New European Green Bond Standard is a game-changer

The energy transition received a transformative boost when European Union lawmakers approved new voluntary standards for companies that wish to issue "green" bonds. The European Green Bond Standard, which will be finalized on December 20, 2023, addresses many of the challenges that have resulted from the lack of transparency surrounding the issuance of bonds labeled as green. Critically, and despite its name, the EGBS also applies to asset-backed securities. Given the outsized role that the securitization market will play in increasing the volume of green investment, the significance of the EGBS cannot be underestimated.

Massive funding needs

The EU's green transition will require additional investment of €620 billion annually until 2030, according to a July 2023 European Commission report. Businesses across sectors will face steep costs as they implement new, greener ways to operate. For example, the steel industry, which is energy intensive and vital to the wider economy, exemplifies the transition's broader funding needs. As it shifts to new production methods, including using hydrogen instead of coal in manufacturing, it struggles to remain consistently profitable.

In Germany, one of the EU's biggest steelmakers, the government has pledged €5 billion to help decarbonize the industry. Yet the total cost of achieving this goal is forecast to be €35 billion. Adding to the challenge, last month, Germany's highest court ruled that €60 billion was unconstitutionally allocated to the government's climate transformation fund, having failed to meet the requirements for emergency borrowing. Green asset-backed securities transactions will be critical to closing the funding gap.

The power of green securitization

Considering one aspect of the steel industry example, the investments needed to fund the vast infrastructure required to produce and transport hydrogen will typically come from banks or the capital markets. A bank may lend to numerous steel producers, and then securitize the loan in order to raise the enormous sums needed from the capital markets.

In an asset-backed securities transaction, the issued bond is backed by a pool of specific assets, which means investors are focused not on the bank's or the bank's customer's credit rating, but rather on that of the diversified asset pool. This allows banks to transfer some risk to investors, release more capital and become players in the green economy.

Banks have cited the lack of consistent definitions for green securitization transactions as a key reason why these deals aren't happening. The EGBS changes that, offering clarity that is consistent with a safe, transparent and robust financial product.

More requirements, more certainty

Issuers that want to use the designation "European green bond" or "EuGB" must meet the requirements outlined in the EGBS. These relate primarily to the nature of the assets backing the bond, the planned use of proceeds and steps that must be taken to ensure transparency. 

Not surprisingly, securitized exposures cannot foster the use of fossil fuels, and all of the bond's proceeds must be put toward environmentally sustainable activities. To ensure transparency, EuGB issuers must publish a prospectus that complies with the EU Prospectus Regulation. The EGBS also mandates pre- and post-issuance disclosures and pre- and post-issuance reviews.

The new normal

As the race to decarbonize accelerates, industry will increasingly rely on the financial products made possible by the EGBS, and the refinements and subsequent regulations that will inevitably follow. These financing options will become the norm for companies as they compete in the green economy.

The greater stability and quality made possible by the EGBS will benefit all market participants. EuGB issuers and investors will be better able to avoid greenwashing claims, and issuing companies will enjoy greater certainty as to the suitability of their bonds. As a result, interest in these financial products will grow in popularity—as they must to provide the financing needed to create change.

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