The EU has been at the forefront of green bond issuances, demonstrating strong growth and commitment to sustainable finance. However, ESMA’s new Fund Naming Guidelines create inconsistencies with other sustainable finance regulations, like the EU Green Bond Standard, which could hamper the growth of the corporate green bond sector.

Regulatory inconsistency: Current interpretations and clarifications in sustainable finance regulation dealing with use of proceeds instruments focus on the project being financed, not the broader activities of the issuing company. For instance, the EU Green Bond Standard (EU GBS) doesn’t restrict the eligibility of issuers and in particular does not exclude companies based on standards for Paris-aligned benchmarks (PAB). However, the new fund naming rules do exclude companies on this basis, regardless of the project they are financing with the bond. This means that a bond fund investing in  green bonds might have to change names if it does not restrict the eligibility of bond issuers.  Alternatively, the said fund could keep its name and divest from all bonds by issuers who generate parts of their revenues from PAB-excluded activities.

Market impact: This restriction could limit the investable universe for green bond funds, particularly investments in corporate green bonds. Non-financial corporate issuers have accounted for 26-34% of annual issuances in the green bond market over the past five years. It could also undermine the future success of the recently created EU Green Bond Standard if major investors like funds were disincentivised from investing in certain EU GBS-compliant bonds.

Implications for the energy transition: The largest corporate issuers are utility companies, which play a vital role in developing the infrastructure needed for a sustainable future. Excluding them from funds using sustainable or environmental terms in their names could raise their cost of capital, hinder key projects and slow down the energy transition.

Anyve Arakelijan, Regulatory Policy Advisor at EFAMA, commented:“In sustainable finance regulation, the general interpretation has been that the project being financed should be the focus, not the wider activities of the issuing company. This is particularly relevant when it comes to funding the energy transition. To ensure consistency across regulations, this principle should also be applied within the fund naming guidelines. Our hope is that ESMA will see the logic of this when it comes to green bonds. If Europe wants to remain a world leader in sustainable finance, consistent understanding and application of key concepts will be crucial.”

 Tanguy van de Werve, EFAMA’s Director General, added:“Green bonds enable capital-raising and investment for projects with environmental benefits. The EU has seen significant growth of the green bond market and accounted for almost half the world’s green bonds last year. If the EU wants to remain competitive in this area and facilitate the financing of green projects in Europe and beyond, regulators and supervisors need to ensure rules like the fund naming guidelines don’t hinder this market or unnecessarily increase regulatory complexity for end-investors.”

Source: EFAMA