Draft EU Taxonomy standards threatens to stymie green bond issuance to finance green buildings by limiting eligibility to those with EPC A labels, with one pioneering covered bond issuer floating a switch to KPI-linked bonds, although there are suggestions the Commission may be open to compromise.
A draft delegated act released by the European Commission on Friday contains technical screening criteria adding flesh to the bones of the sustainable finance Taxonomy Regulation that came into force on 12 July. The draft released on Friday is one of two the Commission is charged with preparing, based on the input of the Technical Expert Group (TEG), and it is now open for feedback until 20 December.
“The EU’s Taxonomy Regulation is a key piece of legislation that is central to the European Green Deal,” said Mairead McGuinness, commissioner for financial services, financial stability and Capital Markets Union (pictured). “It will be instrumental in channelling investment to green and sustainable projects.
“By contributing to this public consultation, you can have your say on the development of these rules.”
When finalised, the delegated act will be subject to approval by the European Council and Parliament, although they can only accept or reject the proposal in full and not amend it.
According to the draft proposals, only green buildings with A label energy performance certificates (EPCs) will be Taxonomy-compliant within the “acquisition and ownership” category that is most relevant for the mortgage loans that currently back use of proceeds green bonds related to green buildings, including green covered bonds.
Existing green bond frameworks would fall foul of such a criterion, given that many include not only A-labelled buildings but B and also C-labelled buildings. These have until now been included thanks to being among the 15% most energy efficient buildings in jurisdictions, which bodies such as the Climate Bonds Initiative and other EU entities have previously deemed captures those buildings that make a sufficient contribution to mitigating climate change, and the TEG previously recommended as a potential criterion.
“Everyone has been working with this standard for a year and a half, so it’s unfortunate that there’s a new definition,” said Eivind Hegelstad, COO and head of investor relations at SpareBank 1 Boligkreditt (SpaBol), which launched the first green covered bond with residential mortgages as the sole use of proceeds. “It’s going to make it more difficult for banks to come up with EU Green Bonds.”
According to market participants spoken to by Sustainabonds, a change to A-labelled only could result in a fall of 90% or more in the amount of mortgage loans eligible for green bonds seeking alignment with the Taxonomy – something that is expected to be required by the voluntary EU Green Bond Standard that is in the pipeline.
Miguel García de Eulate, head of treasury and capital markets at Caja Rural de Navarra – which has a sustainable bond framework under which it has issued cédulas hipotecarias – said that in Spain, for example, the fall in eligible assets could be as much as 95%, with A labels accounting for just 0.3% of the Spanish building stock, Bs 0.8% and Cs 4.3%. And he noted that as well as such a low proportion of buildings being A-labelled, there are also relatively few that could attain an A label through renovation.
“Although mortgages also finance new houses, most finance transactions of existing ones, since new houses represent only around 1% of the building stock every year,” said García de Eulate (pictured), “so the proposed change means that ‘green mortgages’ as defined by this new taxonomy will de facto be irrelevant for the purposes of signalling a trend towards favouring the purchase and renovation of more efficient buildings.”
He noted that as standards are raised and the building stock is modernised, the top 15% of buildings will become more energy efficient, meaning that some mortgages will become ineligible – although borrowers will continue to benefit from preferential interest rates due to the “greenness” at the time the loan was taken out.
Also proposed as a condition of Taxonomy-compliance is that new buildings from next year better a 20% “near zero energy buildings” (NZEB) requirement being introduced across the EU. SpaBol’s Hegelstad said this is overly ambitious, given the likely costs of beating the new stricter regulation, which will hence further limit the amount of eligible assets – as well as noting that NZEB criteria have not been finalised in many countries.
“It sets a very high standard that will not be compatible with the way we have issued green bonds up until now,” he said, “so our green bonds wouldn’t be ‘EU Taxonomy green bonds’. We will then have to look at what we do going forward: Can we work with this in any way? Could the new NZEB code, when completed, provide an angle to be 20% better? Is there an alternative definition for green bonds?
“At any rate, we suspect that we will have to come up with something different than continuing to issue green bonds.
“This could be a portfolio approach, with the whole balance sheet becoming more green or sustainable over time, like these KPI bonds we’ve been seeing examples of.”
Following the first such sustainability-linked bond from Italian energy group Enel in 2019, a variety of corporate issuers have in the past month sold bonds based not on a use of proceeds model but linked to sustainability targets based on certain key performance indicators (KPIs).
Some market participants acknowledge the Commission faces the challenges of balancing “ambition and realism”, and one pointed to an apparent change to the anticipated draft that could signal flexibility on the part of the Commission. While only A-labelled buildings are referred to in the section regarding activities making a substantial contribution to climate change mitigation, B-labelled buildings have been added into the “do no significant harm” part of the climate change adaptation section, suggesting they could be compliant if other adaptation measures are undertaken.
The European Mortgage Federation-European Covered Bond Council (EMF-ECBC) – which is leading the Energy Efficient Mortgages Initiative seeking to boost green mortgage lending and energy efficient properties and renovation – is preparing for the launch of an Energy Efficient Mortgage (EEM) Label at the beginning of December, and secretary general Luca Bertalot told Sustainabonds that the industry body is seeing feedback from members by this Friday so that it can prepare its response in good time following discussion within the advisory council, which will also address to what extent the Label should be aligned with the Taxonomy.
“We need to have an inclusive approach that will allow the market to use the Taxonomy in the proper way,” said Bertalot.
Photo: Claudio Centonze/EC Audiovisual Service; Copyright EU