysis is a key ingredient of competition. In the absence of a level-playing field, this has led to co-operative initiatives between market actors to address the lack of clarity in its various components: transparency, accountability, comparability and reliability.

This self-regulatory, market-driven process has been evidenced on multiple accounts: from the adoption of basic rules of transparency and accountability promoted by the Green Bond Principles since January 2014, to the agreement of 11 international financial institutions coordinated by the EIB on a harmonised framework for green bond impact reporting in December 2015, to the first green bond framework (EIB) including allocation and impact reports audited with reasonable assurance by a supervised auditor in 2016.

Policy-driven push for fair competition and effective investment

The higher comparability produced by green bonds has drawn policy-makers’ attention to the lack of consensus on the definition and impact measurement of green economic activities. At the end of 2015, China launched the first ‘green bond-endorsed project catalogue’, at the same time when the Paris agreement pleaded for transparency, accountability and compliance.

In September 2016, the European Union announced its plan to reform sustainable finance in the context of measures directed to foster its capital markets union. At the same time the G20, under the coordination of the Chinese and UK central banks, characterised lack of clarity as the key challenge of green finance. The pillar of the EU reform has been legislation establishing a single set of criteria in a taxonomy for the uniform assessment of sustainable economic activities across EU jurisdictions and along the investment chain. This approach is increasingly informing analogous initiatives outside the EU, building a solid reference for international co-operation.

Market-driven and policy-encouraged focus on gradual implementation and improvement

At this stage, a focus on full legal compliance would limit the use of the EU framework to a small portion of the economy and the green bond market. Guidance from the European Commission and the EU Platform on Sustainable Finance (EUPSF) indicates that voluntary partial reporting and gradual alignment are the way forward. Improving sustainability in all economic activities rather than just rewarding those that contribute substantially to the policy objectives is key for transition.

Gradual application of the taxonomy to green bonds, which will be supported by further guidance from the EUPSF later this year, is a pragmatic intermediate objective on the way to combining sustainable growth (higher investment productivity) with financial sustainability (lower investment cost) via efficient capital markets directed by clear policy signals on environmental protection. This is a clear objective of EU policies, as Nadia Calviño, EIB president, and François Villeroy de Galhau, Banque de France governor, highlighted earlier this year.

 

Any views or opinions in this article are those of their authors and do not necessarily reflect the views or opinions of the European Investment Bank.