The sustainable bond market continues to evolve, with the EU most recently reaching an agreement on the EU Green Bond Standard. (UBS)

Green, social, and sustainable bonds have fared relatively well amid the recent volatility, as lower government bond yields more than offset widening spreads in the high-quality credit segment. We think the asset class, which continues to evolve, still offers attractive yield levels.

Most recently, the European Union reached a provisional agreement on the European Union green bond standard (EuGB), outlining a criteria for issuers wishing to use the EuGB label. The regulation requires all proceeds of EuGBs to be invested in activities that are aligned with the EU Taxonomy for Sustainable Finance. Up to 15% of the proceeds can be dedicated to activities that comply with the Taxonomy, but no criteria for this segment has been established yet.

The EU Taxonomy establishes six environmental objectives: Climate change mitigation, climate change adaptation, sustainable use of water, transition to a circular economy, pollution prevention, and biodiversity protection and restoration. Criteria from the EU exist for the first two objectives, with over 100 activities outlined as eligible by the EU Commission. Activities range from storage and production of renewable (as well as natural gas and nuclear) energy, to water collection activities, rail transport, or building renovation.

The standard also requires companies to show how investments support transition plans, and to disclose this according to a specific template. In addition, the standard establishes a registration system and supervisory framework for third-party reviewers of EuGBs.

Cumulative labeled green-bond issuance to date stands at USD 2.24tr, according to the Climate Bond Initiative (CBI), an international voluntary standard setter for environmental bonds. EU domiciled issuers make up 54% of total issuance, with EU sovereigns being the largest segment.

In our view, there is significant overlap between the CBI Taxonomy and the EU Taxonomy, implying that issuers bringing EuGBs to market should remain aligned to the existing norms. One key difference with the CBI, however, is that the EU Taxonomy includes “do no significant harm” (DNSH) criteria, which excludes certain issuers in highly pollutive industries from qualifying.

There is uncertainty within the investor community about the quality of data used to determine DNSH and how to deal with issuers where this data is not fully available.

Given interest in high-credibility solutions among sustainable investors, EuGBs may fetch a premium compared to general green bonds, assuming initial lower supply in the market. We will monitor this development once the regulation kicks in.

Investment takeaways

  • We think it’s time to increase exposure to bonds, which we upgraded this month to most preferred in our global strategy. Within bonds, we see opportunities in sustainable bonds, which have been resilient and present attractive yields.
  • The sustainable bond market continues to evolve, with the EU most recently reaching an agreement on the EU Green Bond Standard, setting a criteria to govern issuers choosing to use proceeds to fund environmental activities under the "EuGB" label.
  • The regulation will not kick in until later in 2024. We expect the majority of existing CBI-aligned green bond issuance to continue to comply under the EU rules, although not all will.

Read the full Sustainable Investing Perspectives report (5 April 2023), which also discusses a climate report that will inform COP28 and impact on social issues through private equity.

Main contributors: Amantia Muhedini, Stephanie Choi, and Antonia Sariyska

This content is a product of the UBS Chief Investment Office.