Background
The European Union (EU) acknowledges the significance of green bonds in the low-carbon transition of its economy. However, since the sustainable finance market is continuously expanding and evolving, it requires guidelines to support transparency and help gain investor trust. Consequently, December 2024 saw the introduction of the EU Green Bond Standard (GBS), a voluntary framework for issuers that wish to use the European green bond (EuGB) label.
Besides additional disclosures around the use of proceeds and a supervisory framework for external reviewers, the EU GBS states that an EuGB labeled bond must allocate at least 85% of the capital raised to EU taxonomy activities. The EU taxonomy defines economic activities that can be considered environmentally sustainable and therefore helps provide transparency and consistency across securities for fixed income investors.
We appreciate the transparency, but several unknowns remain
When our investors choose to allocate funds to sustainable products, they usually have two main goals: financial returns and real-world impact. In our opinion, the EU GBS can potentially help with both.
Firstly, bonds with the EuGB label—which signifies that they are backed by a credible and reliable framework—will likely be more attractive to investors compared with securities that are less clear about their goals. The green bond market is expanding rapidly and if there is an area of it that could potentially draw more demand, this might support performance over the medium-to-longer term.
Secondly, investors who want to have a positive impact on the environment will likely appreciate the transparency provided by the EU GBS. The allocation of proceeds to EU taxonomy activities—combined with more stringent reporting requirements—ensures that there is no ambiguity in what a bond finances. It also puts to bed any subjective discussion on which investments are sustainable and which are not.
Overall, we think that the EU GBS is a good step in the right direction, and we welcome it. The added transparency will facilitate our analysis of potential investment opportunities, and the availability of streamlined allocation and impact reports will make our reporting more robust.. Although the EU GSB requires impact to be reported only once during the lifetime of a bond, we find that more frequent updates are beneficial. In our view, it would be best to include impact metrics in the annual allocation report, as this allows for more in-depth insights and greater confidence among investors.
In general, however, we believe that we can achieve a similar result with securities that are not EuGB labeled. Bonds that adhere to the International Capital Market Association’s Green Bond Principles and confirm alignment with the EU taxonomy, for example, offer one alternative. Additionally, considering the depth of our sustainable investing research at Franklin Templeton Fixed Income, we believe that we can find compelling investment opportunities outside of the green bond-labeled universe.
What’s next for the sustainable finance sector?
Over the past two months, we met with multiple sustainable finance market participants to discuss what the EU GBS introduction might mean for investors. Many believe that a long journey lies ahead and envisage a transition period, during which issuers may comply with part but not all of the EU GBS requirements. Simultaneously, the various new processes—for example, for receiving second-party opinions—will have to be tested.
With the announcement of the first-ever EU GBS bonds, Île-de-France Mobilités (in charge of public transportation in the Paris area and focused on low-carbon transportation alternatives) and A2A (an Italian electric utility company that emphasises renewable energy) became the first movers in this space. We did expect that issuers from corporate sectors that are already quite closely aligned with the new regulations, such as utilities and automotive companies, would most likely be early adopters. At the same time, financials might be motivated to issue EuGBs due to the more stringent local regulations they face, as well as by a desire to appear as market leaders. Many other issuers, such as sovereigns, view the rigorous new requirements as a significant hurdle. They will likely adopt a wait-and-see approach to understand all potential implications before committing to issuing a EuGB.
Conclusion
There are still a lot of uncertainties surrounding the EU GBS, and many market participants will likely wish to gather more information before committing to an EuGB issuance. We therefore expect a gradual ramp-up in interest. Nevertheless, we believe that the increased transparency surrounding green bonds will be welcomed by our clients, who wish to know exactly how their funds are allocated and the impact they achieve. At the same time, our already rigorous approach to sustainable security selection means that we are able to choose different instruments—not just those with a green label—while still providing our investors with the clarity they require.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Sovereign debt securities are subject to various risks in addition to those relating to debt securities and foreign securities generally, including, but not limited to, the risk that a governmental entity may be unwilling or unable to pay interest and repay principal on its sovereign debt.
The manager may consider environmental, social and governance (ESG) criteria in the research or investment process; however, ESG considerations may not be a determinative factor in security selection. In addition, the manager may not assess every investment for ESG criteria, and not every ESG factor may be identified or evaluated.
Green bonds may not result in direct environmental benefits, and the issuer may not use proceeds as intended or to appropriate new or additional projects.
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