A long-awaited package of measures, including the European Commission's final draft of the EU Taxonomy Regulation, has dominated the legislative agenda, though not all of the feedback will have been to the Commission's liking.

The three-part package comprises the EU Taxonomy Climate Delegated Act, which defines sustainable activities to enable the EU to achieve its goal of becoming carbon-neutral by 2050; a proposal for the Corporate Sustainability Reporting Directive, which would address the thorny issue of ESG data collection and reporting; and six amendments to delegated acts. The latter will oblige financial firms to incorporate sustainability into investment and insurance advice to clients, their fiduciary duty and their product design.

Not surprisingly, much of the proposed legislation in an area as highly sensitive as climate change has pleased some but disappointed others. The Climate Delegated Act was met with fury and accusations of greenwashing by five of the NGOs that were part of the EU’s Platform on Sustainable Finance, an expert stakeholder group involved in some of the preparatory work. Led by the World Wide Fund for Nature and the European Federation for Transport & Environment, the five organisations have suspended their involvement in the expert group in protest at the inclusion of forestry and bioenergy as sustainable activities.

With industries identified in the legislation as sustainable set to gain easier access to finance, there was a mixed reaction from the biogas sector, While welcoming the labelling of biomethane as a sustainable means of producing heat and power, the European Biogas Association criticised the use of tailpipe emission criteria that will exclude the gas from most vehicles. More turbulence is expected in the coming months as the Commission decided to hold off on controversial decisions about nuclear power and the gas industry, on which it has been subject to heavy pressure from EU member states.

The Corporate Sustainability Reporting Directive, which would supersede the existing Non-Financial Reporting Directive, has enjoyed a smoother reception, being welcomed by both the European Fund and Asset Management Association and Germany''s influential national fund industry body, the BVI. EFAMA has even urged the early adoption of the proposal in order to address the sustainable finance sector’s long-standing bugbear – the lack of meaningful, comparable, reliable and public corporate ESG data.

The associations point out that the directive's provisions would create the primary source of information for asset managers’ disclosures under the Sustainable Finance Disclosure Regulation. And since the latter is already in force and its full provisions will be applicable from January 1, 2022, the clock is already ticking.

As the impact of carbon dioxide emissions on Earth's climate is increasingly impinging on corporate balance sheets, the issue of carbon risk is rapidly moving up the priority list for companies and their investors. Ideally, firms should be assessing these risks and disclosing them to financial institutions and other investors. However, if there are grounds for optimism on assessment, the picture on disclosure is more of a concern.

On the plus side, the latest research by environment disclosure body CDP indicates a sharp upward trend in companies accounting for the cost of carbon. Of nearly 6,000 firms surveyed last year, more than 2,000 said they already included or were planning to include carbon risk in their business plans – an 80% rise in five years. However, out of 1,830 who currently face or expect regulation of the price of carbon emissions, 60% did not see it as a substantive risk to the business – with clear implications for what they may, or may not, decide to disclose to investors.

Unfortunately, these attitudes are in line with the findings of the latest technical bulletin from the Sustainability Accounting Standards Board, a leading non-profit body focusing on reporting standards. While demonstrating that 68 out of 77 industries are now significantly affected in some way by climate risk, the board's research finds that the risk is being inadequately disclosed.

If this issue is a headache for the average company, it’s about to become a full-blown migraine for carbon-intensive businesses. As Moody’s highlights in a briefing paper, the net-zero targets of governments and the financial sector mean that fossil fuel-dependent businesses will represent an increased credit risk to lenders.

Inevitably, that risk will translate into the reduced availability of financing and increased cost of capital for high-carbon activities and companies in the years ahead. As financial markets tighten the purse strings, the credit strength of a fossil fuel company is likely to be determined by the credibility of its transition plans.

In geographical terms, the danger areas are plain to see. Morningstar has used its Carbon Risk Score to identify stock markets with corporate values at the highest and lowest ends of the risk scale. Northern Europe is at the top of the class, along with the US, given Wall Street’s heavy weighting toward technology and healthcare companies, with limited exposure to high-carbon energy and utilities. Russia, with 55% of its market capitalisation in energy stocks, is unsurprisingly at the bottom. For its oil and gas companies, as for many other corporate groups around the world, the energy transition will inherently be fraught with risk.

They may be considered niche products, but soaring demand and insufficient supply of green bonds has led to a nascent market bubble that is placing a premium on prices to investors. Forget any hope of a discount, this is the age of the ‘greenium’.

Designed by issuers to finance projects or businesses that combat climate change by reducing carbon emissions, such as wind farms, a switch from fossil fuels to renewable energy or support for sustainable agriculture, green bonds represent only 2% of the global fixed income market, but they were responsible for almost 17% of flows in 2020, excluding sovereign issues.

The current surge in demand could see up to $500bn being invested in green bonds in 2021, almost double the total of some $270bn last year. Demand is being driven by a range of factors - renewed corporate optimism for this year and beyond, public support for green issues, the bonds' reputation for lower volatility - particularly appreciated in times of crisis - and a glut of post-pandemic stimulus packages.

Along with national governments, the European Union has made it clear that green bonds will form part of its post-pandemic recovery plans, and its issues are widely expected to feature in the portfolios of both institutional and retail investors.

The net result of all this interest has seen green bonds in the primary market being priced at yields of 0.1 to 0.15 percentage points lower than conventional fixed-income instruments. Investors’ appetite is also reflected in yields for sovereign debt, with Germany’s green government Bund trading at a yield of 0.05 percentage points below its conventional ‘twin’.

Faced with unprecedented demand, the supply side has been found wanting. Basically, the 'greenium' has arisen because funds are switching to sustainable investment more quickly than companies can put their transition plans into place. For some market operators, the differentials between 'green' and 'brown' bonds will create opportunities for arbitrage.

Quite how long greeniums will last is an open debate, with some arguing that supply/demand imbalances tend to level out over time – and that in this case it’s a question of the corporate world catching up with financial markets.

Even when it does, however, the environmental impact of a project over time is bound to influence the desirability – and therefore price - of the bonds financing it. This would suggest there will always be a premium for green bonds that deliver the biggest cuts in carbon emissions, while those that represent little more than greenwashing will be hung out to dry.