2.2 The European Union Green Bond Principles: Overview

that issuers and investors voluntarily agree on the climate-related or environmental purpose of a bond, it can be classified as green. This practice has led to the blurring of boundaries between sustainable and nonsustainable projects funded by green bonds (so-called greenwashing). For instance, in China green bonds have been issued to finance clean coal projects—a use of proceeds that would not comply with the sustainability policies of many European and North American institutional investors.14

In practice, backlash against greenwashing has resulted in the increasing adoption of green bond standards with tight eligibility criteria that in most cases rule out the use of proceeds for FMR projects. The Green Bond Principles, published by the International Capital Markets Association, are the best-known set of voluntary guidelines for the issuance of green bonds (ICMA 2018). The Green Bond Principles establish guidelines on the process for project evaluation and selection, management of proceeds, and reporting (see box 2.2 for a summary of

BOX 2.2

The European Union Green Bond Principles: Overview

The Green Bond Principles (GBP) are voluntary process guidelines that clarify the approach for the issuance of green bonds to promote transparency and integrity in the development of this market. The GBP’s target audience includes prospective issuers who need guidance on the launch of green bonds, investors who need to evaluate the environmental impact of their green bond investments, and underwriters who benefit from recognized standards when marketing transactions to investors.

The GBP have four components:

1. Use of proceeds. The GBP list several broad eligibility categories for the issuance of green bonds: renewable energy, energy efficiency, pollution prevention and control, environmentally sustainable management of living natural resources and land use, terrestrial and aquatic biodiversity conservation, clean transportation, sustainable water and wastewater management, climate change adaptation, eco-efficient and/or circular economy–adapted products, production technologies and processes, and green buildings. 2. Process for project evaluation and selection.

Issuers are recommended to clearly communicate to investors the following: the environmental sustainability objective, the process used to determine the project’s fit with eligibility categories, and any eligibility or exclusion criteria

as well as process for the identification and mitigation of environmental and social risks. 3. Management of proceeds. The GBP recommend that issuers create dedicated subaccounts and formal internal processes to track lending and investment operations linked to green bonds. The principles also encourage the appointment of auditors or other third parties to verify the tracking methods and allocation of proceeds. 4. Reporting. The GBP recommend the preparation of annual reports (until full allocation of the proceeds) including a list of the projects funded with green bond proceeds, a brief description of the projects, the amounts allocated, and the projects’ expected impact. If possible, issuers should complement qualitative information with quantitative performance data, as well as disclosure of impact assessment methodology and assumptions.

The GBP also recommend that green bond issuers appoint independent external reviewers to confirm the alignment of the bond with the four GBP components. The content of external reviews may vary in scope, and could include second-party opinions on the alignment with the GBP, independent verification against a specified set of criteria, certification against a recognized green standard label, or assessment of the green bond or specific features (for example, use of proceeds) based on an established scoring or rating methodology.

Source: ICMA 2018.

the Green Bond Principles). They also recognize several broad categories of eligibility (none of which is in the fossil fuel industry) but do not provide prescriptive views on specific technologies and solutions. Several international and national initiatives have tried to fill the gap by producing detailed taxonomies of eligible green-bond-funded projects. Examples include the following:

• The Climate Bonds Initiative (CBI), an international nonprofit organization dedicated to mobilizing the bond market for climate change solutions, has published one of the most prominent taxonomies, which it uses to label bond issuances as “Climate Bond Certified” (in the same spirit as the Fair Trade certificate). The CBI taxonomy excludes any uses of proceeds that foster the continuation of the fossil fuel industry, including investment in FMR projects (CBI 2020a). The CBI certification is rapidly gaining traction, with a cumulative

US$150 billion in certified bond issuance as of 2020, amounting to about 14 percent of the US$1.1 trillion green bond market in the same year (CBI 2021).

• The European Union’s Technical Expert Group on Sustainable Finance has recently proposed a voluntary European Union Green Bond Standard (EU

GBS) to enhance the effectiveness, transparency, comparability, and credibility of the green bond market and to encourage market participants to issue and invest in EU green bonds.15 The eligibility list for EU green bonds would be aligned with the broader EU Taxonomy Regulation for environmentally sustainable economic activities (European Union 2020). Although it does not explicitly mention FMR in one way or another, the taxonomy contains wording that points to challenges in considering FMR a sustainable activity.16 EU

GBS could be implemented on a voluntary basis by both EU and non-EU green bond issuers, and therefore have quite a broad reach (European

Commission 2020). The European Commission is currently considering the possibility of a legislative adoption of the EU GBS.

Green loans

Green loans are loan instruments used exclusively to finance or refinance, totally or partially, new or existing eligible green projects (Loan Market Association 2018). Green loans mirror green bonds in aim and application but are a much less established asset class. CBI (2020c) estimates that only US$10 billion worth of green loans was underwritten in 2019. The Loan Market Association (2018) published a set of Green Loan Principles that follow very closely the structure of the International Capital Markets Association’s Green Bond Principles and list the same broad eligibility categories for use of proceeds.

FMR projects are likely to face eligibility issues for green loans and green bonds. The CBI taxonomy, for instance, applies not just to bonds but to a variety of debt instruments, including loan facilities and syndicated loans.17

Transition bonds and loans

FMR projects could be eligible for a transition bond or loan—an emerging debt instrument that is meant to fund activities that are not yet operating at or near zero emissions but that present significant decarbonization potential. In response to the tight eligibility criteria of green bonds and loans, several market players have proposed standards for this new category of bonds and loans. All guidelines and proposals are very recent, and none specifically mentions the eligibility of