- The EU could become the main liquidity provider for a green safe asset with long duration by financing 30% (€225 billion) of its proposed €750 billion recovery fund through green bond issuance.
- EU green bond issuance on such a large scale would help respond to a fast-growing ESG investor base and increase the size of the global green bond market by around 89% compared with total issuance in 2019.
- A larger pool of green assets would also help policymakers and central banks toward their aim to "green" the financial system. Currently, the green bond market represents only 3.7% of total global bond issuance, making it difficult to ask market participants to build green portfolios.
The EU is intending to use its post-pandemic recovery plan to reinforce its fight against climate change. About 30% of the "Next Generation EU" €750 billion fiscal plan to aid the post-COVID-19 recovery would target climate-friendly projects, according to European Council President, Charles Michel's latest proposal. This translates to a potential of €225 billion of additional green financial instruments, reinforcing the EU Green Deal's pledges (see table 1 for a breakdown of the plan by budget commitments).
Even if, according to the European Commission, this is still too little to bridge the required investment gap of 1.5% of GDP per year to meet 2030 carbon-reduction goals, it is a huge improvement from the €7.5 billion of "fresh money" announced in the Green Deal (see "Related Research" below). The proposed EU budget also contains a pledge to "do no harm", for which the recently approved EU Green Taxonomy would presumably be leveraged, helping reinforce the EU's environment-friendly strategy (see "Sidebar: Taxonomy Regulation Aims To Boost Private Sector Investment In Green And Sustainable Projects").
|Next Generation EU--Breakdown By Budget Commitments|
|1. Single Market, Innovation, and Digital||69.8|
|of which InvestEU Fund||30.3|
|2. Cohesion and Values||610|
|of which Recovery and Resilience Facility||560|
|3. Natural Resources and Environment||45|
|of which Common Agricultural Policy||15|
|of which Just Transition Fund||30|
|4. Resilience Security and Defence||9.7|
|of which Health Programme||7.7|
|5. Neighbourhood and the World||15.5|
|Sources: European Commission, S&P Global Ratings.|
Details are still missing on the specific green and social content of the recovery fund, how the funds will be allocated to member states, or the kind of conditionality that may be attached to the recovery fund (see "The EU’s Recovery Plan Is the Next Generation Of Fiscal Solidarity," published on June 8, 2020"). For countries that emit more greenhouse gases (GHG) for each unit of GDP, some of the funding might come with stronger sustainability conditions attached so as to help decarbonize their economies. The EU Commission has also cited the possibility of a carbon cross-border adjustment tax as a means to repay the recovery fund bond issuances as they come due, although this could be difficult to implement. The EU is also discussing extending its emissions trading scheme (ETS) to the shipping industry, which could also be a source of financing.
A Green Safe Asset
The European Commission has already expressed its desire to finance the recovery fund through debt issuance because member states' contributions to the EU budget only cover the multiannual framework. Given its strong commitment to finance a green recovery, and subject to concrete plans to do so, it is possible that 30% of the EU's recovery bond issuance could be labelled "use of proceeds" green bonds, that is, where issuance proceeds are earmarked for projects that aim to make a specific environmental contribution. In this way, the EU would be able to respond to a fast-rising ESG investor base and further develop its position as an issuer in the green bond market. Google Trends, which shows how frequently certain search terms are entered into its search engine relative to the site's total search volume, highlights that the search for ESG investments and green finance has soared in the past years (see chart 1).
By issuing around €225 billion of green bonds, the EU would also become the largest supranational provider of liquidity for a green safe asset. By comparison, the European Investment Bank (EIB) has issued $33.7 billion green bonds since 2007. Only $53 billion of sovereign bonds have been issued with a green label, and all non-EU issuance (16% of the total) was by countries that do not issue a reserve currency, and thus are not used as safe assets. The availability of an EU green safe asset could help investors, as well as policymakers, achieve their goals to "green" their portfolios and the economy, respectively.
At present, one of the main hurdles to steering capital toward more sustainable investments is the limited size of the green bond market. It constitutes only 3.7% of total global bond issuance, making it difficult for central banks or regulators to ask market participants to build green portfolios. A green bond issuance of €225 billion would represent an increase of around 89% of the global green bond market size (in terms of 2019 total issuance). It would provide the European Central Bank, as well as other central banks holding large foreign exchange reserves in euro, with investment-grade green assets (see charts 2 and 3). EU green issuance would also likely stimulate private sector green bond issuance, since the EU tends to leverage private money for its investments, for example by co-financing projects with the private sector.
Greening The Euro
By providing a green safe asset, the EU would also likely reinforce the international role of the euro as a green currency. Close to 40% of total green bond issuance between 2007 and 2020 was located in the EU. In terms of sovereign green bond issuance, EU countries represent 84% of the total. Outside Europe to date there has been very little green bond issuance and--critically--none by sovereigns with a currency used as a reserve currency (see chart 4).
Nonetheless, EU green bond issuance is unlikely to come all at once. As the proposal currently stands, only one-quarter of Next Generation EU payments will come before 2023. It is unclear what the split between green and other financing would be, but a similar disbursement schedule is likely.
Meanwhile, in terms of duration, we think the EU might be likely to issue longer-dated bonds. This is in part because member states are likely to want to postpone the reimbursement of those bonds to a time when their economies have recovered, strengthening their ability to repay their borrowings. We currently don't expect the European economies to reach their pre-COVID-19 GDP levels before 2022 or 2023 for some cases (see "Eurozone Economy: The Balancing Act to Recovery," published June 25, 2020). What's more, in an environment of low to negative yields, investors are likely to prefer longer-dated assets, which provide higher interest rates (see chart 5).
Looking ahead, the EU is now debating whether to accelerate its net zero carbon ambition. Some stakeholders have recently voiced concerns that the current 55% emissions reduction target by 2030 will not be enough to meet the goal of limiting global warming by no more than 1.5 degrees Celsius set by the 2015 Paris Agreement. There have also been calls for a 65% reduction to be the new target. The more ambitious the EU carbon neutrality goal becomes, the more likely it is that extra funding will be required for green technologies to help meet the transition to net zero by 2050.
Sidebar: Taxonomy Regulation Aims To Boost Private Sector Investment In Green And Sustainable Projects
On June 16, 2020, the European Parliament approved new legislation to establish a framework to facilitate sustainable investment. The legislation, commonly known as the green taxonomy, will determine whether an economic activity is environmentally sustainable and could therefore enable fund-raising for green projects. By leveraging private capital, the green taxonomy will be a tool to help the EU to become carbon neutral by 2050, as outlined in the Green Deal.
In March, the EU Technical Expert Group (TEG) on Sustainable Finance published its final report on the green taxonomy. Among the main changes in the report are:
- Updated criteria for sustainable practices in buildings, forestry, and manufacturing activities;
- Confirmation from TEG that nuclear energy is currently not included in the green taxonomy because it was not able to determine whether nuclear causes significant harm to other environmental objectives;
- The inclusion of criteria covering projects that aim to adapt against the impacts of climate change; and
- A new disclosure requirement for companies subject to the Nonfinancial Reporting Directive (NFRD). The disclosure must include the proportion of turnover, capital expenditure and, if relevant, operational expenditure aligned with the taxonomy (see "Standardized, Non-Financial Disclosures Will Clear The Path For Better ESG Analysis," June 19, 2020).
The criteria for climate-change mitigation or adaptation activities in the EU Taxonomy will be adopted by the end of 2020 and enter into application by the end of 2021. The second set of criteria, which cover economic activities for the remaining four environmental objectives of the taxonomy, will be adopted by the end 2021 and should enter into application by the end 2022.
- Eurozone Economy: The Balancing Act to Recovery, published June 25, 2020
- Standardized Non-Financial Disclosures Will Clear The Path For Better ESG Analysis, June 19, 2020
- The EU’s Recovery Plan Is the Next Generation Of Fiscal Solidarity, June 8, 2020"
- Too Late For Net-Zero Emissions By 2050? The Potential Of Forests And Soils, June 6, 2020
- The EU's Drive For Carbon Neutrality By 2050 Is Undeterred By COVID-19, April 29, 2020
- Led By Green Bonds, The Sustainable Debt Market Looks To Surge Ahead, Feb. 13, 2020
- EU Green Deal: Greener Growth Doesn’t Necessarily Mean Lower Growth, Feb. 10, 2020
- The EU Green Taxonomy: What’s In A Name?, Sept. 11, 2019
- Taxonomy: Final report of the Technical Expert Group on Sustainable Finance, EU Technical Expert Group on Sustainable Finance, March 2020
This report does not constitute a rating action.
|Senior Economist:||Marion Amiot, London + 44 20 7176 0128;|
|Secondary Contacts:||Anna Liubachyna, London;|
|Michael Wilkins, London (44) 20-7176-3528;|
|EMEA Chief Economist:||Sylvain Broyer, Frankfurt (49) 69-33-999-156;|
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