New green bond standard in Europe to divide market

The green bond market is likely to skew in favor of banks and other larger issuers when a newly adopted European standard takes effect.

The European Union's much-awaited Green Bond Standard — effective January 2025 — aims to improve the transparency, comparability and credibility of the green bond market. It also aims to help investors assess the environmental, social and governance stance of issuers more closely.

While it sets out to standardize the issuance process, smaller companies could struggle to issue green bonds that comply with the standard, tilting favor to those with greater resources. The green bond market was worth about $90 billion in the third quarter, according to Climate Bonds Initiative data.

"I suspect the market will likely bifurcate toward the high-grade issuers such as larger financial institutions that have the wherewithal and the means to pull all the requirements out of the hat," Roberto Reyes Gaskin, a partner at law firm Latham & Watkins in Paris, told S&P Global Market Intelligence.

The rules require deals to be 85% aligned with the EU's green taxonomy as a minimum. The remaining "flexibility pocket," which accounts for the remaining 15% and includes economic activity that contributes to the EU environmental objectives but is outside of the scope of the taxonomy, will be reconsidered in the coming years.

Companies wishing to follow the standard to issue their bonds face the prospect of having to meticulously document their steps before and after, which has prompted fears that many smaller issuers would shun the green bond market entirely.

The amount of documentation will increase for issuers, as both an allocation and impact report must be published alongside details of how the issuance aligns with the taxonomy. Issuers must also wait for external verification of their bonds both before and after issuance.

It comes in the same year the European Banking Authority reported a "clear increase" in the risk of its banks misrepresenting their sustainability efforts.

The introduction of the standard is necessary, regardless of whether it comes at the expense of smaller issuers, according to Hortense Bioy, director of sustainability research for financial services firm Morningstar UK.

"Investors want and need standards, they take greenwashing accusations very seriously," Bioy told Market Intelligence. "Bifurcation will be one of the side effects, but net-net the standard is very necessary."

Rates declining

European entities issued $45.59 billion in green bonds between July and September, down more than 44% from the previous quarter, according to the Climate Bonds Initiative. Other than the fourth quarter of 2022, it was the region's lowest issuance total since 2020.

The notable decline comes amid worries that the elevated interest rate environment will remain for a longer period and of wider macroeconomic challenges.

"This is leading many companies to focus on [the] shorter-term outlook on a more urgent basis," Jacqueline Heng, a partner at law firm Addleshaw Goddard, told Market Intelligence. Many analysts also agree that stabilization of both interest rates and geopolitical events would lift the green segment.

On a country basis, Germany was the top issuer in the third quarter, with $15.12 billion, followed by the US with $14.38 billion. China's total issuance was $9.36 billion — half that of the prior quarter. Italy, the third-largest issuer in the second quarter, issued almost eight times less than it did in the preceding quarter with $2.23 billion.

The impending arrival of the Green Bond Standard could also have led some issuers to "hit pause" on issuances in the third quarter, according to Reyes Gaskin.

"This is while they figure out what processes and procedures they need to put into place to be able to get a handle on this," Reyes Gaskin said.

In the third quarter, nonfinancial corporates overtook banks and sovereigns as the largest issuers. Issuance by nonfinancial corporates totaled $52.01 billion compared with banks and sovereigns' combined $25.03 billion. Government-backed entity issuances also fell 29% to $10.3 billion in the quarter.

This could be attributed to generally healthier businesses issuing green bonds to access funding and remain consistent with their green asset base and medium- to long-term strategy of transitioning to net-zero.

"In contrast, banks and sovereigns have exposure to the entire cross-section of borrowers and credit," Heng said.

China's conundrum

In China, where the real estate industry comprises approximately 25% of the economy, the country's largest private developer has hit financial difficulty, which is "bound to have an overall dampening effect on sentiment and bond issuance, green or non-green," said Andrew Chew, director of sustainable finance at ING Bank.

"Green bonds are still bonds, after all, and thus are not immune to macro conditions. Despite impact creeping in as a third factor in recent years in the investment-making decision, the 'incumbent' factors of risk and reward still dominate," Chew told Market Intelligence.

Chew expects that stricter standards associated with internationally aligned issuances — such as the China Green Bond Principles — still have to be digested by Chinese issuers.

"We expect a J-curve effect of a temporary drop in volumes before picking up next year," Chew said.