Today the European Commission published its legislative proposal for a regulation on European green bonds, the ‘European Green Bond Standard’ (see Press Release and related Q&A).

The proposal is part of the EU’s wider agenda on sustainable finance and lays the foundation for a common framework of rules for issuers of bonds that voluntarily wish to use the designation ‘European green bond’ or ‘EuGB’ for green “use of proceeds” bonds (i.e. bonds where the proceeds are used to finance green assets or projects) that pursue environmentally sustainable objectives under the EU Taxonomy Regulation.

The Taxonomy Regulation is the benchmark for classifying whether an economic activity and related assets or projects are sustainable (see here).

By requiring issue proceeds to be exclusively and fully allocated (before the maturity of the bonds) in accordance with the requirements of the Taxonomy Regulation, the proposed new standard is intended to address the lack of a consistent definition of what are environmentally sustainable ways to use proceeds of green bonds and reduce uncertainty about whether bonds are being used to finance activities that can be considered to be legitimately green, thus countering potential accusations of greenwashing.

The proposal includes the establishment of a system for registering and supervising external reviewers for green bonds.

The designation ‘European green bond’ and ‘EuGB’ will be available to all issuers both within the EU and outside for their environmentally sustainable bonds made available to investors in the EU, that meet the requirements of the proposal.

The proposal builds on existing market best practices and establishes additional requirements based on relevant legislation already in place.

Background 

A market for green bonds is already well-established, with a total of more than 680 green bond issuances having been launched globally in 2020 raising a total of $227.6 billion (according to our research). Many of these are based on existing voluntary principles and standards, such as the ICMA Green Bond Principles which were recently updated in June.

However, according to the Commission, whilst the existing standards set out high-level process-based guidelines or recommendations, the underlying definitions of green projects are insufficiently standardised, rigorous, and comprehensive.

In addition, the Commission states that current market standards do not adequately ensure transparency and accountability of external reviewers, and there is no ongoing supervision of companies acting as external reviewers.

These limitations produce difficulties for investors in identifying, comparing and relying on environmentally sustainable bonds, leading in some instances to allegations of greenwashing.

The aim of the proposal is therefore to:

(1) improve the ability of investors to identify and rely on the quality of green bonds;

(2) facilitate the issuance of these higher quality green bonds by clarifying definitions of green economic activities and reducing potential reputational risks for issuers in transitional sectors; and

(3) seek to standardise the practice of external review and improve trust in external reviewers by introducing a voluntary registration and supervision regime.

Scope

The EuGB framework is intended to apply to all green bond issuers including public and private sector and financial and non-financial undertakings. The framework is also meant to be usable for issuers of covered bonds as well as securitisations.

Key provisions regarding issuers

The proposal:

  • will establish a voluntary standard for green bonds where use of proceeds is aligned to economic activities that meet the taxonomy requirements set out in Article 3 of the EU Taxonomy Regulation; and
  • will require issuers of European green bonds to obtain a pre- and post- issuance review from an external reviewer registered and supervised by the European Securities Markets Authority (ESMA).

The voluntary EuGB label shall only be used for bonds where the proceeds are – before maturity of the bonds – exclusively and fully allocated (without deducting costs) to finance eligible assets, such as fixed assets that are not financial assets, eligible capital expenditures, eligible operating expenditures or eligible  financial assets (debt and equity) or any combination thereof.

Sovereign issuers will be permitted to allocate bond proceeds to certain other types of expenditure.

Documentation and reporting

Prior to issuance of an EuGB, issuers must draw up an EuGB factsheet, a concept which is similar to what is currently referred to as a green or sustainable bond framework. An EuGB factsheet will be considered ‘regulated information’ and so may be incorporated by reference in a prospectus prepared pursuant to the EU Prospectus Regulation.

A pre-issuance review of the factsheet confirming that the factsheet complies with EU green bond requirements will need to be prepared by an external reviewer.

Annual allocation reports must be published until the full allocation of the proceeds of the bond, demonstrating that the proceeds of European green bonds have been allocated as required.

A post-issuance review must be prepared by an external reviewer on the first allocation report following full allocation of bond proceeds, assessing whether the issuer has allocated the proceeds in compliance with the EU green bond requirements and complied with the intended use of proceeds set out in the green bond factsheet. 

Issuers will also need to draw up an impact report on the environmental impact of the use of proceeds on an aggregated basis, after the full allocation of the proceeds and at least once during the lifetime of the bond.

Whilst many of these requirements are familiar features of the current green bond market, the contents of the factsheet, pre- and post- issuance reviews, allocation reports and impact report will all be prescribed by templates set out in the legislation (contained in the annexes to the Commission proposal) and will need to be published and maintained on the website of the issuer until the maturity of the bonds.

Sovereign issuers will be permitted to obtain pre- and post-issuance reviews from a state auditor or any other public entity that is mandated by the sovereign to assess alignment with the proposed regulation.

Where a prospectus is to be published pursuant to the EU Prospectus Regulation, that prospectus shall clearly state that the European green bond is issued in accordance with this new regulation.

External reviewers

The proposal envisages the establishment of a regime for registration with, and on-going supervision of, external reviewers by ESMA. External reviewers will need to comply with specified requirements relating to organisation, processes and documents concerning governance, as well as the requirements regarding pre-issuance and post-issuance reviews.

Registered external reviewers will be listed on a database to be maintained by ESMA.

The proposal also envisages procedures for an equivalence assessment, recognition or endorsement under which third country (non-EU) external reviewers may provide external review services (similar to that provided for pursuant to the Benchmarks Regulation or Credit Ratings Agency Regulation).

These provisions will not apply to state auditors and other public entities mandated by sovereign issuers.

Supervision

National competent authorities will have the power to supervise bond issuers and impose administrative sanctions and other administrative measures and ESMA will be tasked with the supervision of external reviewers.

What’s next?

This proposal from the Commission is the first step in the EU legislative process for the European green bond regulation. The draft regulation will follow the ordinary legislative procedure before it can become binding EU law. This will involve negotiations between the European Parliament and Council via the trilogue procedure. This process is likely to result in changes to the proposal published today. The average length of the ordinary legislative procedure is around 18 months, so it is unlikely that the new regime will be in place before the start of 2023 which is a long time in the rapidly evolving ESG bond market.

It will be interesting to see the extent to which this new label will be adopted by the market. There is already some speculation that linking the EU green bond framework to the complex definitions of “environmentally sustainable” in the Taxonomy Regulation may put off some issuers.

The EU authorities are not alone in considering the current state of play for green “use of proceeds” bonds, see for example our earlier blog post on the UK FCA consultation launched on 22 June, which also raises questions regarding transparency and rigour in relation to green bonds.

In the meantime, the market continues to develop. ICMA has recently updated its Green Bond Principles to incorporate additional recommendations in relation to issuer green bond frameworks and external reviews; and sustainability-linked bonds, where a bond is structured so that an issuer’s compliance with pre-defined sustainability performance targets impacts pricing, are gaining popularity as an alternative product.