EUROPEAN COMMISSION Strasbourg, 6.7.2021 SWD(2021) 181 final COMMISSION STAFF WORKING DOCUMENT



IMPACT ASSESSMENT REPORT

Accompanying the document Proposal for a

REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on European green bonds {COM(2021) 391 final} - {SEC(2021) 390 final} - {SWD(2021) 182 final}



Table of contents 1.Introduction: Political, economic and legal context 1.1.Political context 1.2.Market context 1.3.Legal context 1.4.Analytical context 2.Problem definition 2.1.What are the problems? 2.2.Consequences 2.3.Wider consequences 2.4.What are the problem drivers? 2.5.How will the problem evolve? 3.Why should the EU act? 3.1.Legal basis 3.2.Subsidiarity: Necessity of EU action 3.3.Subsidiarity: Added value of EU action 4.Objectives: What is to be achieved? 4.1.General objectives

4.2.Specific objectives 5.What are the available policy options and how do they compare? 5.1.What is the baseline from which options are assessed? 5.2.Description of the policy options 5.3.Policy Dimension 1: Scope of application for green bond issuers (and core requirements of the EU GBS) 5.4.Policy dimension 2: Regulatory treatment of external reviewers of EU GBS-aligned green bonds 5.5.Policy dimension 3: Flexibility for sovereign issuers 5.6.Options discarded at an early stage 6.Preferred option 6.1.Policy dimension 1: scope of application 6.2.Regulatory treatment of external reviewers of EU GBS-aligned green bonds 6.3.The extent of flexibility for sovereign users of the EU GBS 6.4.Alignment with objectives 6.5.Analysis of the expected take-up of standard 7.How will actual impacts be monitored and evaluated? Annex 1: Procedural information 1.Lead DG, Decide Planning/CWP references 2.Organisation and timing 3.Consultation of the RSB 4.Evidence, sources and quality

Annex 2: Stakeholder consultations and selected interviews 1.Targeted Consultation on the EU Green Bond Standard 2.Online consultation on the renewed sustainable finance strategy Annex 3: Who is affected and how? 1.Practical implications of the initiative 2.Summary of costs and benefits Annex 4: Market Context and controversies Annex 5: Market developments Annex 6: Costs and benefits of issuing green bonds Annex 7: Standards and definitions of green Annex 8: EU Taxonomy – coverage and related disclosure obligations 1.What is the Taxonomy? 3.What does the EU Taxonomy cover? 4.Studies on Taxonomy alignment and coverage 5.Case study: energy intensive industry and hard-to-abate manufacturing sectors Annex 9: External review Annex 10: Sovereign bonds 1.Market situation 2.Potential flexibility 3.Summary of responses to questionnaire on sovereign green bonds

4.Analysis: Comparison of key EU Sovereign green bonds and the EU Green Bond Standard 5.Case study: Luxembourg’s Sustainability bond framework Annex 11: ESG Disclosure obligations Annex 12: Legal basis 1.Legal basis 2.Subsidiarity: Necessity of EU action 3.Subsidiarity: Added value of EU action Annex 13: Options discarded at an early stage Annex 14: EU Green Bond Standard as recommended by TEG Annex 15: Project green bonds to support the green transition and the EU Green Deal Annex 16: Summary of responses to stakeholder questions on Social bonds Glossary Term or acronym Meaning or definition AUM Assets Under Management CBI Climate Bonds Initiative CSR Corporate Social Responsibility DG FISMA Directorate-General for Financial Stability, Financial Services and Capital Markets Union DNSH Do No Significant Harm EIB European Investment Bank ESAs European Supervisory Authorities ESG Environmental, Social and Governance ESMA European Securities and Markets Authority EU GBS EU Green Bond Standard ETS Emissions Trading System FTE Full-Time Equivalent GBP Green Bond Principles GHG Greenhouse Gas HLEG High Level Expert Group [on Sustainable Finance] ICMA International Capital Markets Association KID Key Information Document KPIs Key Performance Indicators MS Member States NACE Statistical Classification of Economic Activities in the European Community NECPs National Energy and Climate Plans NFRD Non-Financial Reporting Directive NGOs Non-Governmental Organisations OECD Organisation for Economic Co-operation and Development PEPP Pan-European Personal Pension Product PRI Principles for Responsible Investment RSFS Renewed Sustainable Finance Strategy RTS Regulatory Technical Standards SDG Sustainable Development Goal SFDR Sustainable Finance Disclosure Regulation SPO Second Party Opinion TEEC Transition Énergétique et Écologique pour le Climat (French Label for the Energy and Ecological Transition) TEG Technical Expert Group on Sustainable Finance TFEU Treaty on the Functioning of the European Union TSC Technical Screening Criteria UCITS Undertakings for the Collective Investment of Transferable Securities 1.Introduction: Political, economic and legal context This impact assessment concerns a proposed initiative to establish an official EU standard for green bonds based on the EU Taxonomy for sustainable finance, and to establish a regime for registering and supervising companies acting as external reviewers for green bonds aligned with this standard. 1.1.Political context This initiative is part of the European Commission’s 2021 Work Programme and is one of the actions proposed by the European Commission to implement the European Green Deal . In their December 2020 Conclusions , the European Council mentioned that “the EU should promote the development of common, global standards for green finance”, and invited the Commission to “put forward a legislative proposal for an EU green bond standard by June 2021 at the latest.” To transition to a climate neutral economy and reach the EU’s environmental sustainability objectives, significant investment is required across all sectors of the economy. The achievement of the EU’s current 2030 climate and energy targets would require in the period 2021-30 energy system investments (excluding transport) of EUR 336 billion per annum (in constant prices of 2015), equivalent to 2.3% of GDP. The bond market can facilitate green transition investments and thereby help reach the EU’s environmental targets. Bonds are already one of the main instruments used for financing fixed assets in sectors related to energy and resource efficiency. In addition, several industry-led initiatives and guidance documents exist for the purpose of issuing so called ‘green bonds’.

This green bond market has seen vigorous growth in the number and volume of green bonds issued, both in the EU and globally. Despite this trend, green bonds remain a fraction of the overall bond market, representing about 3 to 3.5 % of overall bond issuance in 2019. Further growth in the market for high quality green bonds could be a source of significant green investment, thereby helping to meet the investment gap of the European Green Deal. The EU is a global leader in green bonds, with 48% of the around EUR 253 billion of global green bond issuances in 2020 denominated in euro. Providing a trusted regulated environment that supports the issuance and creation of green bonds would also promote the international role of the euro, and help to achieve the goal of developing EU financial markets into a new ‘green finance’ hub. The Commission committed to developing an EU Green Bond Standard (EU GBS) in its Action Plan Financing Sustainable Growth adopted in March 2018. As a first step, the Commission asked the Technical Expert Group on Sustainable Finance (TEG) to produce a report on an EU GBS. The TEG published its interim report in March 2019, followed by a call for feedback period. The final report with a draft EU Green Bond Standard was published in June 2019, and the TEG also published a usability guide for the draft standard in March 2020. 1.2.Market context Green bonds are a relatively new form of debt instrument that provide investors with additional commitments and transparency on the green use of proceeds. In the typical “use of proceeds” model, issuers commit to spend the money raised or an equivalent amount on environmentally sustainable investments. This information is usually contained in separate stand-alone documents, not within the bond’s prospectus or other legal documentation (bond covenants etc). Under existing market practices and regulations, green bonds are legally no different from conventional bonds. The use of proceeds model enables a wide-range of approaches, including securitisation bonds, revenue bonds, project bonds, covered bonds, and other debt instruments. The success of green bonds can be traced back to growing demand for green financial assets from investors, especially institutional investors such as insurance companies, pension funds, and investment funds. These assets allow them to meet their self-set targets for the green proportion of their investment portfolios. As evidenced by the recent growth of the green bond market, some issuers have been willing to absorb the additional administrative costs associated with the greater transparency and credibility requirements for investors. For issuers, issuing a green bond offers a strategic marketing opportunity to showcase their green commitment and ambition to existing or new investors, possibly as part of the broader corporate or institutional green transition. This allows issuers to enlarge and diversify their investor base, as new dedicated green and socially responsible investors enter the market and drive demand for these types of bonds. Alongside the signalling effect, green bond issuance also provides issuers with an opportunity to improve their procedures for handling and acting on sustainability-related information, such as climate-related risks. In this way, issuers may use green bonds as an organisational opportunity to boost their adaptability to the changing environmental and regulatory context, thereby improving their future competitiveness and profitability through a first-mover advantage, or allowing public organisations to better respond to the demands of their stakeholders. Analysis of the current market for green bonds in the EU and world-wide indicates that the market is growing rapidly. In the EU27, the number of green bonds issued has been growing by about 47.2%, while the volume has been growing by about 50.9% per year between 2015 and 2020. This growth is driven by inter alia the following factors: -Increasing need to finance investments that help to mitigate the risk of climate change -Increasing demand from institutional investors and their clients to hold green financial assets, for example to hedge against the risk of stranded assets and make a positive impact against climate change. -Intensifying competition among financial market participants to offer such green financial products (such as green investment funds) to investors. -An overall legislative and political environment favouring transparency on the sustainability of investments (including requirements for financial market participants to disclose the alignment of their investments with the EU Taxonomy Regulation). These factors are all linked to the growing awareness about the need to tackle the risk of climate change, and are therefore likely to remain relevant factors in the long run. For this reason, it is reasonable to assume that the green bond market is likely to continue growing, potentially at or close to its current course. Based on projections in annex 5, this would mean that yearly EU green bond issuance in 2023 could reach EUR 430 billion, spread out over roughly 1350 green bond issuances. The development of standards Along with the growth of the green bond market, market players have cooperated to standardise practices and develop guidelines for green bond issuance. Such so-called standards benefit both issuers and investors: 1.For issuers, a widely accepted standard conveys investors’ expectations and thus reduces the need for specialised advisory services to issue a green bond that would be accepted as green by investors. It increases the credibility of the issuer’s sustainability commitments and mitigates the potential reputational risk of accusations of ‘greenwashing’. 2.For investors, it provides increased certainty that their investments are being used to deliver real environmental objectives without having to conduct their own extensive due diligence.

Currently, the most commonly-used market standard is the Green Bond Principles (GBPs), which are process-based guidelines maintained by the International Capital Market Association, or ICMA . To align with this standard, a green bond’s proceeds should finance assets and projects with positive environmental impacts. The standard sets out a clear process for the selection of projects and the allocation and tracking of funds, although it lacks a clear definition of green economic activities. Bond issuers should also report on the use of proceeds including, if possible, information on the environmental impact of the projects. In addition, the GBPs recommend obtaining a third party external review. Other standards are also widely used, including the more prescriptive Climate Bond Standard, developed by the Climate Bonds Initiative (CBI). The CBI standard sets the same basic requirements as the ICMA standard, which means that any bond compatible with the former should normally also be compatible with the latter. However, unlike the GBPs, the CBI includes a taxonomy with screening criteria to define green economic activities, and the requirement for green bonds to be certified by approved external reviewers. About a quarter of green bonds issued in 2020 were certified according to the CBI standard. Table 1 below compares ICMA’s Green Bond Principles and CBI’s Climate Bonds Standard. More details are available in annex 7. Green Bond Principles Climate Bonds Standard Owner International Capital Markets Association Climate Bonds Initiative Reach The dominant international standard (used by most of the international green bond market) 24% of all green bonds issued in 2020 Environmental objectives Climate mitigation and adaptation, natural resources, biodiversity, and pollution prevention and control. Low-carbon and climate resilience Main requirement on use of proceeds 100% green 100% aligned with climate bonds Taxonomy and certified by external reviewer. Definition of green High level categories for eligible projects Climate Bonds Taxonomy covering eight sectors. Screening criteria N/A Screening criteria available for some sectors, including power generation, transport, buildings, and other sectors. External review requirements Recommended Dedicated certification scheme – certification is required both pre-issuance and post-issuance (2 years after) Requirements for external reviewers High level guidelines for external review External reviewers must be pre-approved by CBI. High-level requirements. Allocation reporting Not required Required Impact reporting Recommended Recommended External review The development of these new standards has been accompanied by the growing use of external review to provide assurance to investors. It is common market practice for green bonds issuers to contract a third party to review the green bond documentation, either prior to bond issuance (to check alignment of the bond framework against the respective standard) or post-issuance (to check alignment of the projects funded by the bond against eligibility criteria). This is recommended under the ICMA GBPs and required under the CBI standard. External review is sometimes referred to as “verification”, for example in the TEG’s draft EU GBS. According to the TEG report, external reviews have become common market practice in the EU green bond market. Research conducted by the Luxembourg Stock Exchange indicated that more than 85% of issuers use some form of pre-issuance review and of this grouping, 98% were in the form of an external review. 1.3.Legal context Furthermore, on 21 April 2021 the Commission adopted a proposal to review the NFRD, which currently imposes reporting requirements on large public interest entities with more than 500 employees. It is expected that this review will expand the scope of companies falling under the NFRD from 11 700 to close to 50 000 companies. The Commission also proposed that companies subject to the NFRD should be required to obtain limited assurance on their non-financial reporting. This would substantially increase the availability of information on the share of Taxonomy-aligned assets of EU companies, and should help facilitate and reduce the costs of issuing Taxonomy-aligned green bonds.

Another relevant development is the entry into application, as of March 2021, of the Sustainable Finance Disclosure Regulation (SFDR), which governs how financial market participants (including asset managers and financial advisers) should disclose sustainability information towards end investors and asset owners. Under this Regulation, financial market participants will also be required to report on the share of Taxonomy-alignment of the assets in which they invest, including potentially, green bonds. The European Commission is also currently working on establishing criteria for a new EU Ecolabel for Financial Products. It will apply to retail financial products, such as equity funds and bond funds, and it will be legislated using an extension of the EU-ecolabel Regulation. This means the EU Ecolabel for financial products would rely on an existing “brand”, which already benefits from a certain consumer recognition. While financial instruments such as bonds and equity will not be directly eligible for the EU Ecolabel, as they are financial instruments and not retail financial products, they will qualify indirectly, as part of bond or equity fund portfolios. The Commission aims to create a coherent approach to sustainable financial products based on increased transparency and the use of the EU Taxonomy. It is expected that the definition of green in the criteria for the new EU Ecolabel for financial products will be based on the EU Taxonomy, and that EU GBS bonds would be eligible for EU Ecolabel bond fund portfolios. This could incentivise investment in bonds aligned with the future EU GBS. In conclusion, the EU Green Bond Standard is one of several interlinked initiatives that aim to incentivise (in the case of the EU GBS) or require (in the case of the Taxonomy, reviewed NFRD, and SFDR) the disclosure of Taxonomy aligned green assets by corporations in the EU. For this reason, the impact of the EU GBS initiative should be considered in the context of the aforementioned initiatives. The Delegated Acts setting out the technical screening criteria for the “Substantial Contribution” and “Do No Significant Harm” conditions for the two environmental objectives of climate mitigation and climate adaptation was adopted in June 2021 and will enter into force by the end of 2021 subject to a 6-month scrutiny period by co-legislators. The entry into force of the delegated acts covering the other four environmental objectives of the Taxonomy should follow 12 months later. For this reason, it is expected that at least the climate-related part of the Taxonomy would be in place before the EU GBS enters into force, and potentially all six environmental objectives of the Taxonomy. 1.4.Analytical context This impact assessment aims at providing an unbiased, comprehensive and evidence-based assessment of the trade-offs implied by the potential policy options. Significant efforts have been undertaken to support the analysis. In addition to the evaluation of the stakeholder consultations and the work of the TEG, market data was collected from external databases to map the green bonds market with a view to informing the regulatory response. Further cost data and cost estimates were collected from stakeholders and supervisors directly. A key limitation of the analysis pertains to the extent to which the current green bond market aligns with the technical criteria under the Taxonomy Regulation. Given the current supervisory reporting and public disclosure frameworks, the availability of relevant data and information is sporadic and lacks necessary depth to carry out a data-driven analysis. Information was however collected in the form of stakeholder feedback. It should be noted that an assessment of the taxonomy criteria is not material to the available policy choices under this initiative. Co-legislators have already taken such choice in the form of adopted primary legislation. As mentioned above, the legal drafting of the Taxonomy Regulation rules out a Commission initiative on green bonds which stands disassociated from the taxonomy-based criteria. Only the taxonomy criteria may be used to define an ‘environmentally sustainable economic activity’. The choice to deviate from this definition is excluded given the objective to define and standardise bonds which finance environmentally sustainable activities. As such, there is no policy option that would require a further assessment of the usability of the taxonomy criteria (excluding for sovereign bonds). A broader market assessment based on the available data is provided in the impact assessment supporting the Delegated Regulation on the Taxonomy. In view of these constraints on the initiative, the collective evidence stemming from the different methodological approaches overall can be considered to be sufficiently sound as a basis for the impact assessment. Two factors limit the amount of quantitative analysis included in the present report, namely (1) the difficulties with using existing data to estimate the effect of a currently inexistent framework, and (2) the intangible nature of certain benefits of green bond issuance, such as the green bond premium, or a reputational boost. Despite these hindrances, this analysis takes a quantitative approach to cost benefit assessment where possible. Annex 3 sets out a quantitative estimate of the costs of registration and supervision by ESMA for external reviewers, as well as a related estimate of the cost for issuers of making use of external review services under the proposed EU GBS. Annex 6 includes estimated ranges for the green bond premium, although the data on the size of this premium is inconclusive. At the same time, other reported benefits of green bond issuance, such as a reputational boost for the issuer, could not be quantified, and little relevant literature was found no this topic. For these reasons, the cost-benefit assessment in section 6, which brings together all these elements, is mostly qualitative. 2.Problem definition 2.1.What are the problems?

The current impact assessment considers the functioning and interplay of two closely interlinked markets: the market for green bonds (in particular high quality green bonds) and the market for external review services, used to give investors assurance about the alignment of their green bond to existing market standards. This section will identify the main problems affecting the two markets in scope, and their consequences. It will then consider the underlying problem drivers. 2.1.1.For investors: Costly/difficult to identify high quality green bonds The green bond market suffers from a moral hazard problem that reduces trust in the market and drives up costs for investors (and issuers). The problem can be summarised as follows: once an investor has bought a “use of proceed” green bond, it relies on the issuer to follow up on the green commitments made, usually in terms of investing bond proceeds in certain activities. From the issuer side, green bond issuance can be profitable, for instance due to reputational gains or potential price benefits from issuing green debt. But the real costs associated with following up on green commitments create an incentive for the issuer to shirk on the commitments made to investors once the bond has been issued. If so, investors will be the main losers, as the bonds they hold will no longer be green. For these reasons, investors may worry about the greenness of the bond and want to verify the bond’s greenness ex ante. However, investors currently face significant constraints to (i) determine the positive environmental impact of a bond, and (ii) compare different green bonds. Despite the existence of several commonly used market standards, which to a certain degree overlap and can be used conjunctively, the green bond market does not sufficiently enable investors to identify high quality green bonds. In particular, definitions of green projects vary or are inexistent. For example, the dominant market standard (ICMA’s Green Bond Principles) relies on high-level principles for eligible green projects, not detailed criteria. As for the more prescriptive CBI standard, its privately maintained definitions omit many potential sectors of green economic activities. Also, the quality and role of external review varies widely. ICMA GBPs has no clear and formalised mechanism to guarantee the quality and integrity of the external review process, for example through registration and supervision of external reviewers of green bonds. As for the CBI standard, it includes certification but lacks a rigorous mechanism for supervising the conduct of those external reviewers. Because of this lack of standardised definitions of green projects, lack of standardised transparency requirements, and the varying quality of external review, investors may need to expend time and resources on assessing and double-checking information published by existing green bonds issuers. While this situation is already problematic today, two trends further aggravate the moral hazard problem, which could accentuate the issue in the future: 1)As explained in Annex 6, demand for green bonds is increasing, which may have the effect of driving up green bond premia, and thereby increase the incentive for issuers to issue green bonds. 2)As explained in Annex 8, the green bond market is increasingly expanding into sectors where it is more difficult agree on what is sustainable, such as manufacturing. While sovereigns also are confronted with controversies around green bonds, and in particular the need to better define green proceeds, the risk to investors is less acute, as sovereigns generally have a transparent approach to use of proceeds, and benefit from high levels of trust in the green bond market, as evidenced by green bond premia for sovereigns, which are relatively high. 2.1.2.For issuers: Additional costs for issuing a green bond (due to market fragmentation) Issuing a green bond already requires additional cost for issuers, for example in terms of reporting, external review, and internal reorganisation and training. However, the moral hazard problem referred to in 2.1.1 means that issuers are under increasing pressure to demonstrate the greenness of their bonds. The diversity of market practices in the green bond market (both with regards to definitions of green, and the market for external review) means that issuers may need to incur additional costs in order to enhance the credibility of their green issuance: ·In the case of corporate green bond issuers, investors frequently require issuers to obtain an ESG rating for their company. This is in principle an unnecessary cost, since the green bond itself and the underlying projects are usually already reviewed by an external reviewer. ·Issuers, and in particular first-time issuers, may need to spend significant resources deciding which standard to make use of, due to the diversity of market practices. ·The lack of a common definition of green and of a green bond means that issuers may need to spend additional resources, e.g. on additional advisory services, to demonstrate the green credentials of their bond, even after the requirements of the chosen standard has been met. 2.1.3.For issuers: Uncertainty around green assets, potential reputational risks There is overall uncertainty on the type of economic activities that can be considered green, due to a lack of international agreement on such definitions. This has helped to cause some issuers to experience reputational damage as stakeholders questioned the greenness of their bond. Collected feedback shows that the fear of adverse publicity because a deal is deemed “insufficiently green” has prevented some issuers from tapping the market. This is particularly the case in economic sectors that are very important for the transition to a low carbon economy, but where the identification of green assets and projects is not straightforward due to a lack of carbon neutral and/or otherwise fully sustainable alternative production process and technology, such as steel or cement industries.

So far, these sectors have seen relatively limited green bond issuance. 2.2.Consequences 2.2.1.Potential future market disruption from greenwashing As the current market for green bonds is based on voluntary market standards with minimal government intervention, it mainly relies on trust among investors and issuers. While controversies relating to alleged greenwashing of the bond itself or the underlying projects are relatively rare, a more frequent criticism relates to the sustainability credentials of the green bond itself. However, with continued fast market growth and in the absence of regulatory intervention, the risk of major controversies regarding greenwashing, insufficient environmental impact of a bond, or issues linked to a bond not complying with minimum social standards, for example, will only increase. But as the market grows, and as the problems identified in section 2.1 become more acute, the risk of such incidents and their potential impact on the functioning of the whole of the green bond market increase. In addition, while issuers might communicate their green promises for the use of proceeds in their marketing and standard related documents, such information is not systematically included in the contractual and regulatory documents for the bond transaction, which can make it difficult for investors to hold issuers to account for honouring their green commitments. The combination of these factors may lead to situations where investors are given a false sense of the sustainability impact of the funded project or asset. In effect, the sustainability impact may fall short of investor’s initial expectations. If this should occur, investors could risk financial losses, as they may have to sell their bonds because they no longer comply with investment guidance or criteria, particularly in the case of institutional investors. Any such incident could disrupt the current green bond market by creating reputational problems for the whole sustainable investment market, reducing the trust of investors on which this market relies, and further increasing costs for issuers. 2.2.2.Not enough high quality green bonds issued compared to market demand In their June 2019 report, the TEG found that there was a fundamental problem of lack of supply in the market for green bonds, as evidenced by the frequent oversubscription of green bond auctions or sales. In 2019, demand for green bonds outstripped supply by more than 5 to 1, compared to a ratio of 3 to 1 for conventional bonds. This means that the green bond market is not exploiting its full potential for growth. Green bond issuance is conditional on the existence (or creation) of a corresponding amount of green investments on the issuer’s balance sheet. For this reason, the lack of eligible investment is the main limiting factor for green bond issuance. This factor is out of the scope of this impact assessment. However, the problems for issuers identified in 2.1 also play a part in limiting supply. The problem of uncertainty around green assets and potential reputational risks serves to dissuade potential green bond issuers. At the same time, the additional costs for issuing a green bond due to market fragmentation contribute to reducing the net benefits of green bonds, and therefore indirectly reducing issuance. 2.3.Wider consequences 2.3.1.Risk that not enough investment is channeled towards projects with substantial climate and environmental impact The market for high quality green bonds is important for channelling funding into the type of fixed investments needed to reach the EU’s climate targets. However, despite the overall situation of growth, the problems and consequences identified in 2.1 and 2.2 constitute market barriers that could trap the market in an inefficient equilibrium and hinder future market development. If not enough high quality green bonds are issued to respond to market demand, there is a risk that substantial funding is instead diverted to activities and projects that – while they may have environmental benefits – are not substantially contributing to the EU climate and environmental objectives.

In order to fund climate mitigation, climate adaptation, and wider environmentally sustainable purposes, the market for high quality green bonds therefore needs to be supported to reach its maximum potential. 2.4.What are the problem drivers? The problem drivers can be divided into those affecting the market for external reviewers, and those affecting the market for green bond issuance. 2.4.1.External review market: Heterogeneity, lack of transparency, and potential issues relating to conflicts of interest in the external review market The external review (see Annex 9) is usually carried out by third parties, according to procedures which are specific to each reviewer, and which have emerged organically alongside the development of various market standards. For this reason, there is also a considerable amount of diversity in market practices and in the quality of services provided. In turn, this diversity obstructs market transparency and hinders the market from functioning effectively and from delivering high quality external review services that serve the interests of issuers and investors alike. To give only a few examples of market diversity: -External reviews may include a consideration of the ESG rating of the issuer, or not. -They may rely on the project categories of ICMA’s Green Bond Principles, or more prescriptive definitions of green projects. -They may be valid for several transactions or concern specifically the pre-issuance or post-issuance stage of the bond. -There is also a wide variety of actors: non-financial rating agencies specialising in second party opinions, big-four audit firms providing mostly post-issuance verification, credit rating agencies, and global technical inspection and certification bodies are all active in the external review market. In its report, the TEG also highlighted a number of challenges in this sector, including variable quality of assessments, potential lack of independence or management of potential and actual conflicts of interest and the handling of potentially price sensitive information. This situation can lead to information asymmetries and a reduction in overall trust in the green bond market and the integrity of the credentials of specific bonds. The range of differing approaches by entities with varying levels of expertise in environmental matters can create uncertainty for issuers and investors on the actual value, quality and impact of external reviews. It can also lead to duplication and increased costs. In Deschryver and de Mariz (2020), investors note the lack of a consistent certification system, in comparison with credit ratings in the conventional bond market. In addition, given the lack of a common classification system and criteria, some issuers in fact engage with multiple reviewers in order to attain a higher degree of certainty and investor confidence. Another common practice is for issuers to obtain ESG ratings in addition to the external review, as many investors associate the greenness of the bond with the greenness of the company itself. This gives rise to additional costs that would potentially not arise if these issuers could instead more fully rely on the opinion of the external reviewer. In January 2021 the Commission published an extensive study on the market for Sustainability-Related Ratings, Data and Research, which overlaps to some extent with the market for external review services. The study noted that while efforts to develop common voluntary standards for sustainability-related product and service providers have been undertaken, none have been firmly established across the market. The study also highlighted the increasing array of sustainability-related product and service providers operating in this growing market, which emphasises the need for greater transparency across the industry in terms of methodologies, disclosures and how research providers assess the performance of green assets and investments. Amid increasing demand, more financial data and research providers and credit ratings providers are entering the sustainability-related products and services market, which is leading to increased merger and acquisition activity as those traditional players to expand their service offerings by buying up specialised sustainability-related providers. The high level of industry consolidation identified in the study also highlights the potential for conflicts of interest to emerge, particularly associated with providers both evaluating companies and offering paid advisory services. Concerns have been raised about potential conflicts of interest and quality control issues: at present, there is no legal framework in place for minimum operational requirements and safeguards, nor for registration or authorisation and supervision of external reviewers, as the industry has developed organically without regulatory support. A report by Bloomberg Law indicates that most external reviewers are not subject to any stand-alone independence requirements and in some cases, reviewers and their affiliates also provide advisory services to potential green bond issuers, which may raise independence issues. The report highlighted that the conclusion or opinion provided by external reviewers can vary depending on the provider in particular, and on differing definitions of what constitutes a ‘green’ investment, particularly the difference between ‘dark’ and ‘light’ green.

External reviewers fulfil an important role in bridging the gap between analysing potentially complex green projects and assessing them against the requirements of the EU Taxonomy and assisting investors with making suitably informed investment decisions. It is therefore important that potential conflicts of interest are managed and averted, ensuring an appropriate level of market transparency. The absence of a supervisory framework for external reviewers with minimum standards to ensure the quality and objectivity of their reviews combined with a lack of transparency regarding their activities could lead to the misallocation of investments or even greenwashing, which would damage investor confidence in the EU GBS market and undermine the future development of the EU GBS market. The situation is less urgent in the case of sovereign issuers, who frequently make use of state auditors instead of external reviewers. These state auditors typically have legally guaranteed independence, and there does not appear to have been any controversies regarding their performance of the external review tasks. More information available in Annex 9 on external review. 2.4.2.Green bond market: Imperfect information due to a lack of clear and harmonised definitions of green projects and green bonds. The market for green bonds is hampered by the lack of clear and comprehensive definitions of a green economic activities to guide green bond issuance, and of a common yet prescriptive standard for green bond issuance. The most commonly used standard, ICMA’s Green Bond Principles, is market-developed, mostly principles-based and does not refer to a specific taxonomy of eligible green projects. The more ambitious CBI standard includes a market-based Taxonomy, but it only covers climate-related matters, leaving out important sectors for further emission reductions, or areas where it is more difficult to agree on the definition of green, such as high emission manufacturing. The creation of the EU Taxonomy is an attempt to address this situation, by providing comprehensive and granular definitions of how various economic activities can qualify as environmentally sustainable (more information in Annex 8 – the Taxonomy). The EU Taxonomy will be freely available for existing standards to make use of, if they wish. However, in order to make use of the detailed definitions of the Taxonomy in the “use of proceeds” space, and ensure that investors can have proper trust that the strict criteria are complied with, it is necessary to have a standardised system of verification with qualified and experienced entities checking that the relevant Taxonomy-criteria have been met. As explained in 2.4.1, the current practices around external review do not currently meet this requirement, and so far there are no indications that existing market-based standards intend to impose a more stringent oversight over external reviewers. It is also not clear whether it would be feasible for market based standards to operate a rigorous system of monitoring of external reviewers. For this reason, it is unlikely that market-based standards will be able to credibly enforce Taxonomy-alignment of standards within an acceptable timeframe. This situation of imperfect information poses problems for both issuers and investors, in particular those with high sustainability-related ambitions. Without a clear definition of green, environmentally ambitious issuers are lacking a clear and reliable way to signal this to investors. As for investors, who are increasingly on the lookout for green debt instruments to add to their portfolios, their search is complicated by the fact that there is no commonly accepted definition of a green bond, in particular on the more environmentally ambitious segment of the market. 2.5.How will the problem evolve? Without EU action regarding green bonds, the most likely outcome would be the continued development of differing market-based standards for green bonds or new legislative initiatives at national level. For more information, see section 5.1 – what is the baseline? The TEG has pointed to the large range of approaches in the field of external review as a potential source of problems, creating uncertainties for issuers and investors on the actual value, quality and impact of the external reviews. Concerns have been also raised about potential conflicts and quality control issues in this market. Without a legal framework in place, the market cannot provide for the registration and supervision of external review on its own, and thus most of these issues would likely remain unaddressed. Because of the expected strong growth of the green bond market, the vulnerabilities that exist within the current market-based system are likely to grow, which may amplify the risk of a potential high impact or high visibility occurrence of greenwashing. Such an incident could potentially create reputational problems for the whole green bond market, thereby reducing the trust of investors on which this market relies, and increasing costs for issuers. 3.Why should the EU act? 3.1.Legal basis The legal basis for this initiative is Article 114 of the Treaty on the Functioning of the European Union (TFEU), which confers to the European institutions the competence to lay down appropriate provisions that have as their objective the establishment and functioning of the internal market.

Taking into account the criteria set out in the Vodafone case (C-58/08) Article 114 TFEU allows the EU to take measures not only to eliminate existing obstacles to the exercise of the fundamental freedoms, but also to prevent the likely emergence of such obstacles in the future. This also includes those obstacles that make it difficult for market participants, such as issuers of green bonds or investors, to take full advantage of the benefits of the internal market. Although other national legislation exists stipulating a framework for green bond issuance (e.g. in China), no EU Member State has yet legislated to establish an official green bond standard at national level. The current EU market for green bonds is therefore entirely based around market-defined standards and practices, with assurance to investors provided by companies acting as external reviewers. These market-based standards set out high-level process-based guidelines or recommendations, but as outlined in Section 2, the underlying definitions of green projects are insufficiently standardised, rigorous, and comprehensive. For this reason, various practices co-exist, which make it costly for investors to identify genuine green bonds. In light of the continued growth of the green bond market and its role in funding the type of fixed investments needed to reach the goals of the Paris agreement, it is likely that some Member States would consider creating a standard at national level, or establishing national guidelines. Such national standards would likely seek to address the same problems that the proposed EU GBS initiative aims to address, but the results may be divergence across EU Member States. There are already examples of Member States operating with diverging frameworks in their issuance of sovereign green bonds, or in the area of labels for environmentally sustainable financial products. For this reason, it is likely that disparities between national laws would emerge that obstruct the fundamental freedoms and undermine a European level playing field. Therefore there is an identifiable need for a harmonized green bond standard to be applied across the EU. 3.2.Subsidiarity: Necessity of EU action For now, Member States seem to refrain from establishing national legislation, which is likely linked to the widespread expectation that the Commission will act in this area, as announced in the 2018 Sustainable Finance Action Plan. In consultation feedback, many EU Member States have been calling for a harmonized green bond standard at EU level. However, in the absence of such a harmonised standard, it is predictable that Member States would bring forward their own legislation in the area of green bonds. Without EU action regarding green bonds, the most likely outcome would be the continued development of market-based standards for green bonds or new legislative initiatives at national level. Such uncoordinated actions at national level may lead to a proliferation of diverging green bond standards, which would fragment the green bond market in the EU and potentially hamper cross-border investment flows. The EU GBS would ensure a level playing field and reduce the potential scope for disparities across the EU while supporting the attainment of the EU’s sustainable finance policy objectives. It also has the potential to become a leading global standard for green bonds. An intervention at the EU level is more likely to successfully define consistent requirements for the internal market and thereby prevent market distortions. Therefore, a legislative measure (based on Article 114 TFEU) would further improve the functioning of the Single Market. 3.3.Subsidiarity: Added value of EU action In a similar way to the bond market, the green bond is an inherently international market made up of issuers, typically larger companies, seeking out a broad and diverse population of investors, and investors seeking out the highest possible liquidity and frequently trading debt on cross-border secondary markets. For this reason, national legislation to tackle the failures identified in the green bond market would have the potential effect of fragmenting a market which is inherently international. The market for external reviewers of green bonds is also a cross-border market. In order to preserve a level playing field for the companies providing external review services, any legislation setting up a regime for the registration and supervision of these entities should also be at EU level. Finally, given the many interactions between a potential initiative for an EU Green Bond Standard, and other relevant EU-level legislation, such as the Taxonomy Regulation, an EU instrument appears to be more suitable. A possible intervention at EU level therefore complies with the principle of subsidiarity as set out in Article 5 of the TFEU. For a detailed analysis of the legal basis, see Annex 12. 4.Objectives: What is to be achieved? This initiative is a direct response to vocal requests from green bond investors and issuers alike for a credible and high-quality standard for Taxonomy-aligned green bonds, as expressed for example in the targeted consultation on the EU GBS. According to this feedback, such an initiative should standardise and develop the market for green bonds and set the global standard for the application of the EU Taxonomy in green bond markets, so that green bonds become a genuine tool for the EU to transition towards climate neutrality. Building on this feedback, this section sets out the main objectives for this initiative. 4.1.General objectives The general objective is to better exploit the potential of the single market to contribute to meeting the EU’s climate and environmental objectives, in accordance with Article 2(1)c of the Paris Agreement, by -facilitating further development of the market for high quality green bonds, while -minimising disruption to existing green bond markets, and -attracting sovereign issuers to the framework while catering to their specificities



This would be achieved by establishing a standard (or similar) for high quality green bond issuance that would: -Improve the ability of investors to identify and trust high quality green bonds -Facilitate the issuance of high quality green bonds, by: -reducing costs from market fragmentation -clarifying green definitions and reducing the reputational risk for issuers from sectors that are not sufficiently covered by existing market-based taxonomies -include some flexibility for sovereigns issuers. 4.2.Specific objectives There are two specific objectives, which relate to the two problem drivers identified in section 2.4. 4.2.1.The EU GBS should clarify and harmonise definitions of green projects and green bonds By aligning green bonds with the EU Taxonomy, this initiative should contribute to clarifying green definitions on the bond market. This should help investors in the process of identifying high quality green bonds, comparing them against each other, and mitigating against the risk of greenwashing. It should also help issuers in the process of issuing green bonds and identifying green economic activities on their balance sheets. 4.2.2.The EU GBS should harmonise outcomes, improve transparency, and address potential conflicts of interest for external reviewers External review is a well-established market practice and a core part of almost any green bond issuance, irrespective of the type of issuer or the standard followed. However, as detailed in 2.2, a wide-range of market practices and actors co-exist in a limited space. This initiative will aim to strengthen external review for the high quality EU green bonds, and improve its quality, usefulness, and trustworthiness for investors, by harmonising outcomes, addressing conflicts of interest, and improving transparency and oversight over the overall process. For the EU GBS itself, the requirements for external reviewers are intended to provide an additional level of assurance to issuers and investors that those external reviewers that are registered have implemented effective policies and procedures to ensure the quality, independence and overall integrity of their assessments. This will make the EU GBS distinct from other green bond standards in the market and support the intention to establish the EU GBS as the gold standard for green bonds. Problems Objectives For investors: Costly/difficult to identify high quality green bonds For issuers: -Additional costs for issuing a green bond due to market fragmentation -Uncertainty around green assets, potential reputational risks Improve the ability of investors to identify and trust high quality green bonds Facilitating issuance of high quality green bonds by: -Reducing costs from market fragmentation. -Clarifying green definitions and reducing the reputational risk for issuers. Problem drivers in the external review market Specific objectives in the external review market Heterogeneity, lack of transparency, issues related to conflicts of interest Harmonising outcomes, improving transparency, and addressing conflicts of interest. Problem drivers in the green bond market Specific objectives in the green bond market Lack of clear and harmonised definitions of green projects and green bonds. Clarifying and harmonising definitions of green projects and procedures for issuing green bonds. 5.What are the available policy options and how do they compare? 5.1.What is the baseline from which options are assessed?

Under the baseline, there would be no Commission action in the green bond market, whether in the form of legislation or guidance. This would maintain the status quo in the market, with most green bond issuers relying on existing market-based principles and guidance. The principle characteristics of the baseline scenario are: ·Continued market growth along or slightly below current trajectories. 2015-2020 saw an impressive average annual growth of 46% in terms of green bonds issued, and also 46% in terms of volume. It is expected that the green bond market will continue to grow along or slightly below these trajectories. The main factors driving this trend are an enhanced awareness for sustainability factors of downstream consumers, increasing market demand for green bonds, and a reinforced sustainability focus in many Member State and EU policies. ·Growth of external review market, but no legal framework in place for the registration and supervision of external reviewers. The assessment of green bonds by an external reviewer will likely remain the market norm, and hence this market will grow in line with market needs. However, the differing approaches of the range of entities in this field will continue to be a potential source of problems, creating uncertainties for issuers and investors on the added value, quality and impact of the external reviews. Issues relating to potential conflicts of interest and quality control would not be addressed and the EU GBS would therefore have to rely on existing market processes and external reviewers. ·No dominant classification system to determine the greenness of projects and assets, and continued use of partial and high-level taxonomies. While the Taxonomy Regulation for climate mitigation and climate adaptation will enter into force in 2021, the Commission would not take any action to promote it as part of an official green bond standard. While existing market-based guidance provides broad ‘green criteria’, they generally lack specificity and granularity for more detailed assessments. Some issuers also prefer to refer to their own taxonomies, rather than using the CBI Taxonomy. This indicates that the market is unable to converge around a single standard classification system that is at the same time comprehensive and granular. ·Continued uncertainty for investors and issuers on the definition of green. This in turn generates inefficiencies in terms of search costs, increased risk exposure for investors and, depending on the applied market practice, higher issuing costs. On the one hand, issuers will continue to face reputational risks in cases where there is doubt over the greenness of assets or projects. This is particularly a concern for non-traditional green issuers which generate revenue mainly from carbon intensive activities. In effect, their green bond issuance levels are likely to remain very low with potential negative impacts on their ability to transition. On the other hand, investors would lack clarity and transparency on the greenness of investments. Since there is no common classification system in place, each bond and its corresponding activities need to be assessed individually to determine whether it meets the individual investor’s understanding and expectations of ‘green’, thus driving search costs. It can be expected that there will be some uptake of ‘taxonomy aligned’ bonds (i.e. making use of the EU taxonomy) even without EU intervention. It is expected that market standards would allow the use of the EU Taxonomy as one of several definitions of green. However, the issues set out in terms of consistency, comparability and certainty would still largely persist. The market would also remain heavily fragmented due to possible different understandings of the taxonomy criteria. As there would not be any means of enforcement, issuers could claim taxonomy-alignment without facing supervisory repercussions. This may in fact lower transparency and confidence in the market and negatively affect the wider uptake of the taxonomy criteria as a benchmark. It is unclear whether the CBI Taxonomy would converge or diverge from the EU Taxonomy. ·Amplified risk of high visibility or high impact market controversy. Seen against the expected growth of the green bond market, the vulnerabilities that exist within the current market-based system may amplify the risk of a potential high impact or high visibility occurrence of greenwashing. Such an incident could potentially create reputational problems for the whole green bond market, thereby reducing the trust of investors on which this market relies, and increasing costs for issuers. ·Potential national action: There is also the potential that Member States may develop their own legal regimes for green bonds, potentially based on discrepant Taxonomies. We have seen a similar development in the case of labels for green investment funds (see section 3 – legal basis). The fact that Member States are not actively pursuing such plans at this moment is likely due to the Commission’s ongoing work on the EU GBS. Should the Commission abandon these efforts, it is likely that Member States would seek to compensate with national initiatives, given the growing importance of sustainable finance for the financial industry and for low-carbon investments. 5.2.Description of the policy options This impact assessment focuses in particular on the three key policy dimensions set out below. The three dimensions are related, but the policy choices do not depend on each other across policy dimensions. 1)Scope of application for green bond issuers (and core requirements of EU GBS) ·Option 1: EU GBS alignment voluntary for all green bond issuers ·Option 2: EU GBS alignment mandatory for non-sovereign EU green bond issuers, following transition-period 2)Regulatory treatment of external reviewers of EU GBS-aligned bonds ·Option 1: Registration and limited supervisory oversight ·Option 2: Authorisation and supervision with more stringent requirements 3)The extent of flexibility for sovereign users of the EU GBS

·Option 1: No flexibility compared to corporate issuers ·Option 2: Flexibility regarding non-Taxonomy-related requirements. ·Option 3: Flexibility regarding non-Taxonomy- and Taxonomy-related requirements

Each policy option is described and also assessed below. The potential willingness of green bond issuers to make use of the proposed standard, based on the preferred policy choices across all policy dimensions, is assessed in section 6: Preferred option. 5.3.Policy Dimension 1: Scope of application for green bond issuers (and core requirements of the EU GBS) The current section will assess the extent to which the EU GBS should apply to current and future green bond issuers, and the core requirements of the standard. In the 2018 Sustainable Finance Action Plan, the Commission tasked the Technical Expert Group on Sustainable Finance (TEG) with drawing up a report on an EU Green Bond Standard, based on current market best practices. In line with this mission, the TEG proposed the standard that is summarised in table 2 below (full standard is available in Annex 14). TEG’S PROPOSAL FOR THE EU GREEN BOND STANDARD ELIGIBLE GREEN PROJECTS: ·Physical or financial assets. ·CapEx or selected Opex (with 3-year look-back period) ·Public investments or public subsidies Must be aligned with Taxonomy Regulation: 1.Contribute substantially to at least 1 environmental objective. 2.Not significantly harm any other objective 3.Comply with the minimum social safeguards 4.Align with Technical Screening Criteria (TSCs) where available. Flexibility: If no TSCs are available or applicable, an external reviewer shall confirm that projects nonetheless meet the 3 other requirements. Grandfathering: Subsequent changes to TSCs should not apply to outstanding EU Green Bonds (grandfathering). REQUIRED REPORTING: Green Bond Framework: setting out environmental objectives, process to determine Taxonomy alignment and track proceeds, projects to be financed by the bond, and what impact metrics will be used. Allocation Reporting (annually): Shall include a breakdown of allocated amounts to Green Projects at least on sector level. Impact Reporting: At least once during bond lifetime after full allocation of the bond proceeds. VERIFICATION REQUIREMENTS (a.k.a. EXTERNAL REVIEW): -The issuer shall appoint an external reviewer to confirm alignment of the Green Bond Framework with the EU GBS. -Verification of the Final Allocation Report is required. Verification providers will be subject to accreditationincluding explicit requirements related to: 1.professional codes of conduct related to business ethics, conflicts of interest and independence; 2.professional minimum qualifications and quality assurance and control; 3.standardised procedures for Verification. Alignment with market best practices The final set of requirements of the EU GBS itself that are being examined in this impact assessment are based on the draft standard proposed by the TEG, which in turn is based on (or similar to) market best practices, including best practice within the existing standards such as the ICMA GBPs and the CBI standard (for example where an existing standard does not require but recommends certain practices): owith regards to reporting, these include the publication of a green bond framework, of allocation reports, and impact reports. oWith regards to external review, these include external review of the green bond framework and the final allocation report. oWith regards to eligible green projects, these include the “use of proceeds” approach. This model enables a wide-range of approaches, including securitisation bonds, revenue bonds, project bonds, covered bonds, and other debt instruments. Allocation and impact reports

Building on a practice established in the CBI standard, the EU GBS would require issuers to publish yearly allocation reports detailing the use of green bond proceeds, and providing evidence on the Taxonomy-alignment of the projects funded by their bonds. These allocation reports are what enable external reviewers and investors to check the issuer’s progress and hold the issuer to account for fulfilling its sustainability commitment. In line with market best practice, the EU GBS will require issuers to have their allocation report reviewed by an external reviewer after a certain amount of time. As is also common market practice, the impact report is the issuer’s review of the environmental impact of the bond once all the proceeds have been allocated. This allows investors to quantify and compare the environmental impact of their investment, and mitigates against the risk of “greenwashing”. For transparency reasons, both reports would be publicly made available to ensure full transparency. Feedback from stakeholders By following established market practice, the EU GBS would avoid needlessly changing well-established practices regarding the format, frequency, and type of reporting. It would also avoid needlessly disrupting the market for external review. The alignment with market best practices is also justified based on the desire to position the EU GBS as the foremost standard in terms of transparency and environmental credibility. Finally, the alignment with existing market best practice was preferred by a large majority of respondents to the targeted consultation on the EU GBS, who also agreed with all the main requirements of the EU GBS as proposed by the TEG. In particular, investors argued that the core requirements of the EU GBS would respond to their needs for clarity, consistency, comparability, transparency and assurance that the financed projects are aligned with the EU Taxonomy. A majority of issuers and financial service-providers also agreed with the proposed requirements, arguing that the EU GBS could help to standardise, clarify, and create a genuine market for high quality green bonds. However, some respondents worried that the requirements would be difficult to meet for SMEs wishing to issue green bonds, especially with regards to reporting and external review. Table 3 below provides a summary of the consultation feedback on this issue. Requirements proposed by the TEG Answers to the question Strongly agreed + rather agreed Strongly disagreed + rather disagreed Aligning eligible green projects with the EU Taxonomy: 160 136 (87%) 8 (5%) Publishing a Green Bond Framework before issuance 160 145 (90.5%) 2 (1.5%) Publishing an annual allocation report 161 145 (90%) 6 (4%) Publishing an environmental impact report at least once before final allocation 159 126 (79%) 15 (9.5%) Having the (final) allocation report and the Green Bond Framework verified 157 139 (81.5%) 12 (8%)



For the reasons set out above, it is recommended that the core elements of the EU GBS should be aligned with market best practice. Alignment with the EU Taxonomy While being modelled on market best practice, the potential EU GBS would also go beyond existing standards by including a requirement to align bond proceeds with the Taxonomy. As noted in section 1, this is a legal requirement for the EU GBS. In practical terms, this means that only those issuers with existing Taxonomy-aligned assets on their balance sheets, or plans to invest in new assets aligned with the EU Taxonomy, would be able to issue using the EU GBS. Given that the Taxonomy sets out comprehensive and detailed criteria for the definition of projects that are green, some potential green bond issuers may struggle to meet this requirement. This means the standard would likely be more costly for the average green bond issuer to align with, compared to current market standards. At the same time, the EU GBS would likely allow certain issuers to increase the benefits typically associated with green bond issuance, such as a reputational boost for the issuer, a diversification of the investor base, and a potential green bond premium, since these benefits typically increase with the level of ambition and green assurance of the bond. For the reasons set out above, the issuers most likely to benefit from (and therefore employ) the EU GBS are those wishing to demonstrate a strong green commitment. The overall positive feedback from issuers to the targeted consultation indicates that there are many such issuers. A more detailed assessment of the impact of the link with the Taxonomy is carried out in section 6 – Preferred option.

Transitional sectors in the Taxonomy Because the EU Taxonomy includes transitional sectors, such as manufacturing, proceeds from EU GBS could also be used to fund activities that are not low carbon. These sectors are included because there is a need to stimulate emission reductions even in those sectors where zero carbon is challenging or impossible to achieve today. At the same time, many of these sectors have significant potential for CO2 reduction. However, this inclusion creates a theoretical risk of undermining the green credibility of the standard, in particular given the fact that the leading ambitious green bond standard on the market, CBI, does not include such activities in its Taxonomy. At the same time, this risk is mitigated by the strict conditions impose by the Taxonomy Regulation, as also explained in annex 8.5, on those activities that may be considered transitional. In particular, in order to be considered transitional, activities must have greenhouse gas emissions that are substantially lower than the sector or industry average and they must not hamper the development and deployment of low-carbon alternatives or lead to a lock-in of assets incompatible with the objective of climate-neutrality. For green bond market participants, the advantages of including such activities are clear: issuers in transitional sectors, which has been an underperforming sector for green bonds, will have clear EU-sanctioned definitions of green to underpin their green bond issuance, substantially reducing the reputational risk of issuing. This could allow issuers that are currently wary of issuing green bonds to join the market. For investors, the EU Taxonomy will provide clarity on what is considered best in class, allowing those investors that wish to fund transitional activities to do so with more confidence in the greenness of their bond. Grandfathering The EU GBS proposal would envisage to allow issuers of existing green bonds to opt-in and designate their bond as an EU green bond, provided that all criteria for a new EU GBS bond are met. Green bonds that financed assets which do not meet the taxonomy criteria will not be able to carry the EU GBS designation. Deviating from this strict approach would undermine the increased transparency and consistency (in particular as concerns the green definition) that the standard aims to achieve. As concerns grandfathering in the case of subsequent changes to the taxonomy, the proposal could stipulate that an EU green bond would retain this designation until it matures (= full grandfathering), even if a later amended version of the taxonomy would no longer classify the underlying asset or project as green. Options that would deviate from this approach have been excluded at an early stage (for more information, see Annex 13). 5.3.1.Policy options For non-sovereign green bond issuers, such as Corporates, there are two alternatives: 1)Option 1: EU GBS alignment voluntary for green bond issuers in the EU Under this option, issuers of green bonds would retain the freedom to decide whether to issue green bonds using the EU GBS or not. Should they choose to align with the EU GBS, they would have to meet all the requirements under the standard. Other market standards would still be available, and could potentially be used in combination with the EU GBS. For sovereign green bond issuers, this is the only alternative, since for legal reasons the standard cannot be made mandatory for these issuers. 2)Option 2: EU GBS alignment mandatory for non-sovereign green bond issuers in the EU, with transitional phase in: The second option would be a mandatory standard for non-sovereign issuers, where all green bonds issued by such an issuer in the EU would need to make use of the EU GBS in order to be able to be called a green bond. The option of a mandatory standard also covering sovereign issuers was not assessed (see Annex 13). For corporate issuers, the mandatory alignment with the EU GBS would be phased in over a defined transitional period, with grandfathering of existing bonds to ensure that investors who have purchased green bonds in good faith are not penalised. After the transitional period, any green bonds that are issued without being aligned with the EU GBS would lose the right to label themselves as green bonds in the EU. In addition, the policy option of “Flexibility for corporate issuers with regards to Taxonomy-alignment” was discarded at an early stage. Annex 13 describes the policy option in detail, as well as the reasons for discarding it at an early stage.

5.3.2.How do the policy options compare? 1)Option 1: EU GBS alignment voluntary for green bond issuers in the EU PROs: This approach minimises the risk of holding back the market. It provides issuers of high quality green bonds with a dedicated standard to signal to investors their sustainability ambitions or achievements, without imposing it on those green bond issuers who are less ambitious. It would allow use of the standard to grow over time in line with market experience with the use of the taxonomy, and as legal requirements for Taxonomy-aligned disclosure gradually enter into force. Several respondents to the targeted consultation made the comment that it was important to keep the standard voluntary, and were worried that otherwise existing green bonds could lose their status as green. Depending on the development of the green bond market and the success and take-up of the EU GBS, its voluntary nature could be reviewed (and potentially changed to binding) after a certain amount of time. CONs: Take-up of EU GBS may be limited at first, or permanently. The risk of green-washing and potential market disruption from a controversy could persist. The lack of transparency and confusion about the green credentials of those green bonds not making use of the EU GBS would continue. Financial flows labelled ‘green’ would only partially contribute to achieving the EU climate objectives. Impact on issuers ·Issuers would be given an extra standard which they can make use of. This would in particular benefit issuers of high quality green bonds, as the EU GBS is better tailored to such issuers. This would allow those investors the opportunity to better differentiate themselves from the market competition, which could contribute to increasing the benefits of green bond issuance for those issuers (i.e. reputational boost, green bond premium). ·The additional cost of using the EU GBS would be lower for (1) issuers with a higher existing share of Taxonomy-aligned assets on their balanced sheet, and (2) issuers falling under the scope of the current NFRD, the future revised NFRD, or the SFDR (for financial institutions), who would all be required to disclose their share of Taxonomy-aligned assets and expenditure. For those issuers, some of the costs of identifying and reporting on the Taxonomy-aligned assets would already have been incurred. ·For issuers active in sectors underserved by existing market-based taxonomies (e.g. steel, cement, aluminium or chemicals) the link to the EU Taxonomy in the EU GBS may persuade some of them to issue new green bonds to fund mitigating measures in their manufacturing process. Impact on smaller issuers ·In the targeted consultation, some respondents worried that the requirements would be difficult to meet for SMEs wishing to issue green bonds, especially with regards to reporting and external review. Impact on investors ·Investors would on the one hand be faced with yet another standard, which may increase confusion and fragmentation of the market. ·On the other hand, they would benefit from the existence of a green bond standard with high quality assurance, allowing them more easily identify high quality green bonds, and to be less exposed to the risk of greenwashing. ·Institutional investors wishing to bolster the green credentials of their portfolios would have at their disposal a new tool for identifying Taxonomy-aligned bonds, and this should help for example with increasing the share of taxonomy-alignment for the purposes of disclosures to clients under the SFDR. ·Ultimately, this could also help retail investors access more high-quality green investment opportunities, for example through bond funds whose assets include EU GBS aligned bonds. Impact on external reviewers ·External reviewers would be given a new business opportunity as registered reviewers of the EU GBS. ·Even if a supervisory regime is set up, they would not be under any obligation to seek registration, as they would be free to continue serving other parts of the green bond market. 2)Option 2: EU GBS alignment mandatory for green bond issuers in the EU, with transitional phase in: PROs: The average quality of green bonds traded on EU markets would be higher. The clarity regarding green projects for all green bonds on the market would be higher. Investors would benefit from reduced cost of due-diligence. Financial flows labelled ‘green’ would strongly contribute to achieving the EU climate objectives as per the criteria in the Taxonomy Regulation. CONs: There is a risk of constraining the market as the mandatory requirement is phased in. The Taxonomy remains untested in practice so it is difficult to assess the feasibility of using the EU GBS for current green bond issuers. There is a strong risk of issuance and trading moving to markets in third countries, especially as many issuers currently cannot comply with the Taxonomy at this stage. Only a very small group of respondents to the targeted consultation (3 out of 167) called for a mandatory standard. Impact on issuers ·Since the term “green bond” would be reserved for green bonds aligned with the EU GBS, this option would narrow the available options for existing and prospective green bonds issuers. They would have the choice between issuing a green bond according to the EU GBS, or opting for another type of bond or debt instrument altogether. There would be no other forms of green bonds available. ·For those issuers who are not able to identify Taxonomy-aligned assets on their balance sheets, or willing to invest in Taxonomy-aligned assets, issuing a green bond in the EU would no longer be possible. For this reason, they may choose to issue under third country jurisdictions. Impact on investors ·The clarity regarding green projects for all green bonds on the market would be higher, which would reduce the risk of greenwashing. ·However, the flow of green bonds would likely be reduced, at least in the short run, which is a bad outcome for investors, given the current high demand and oversubscription for green bonds. Impact on external reviewers ·In the short run, the flow of green bonds would likely be reduced, so business opportunities would be reduced for external reviewers. However, in the long run, it is possible that business opportunities would increase, if the EU GBS leads to increased use of external review, especially for post-issuance review of the Taxonomy-alignment of proceeds. ·If a supervisory regime is set up, all external reviewers of green bonds that wish to continue offering this service would need to seek registration under this regime. The costs of this for the reviewer will be assessed in section 5.4

Comparison table: The following table summarises the assessment of the options against those objectives which are relevant for the green bond market: Option 1: Voluntary standard Option 2: Mandatory standard Clarifying and harmonising definitions of green projects and procedures for issuance + Depends on take-up. If EU GBS is used, it will help to disseminate Taxonomy and harmonise definitions. Further fragmentation will be limited by alignment of EU GBS with market best practice. ++ EU Taxonomy and market best practices on reporting and external review would become the norm. Full harmonisation. Reduce costs for issuers 0 No net costs, as only those issuers who estimate a benefit from using standard would do so. - While there may be a net benefit for some issuers, others may forego green bond issuance altogether. Efficiency (cost-effectiveness) + Achieves objectives (partially) without imposing net costs on any issuers. - Achieves objectives but imposes net costs on some issuers, and may end up disrupting market. Impact on SMEs 0 SMEs will be free to disregard the standard, but in some cases they may also be disadvantaged by not being able to afford to use the standard. - Some issuers may struggle to use standard due to market best practice requirements. Other economic, environmental, social and fundamental rights impacts + Positive environmental impact and positive economic impact. Social safeguards are included in Taxonomy. + Positive environmental impact but less positive economic impact, as there may be less green bond issuance.

Social safeguards are included in Taxonomy. Coherence with EU policy objectives ++

Aligned with overall EU sustainable finance strategy and transition to carbon neutrality + Aligned with overall EU sustainable finance strategy and transition to carbon neutrality, but market disruption may harm Capital Markets Union. (Issuers could choose to stop issuing green bonds altogether) 5.4.Policy dimension 2: Regulatory treatment of external reviewers of EU GBS-aligned green bonds This policy dimension assesses two potential options for the regulatory treatment of third parties providing external review services to issuers of EU GBS-aligned green bonds, in light of the issues identified as part of problem driver 2.4.1 Stakeholder feedback to both the RSFS public consultation and the EU GBS targeted consultation indicated broad market support for an external reviewer regime. In the RSFS public consultation, a significant majority (78.8% of 141 responses) supported the introduction of a certification and supervision regime for external reviewers administered at the EU level. At the same time, respondents highlighted the importance of proportionality in any new regime to ensure that smaller entities can continue to provide these services. The introduction of a formalised regime for external reviewers would be a forward-looking and pre-emptive action. . So far, there are no significant issues identified in the market for external review of green bonds, which in any case is still quite small, with annual revenue estimated between EUR 5 million and EUR 10 million. But the market for EU GBS bonds does not yet exist, so it is impossible to say for certain what issues may be encountered in the external review market for such EU GBS bonds. In particular, the potential regime for external reviewers would aim to raise overall trust levels in the external review process and the protection of the integrity of the EU GBS. By raising the level of trust in the market, investors will be able to more easily identify green high quality green bonds, which will support the further development and growth of the market. Integrity is particularly important for the EU GBS, since it will cater to the higher quality segment of green bonds, thanks to its alignment with the EU Taxonomy and market best practice. Imposing a framework on all external reviewers would undermine the voluntary approach being taken for the EU GBS which is intended to only be used by those market players that fully support its objectives and are willing to bear the additional cost or administrative burden to deliver meaningful and trustworthy green investments to the market. In the same vein, the TEG recommended the establishment of a regime to promote the development of the European green bond market by improving the quality and standardisation of the review process for the EU GBS, while ensuring a level playing field across the Union and meet the high demand from investors seeking quality green financial assets.

The framework should build upon the existing pool of service providers while ensuring a level-playing field for companies that have the relevant skills to provide external review services. The calibration of the framework’s requirements are key to ensuring that it does not act as a disincentive for firms to register or force smaller firms out of the market. It is also important to consider the resource requirements at supervisor level to minimise costs and resource demands to administer the new scheme. In order to support the entry of smaller participants into the market, the framework must be proportionate in its requirements in order to reflect the nature and scale of activity. By including proportionality measures and limiting the framework’s requirements that would necessitate organizational changes and require additional financial resources, risks associated with insufficient competition can be avoided. Such risks include higher prices or other barriers to entry, and inadequate choice for smaller issuers. As the market grows in size and importance or if specific issues arise regarding the conduct of external reviewers more generally, the framework could be reviewed and extended to encompass all external reviewers or could be incorporated into other potential Commission initiatives to improve supervision of entities in the green market more generally. While the majority of existing external reviewers are based in the EU, provision could be made in the proposed framework to facilitate third country reviewers that wish to assess compliance with the EU GBS. Existing frameworks contain equivalence provisions or allow for certification or endorsement of third country entities . 5.4.1.Policy options With regard to a potential regulatory regime for external reviewers, the two main policy options are: 1)Registration and limited supervisory oversight and requirements: This option consists of tasking ESMA with registering external reviewers of the EU GBS, which would require a legislative instrument. Under this approach, external reviewers would be required to only register with ESMA with limited ongoing supervisory requirements. 2)Authorisation and supervision with more stringent requirements: This option consists of tasking ESMA with authorising and supervising external reviewers of the EU GBS, which would require a legislative instrument. This approach entails a more stringent framework for the authorisation and supervision of external reviewers. In addition, the policy option of “tasking national competent authorities (NCAs) with managing a regime for external reviewers” was discarded at an early stage. Annex 13 describes the policy option in detail, as well as the reasons for discarding it at an early stage. 5.4.2.How do the policy options compare? 1)Option 1: ESMA registration with limited ongoing supervision The framework for external reviewers of the EU GBS could set out requirements on their minimum professional conduct, transparency and registration and supervision. For example, external reviewers could be subject to requirements on professional ethics, good repute, objectivity, independence and conflicts of interest, and be required to demonstrate and maintain professional minimum qualifications, quality assurance and control and be required to follow specific procedures when carrying out verification activities, in particular whether bond proceeds have been used to finance Taxonomy aligned expenditures. In order to be registered, the external reviewer would need to demonstrate that it only charges non-discriminatory and cost-based fees to issuers and that its fees are not dependent on the results of its assessment activities. The external reviewer would be required to ensure that the members of its management body have appropriate levels of qualification and expertise to fulfil its tasks and that they conduct their activities with integrity and good repute. The external reviewer should have proper operational safeguards and internal processes that enable it to assess the compliance of a green bond with the EU GBS requirements.

With regards to conflicts of interest, there could be specific requirements to ensure that the external reviewer and its employees are independent from the issuer and the verification is carried out objectively, independently and is not affected by any existing or potential conflicts of interest or business relationship. Potential or existing conflicts of interest that have been identified should be eliminated or mitigated and disclosed without delay. The reviewer would also be required to document its relevant policies and procedures in order to evaluate their effectiveness. The designated competent authority would be empowered to investigate and take enforcement action if necessary to ensure the integrity of the market and the EU GBS. The approach for registration and supervision of external reviewers could be similar to that for third party verifying STS compliance. This would allow for the registration of an external reviewer with a designated competent authority, in order to register them to assess the compliance of a green bond with the EU GBS and to carry out post-issuance verification of the use of proceeds. A current list of registered external reviewers and green bonds that have been issued with an SPO (Second Party Opinion) on their compliance with the EU GBS requirements could be provided on an official website maintained by ESMA. PROs: This approach would have the benefit of a single registration process for external reviewers with a limited ongoing supervisory burden. The framework would be based on a set of proportionate requirements covering professional conduct and transparency of the external reviewer’s policies and procedures that the designated competent authority would assess an application against. These requirements would be proportionate to the current size of the external reviewers, the general market and the non-systemic nature of their activity. This approach would minimise the cost and resource implications for both external reviewers and the designated competent authority whilst increasing accountability and market transparency. CONs: Under this option, external reviewers would not be subject to more stringent requirements covering their organisational structure and financial resources. This might create the risk that the external reviewer’s activity is of lower quality, which could lead to increased reputational risk for issuers and negatively impact the reputation of EU GBS bonds. Less intensive ongoing supervision would limit the ability of the designated competent authority to actively detect and intervene in the event of a failure to comply with the requirements of the framework by an external reviewer. Impact on reviewers •This option could impose initial compliance costs for reviewers, because they will have to fulfil a number of on-boarding requirements, including paying an initial application fee, set under the registration process which they may not necessarily do at the moment. •They have to pay a fee for registration. •There will only be limited costs for ongoing supervision. For example, 1 FTE may be required for compliance purposes. •Registration is mandatory only for reviewers of EU GBS bonds. •While existing industry-based green bond standards might evolve and incorporate the Taxonomy, only issuers of EU GBS bonds will be able to show that their external reviewers are registered and supervised. Registering will allow external reviewers to access the additional business segment of verifying bonds issued according to the EU GBS. It will also give a proof of quality comparative advantage over those reviewers that chose not to register when competing for verification business in the segment of industry-based green bond standards. •1 – 1.5 FTE for compliance activity. •Initial application fee between EUR 1,500 and EUR 5,000. •Ongoing supervision EUR 500 to EUR 2,000 per year. Impact on issuers •Issuers may have to pay more, because reviewers might pass on their compliance costs to them. •If issuers do not want to pay for external review, they can choose to follow other practices or market standards as the EU-GBS is a voluntary standard. •The TEG expects that, even if only voluntary, the EU-GBS would rapidly gain significant market recognition. Investors may expect issuers to use the EU GBS and this may lead to a market preference or pricing advantage over other standards. •Non-compliance with the verification standards entails a reputational cost for the company. It is reasonable to assume that external verification provides a stronger signal to investors of the environmental commitment of the green issuers than a self-attributed green label. Impact on investors •The benefits for investors are dependent on the types of requirements that will be imposed on external reviewers. For instance, investors will benefit from more credible external reviews where the independence, objectivity and quality assurance of the service is guaranteed by the framework. Greater standardisation of reporting templates would improve transparency and comparability. Investor confidence in the integrity and independence of the process would be enhanced. Impact on EU budget •ESMA would require additional resources to carry out supervisory tasks with a one-off cost to cover the development of the IT platform. •According to the TEG, even under a scenario that assumes strong and continued growth in the green bond market the number of external reviewers to be registered is expected to remain relatively small implying that the additional supervisory resources required would also be limited. •<0.3 FTE per regulated entity. 1-2 FTE for database and ICT development and maintenance. 2) Option 2: ESMA Authorisation with more stringent ongoing supervisory oversight and requirements: Under this approach, external reviewers of the EU GBS would be required to submit significant information on their business plans, organisational and resourcing arrangements, governance structures, policies and procedures for ensuring compliance with the Regulation and their assessment methodologies. Once an application is deemed complete, the supervising body would then have to carry out a detailed analysis to ensure it meets the Regulation’s requirements before submitting a decision on authorisation to ESMA’s Board of Supervisors or the NCAs’ Board. A fee would be payable to submit the application and reviewers would be subject to ongoing supervisory fees depending on their size and turnover. This approach would be similar to that taken in the Credit Rating Agency Regulation (EU) 462/2013 with stringent requirements imposed on external reviewers that wish to provide services to issuers of the EU GBS. In this regard, it is important to note the key differences between CRAs and external reviewers – CRAs are systemically important entities relied upon by the market to issue independent ratings on the creditworthiness of a financial instrument. The determination of a rating is a complex and detailed process requiring forecasting and modelling of potential impacts of changes in market conditions or in the underlying assets. Credit ratings have significant implications for the pricing of an instrument. In the case of credit ratings, there are requirements in the EU legislations (CRR, Solvency II) related to the use of credit ratings in the process of determination of the amount of regulatory capital. Credit ratings therefore have an impact on the type and amount of financial instruments that credit institutions and insurance undertakings need to hold for the regulatory purposes. In contrast, external reviewers operate in a niche market for green bonds, and while their opinions are an important source of assurance for investors and issuers regarding the sustainability of their investments, the activity is non-systemic and has limited pricing impact on the final price of the bond. PROs: This approach would have the benefit of a single authorisation process for external reviewers and harmonised supervision across the union. It could improve standardisation and quality of the external review process and transparency for issuers and investors about the activities of external reviewers. CONs: ESMA or the designated national bodies will require additional resources to establish and administer this new process, and it will take time to complete the legislative process to grant the necessary powers to ESMA or the designated national bodies. A comprehensive framework would create significant additional costs for external reviewers and ESMA or the designated national bodies. A more stringent framework, similar to the Credit Rating Agency Regulation, is not proportionate given the size of the market and the non-systemic nature of their activities. Impact on reviewers •This option would impose higher compliance costs for reviewers, because they will have to fulfil the requirements set under the supervision framework, which they may not necessarily do at the moment. •They will have to pay a fee for registration •They will have to bear costs for ongoing supervision. •They would have to incur organisational and resource costs to comply with the framework. For example, a minimum headcount of 5 FTEs is required for a small entity to be able to comply with the full CRA framework. Based on average salary of EUR 50,000 to EUR 90,000 this would be approximately EUR 250,000 to EUR 350,000. •Authorisation would be mandatory only for reviewers of the EU GBS bonds. •Given the small size of the market for external review in terms of annual total revenue, external reviewers may not see the benefits of seeking authorisation compared to the costs they have to bear for it. •This approach could favour larger entities in particular CRAs that are active in the space and can more easily comply with the requirements. The overall burden of the new regime could be too much for smaller entities. •ESMA application fees under the CRA Regulation range from EUR 30,000 to over EUR 100,000 for larger entities. Ongoing supervision costs of up to EUR 20,000 per year. Impact on issuers (larger entities) •Issuers may have to pay more, because reviewers might pass on their compliance costs to them •If issuers do not want to pay for external review, they can choose to follow other practices, because the EU-GBS is a voluntary standard. However, the TEG believes that, even if only voluntary, the EU-GBS could rapidly gain market recognition and become the new standard for green bonds. Investors may have a preference for EU GBS aligned green bonds. •Non-compliance with the verification standards entails a reputational cost for the company. Hence, it is plausible to assume that external verification provides a stronger signal of the environmental commitment of the green issuers than a self-attributed green label. •At least 1 authorised external reviewer would be required to provide the necessary SPO and/or post-issuance reporting. If the compliance costs are too high there is a risk that no external reviewers seek authorisation which would have a significant impact on the ability of issuers to issue bonds under the EU GBS. Impact on issuers (smaller entities) •If smaller entities are forced out of the market by larger entities, this leads to market concentration of external reviewers, which could lead to higher costs for issuers •The EU-GBS is a voluntary standard, so smaller entities can also choose to follow other practices in order to avoid any additional costs of the EU GBS framework. •The TEG expects that, even if only voluntary, the EU-GBS would rapidly gain significant market recognition. Investors may expect issuers to use the EU GBS and this may lead to a market preference or pricing advantage over other standards. •Non-compliance with the verification standards entails a reputational cost for the company. Hence, it is plausible to assume that external verification provides a stronger signal of the environmental commitment of the green issuers than a self-attributed green label. Impact on investors ·Investors will benefit from more credible and comparable external reviews Impact on EU budget •ESMA will require additional resources to carry out supervisory tasks. Initial estimates based on the approach t