The consultation aims to gather technical input from stakeholders in the green bond market before finalising an EU GBS.
On 12 June 2020, the European Commission (the Commission) published a targeted consultation document on the establishment of an EU Green Bond Standard (EU GBS). The Commission has committed to the establishment of an EU GBS as part of its broader Action Plan on Financing Sustainable Growth (the Action Plan), and hopes that the promulgation of an official EU standard will help address some of the barriers it has identified in the current green bond market.
The consultation document seeks to build on the work toward an EU GBS that has already been undertaken by the Commission’s Technical Expert Group on sustainable finance (TEG), a group of members from civil society, academia, business, and the finance sector tasked with providing specialist knowledge on the implementation of the Action Plan. The TEG published an initial report in June 2019 that contained 10 recommendations for the establishment of a voluntary, non-legislative EU GBS based on market practices and feedback, including the suggestion that any EU GBS would be aligned with the EU Taxonomy Regulation, which provides a classification system for sustainable economic activities. The EU GBS could be adopted by any issuer of listed or unlisted bonds, whether domiciled in Europe or not. Subsequently, the TEG produced further usability guidance on an EU GBS in March 2020, which includes an update proposed standard.
The purpose of the consultation document is to gather technical input from stakeholders in the green bond market in order to take forward the recommendations of the TEG, and then develop them into a finalised EU GBS. The consultation document also seeks stakeholder engagement on COVID-19 and social bonds, products that experienced significant growth over the first half of 2020, and asks whether the Commission can take action to support this market in addressing future crises.
The consultation document asks a total of 19 questions, spanning a variety of issues related to green bonds and social bonds. The questions assume an underlying knowledge of the TEG’s proposals, and do not provide significant additional information in this regard. However, the key components of the proposed EU GBS are set out. These key components are:
- Alignment of the use of proceeds from the bond with the EU Taxonomy Regulation
- Publication of a Green Bond Framework
- Mandatory reporting on the use of proceeds (allocation reporting) and on environmental impact
- Verification of compliance with the Green Bond Framework and the final allocation report by an external authorised verifier
As acknowledged by the Commission, these components build on existing market practices such as the Green Bond Principles and the Climate Bonds Initiative labelling scheme. The EU GBS largely mirrors the regime under the Green Bond Principles, the most widely utilised green bond standard currently in the market. Notably, the EU GBS does depart from the Green Bond Principles in some areas. Specifically:
- The EU GBS contains a concrete list of substantive activities that can be categorised as green (by reference to the EU Taxonomy Regulation). This is a marked shift from the more market-led approach under the Green Bond Principles, which includes only a non-exhaustive indicative list and seems to exclude products such as transition bonds (which are discussed more fully in this blog post).
- The EU GBS would require mandatory reporting on the environmental impact of projects, in addition to how proceeds are allocated. Whilst issuers commonly report on environmental impact in practice, the codified requirement to do so under the EU GBS differs from the Green Bond Principles.
- The EU GBS would also require mandatory post-issuance verification of use of proceeds. The impact of this requirement will be interesting to monitor, as currently investors in green bonds very rarely suggest that an issuer did not comply with its framework.
The consultation document includes a question on whether stakeholders agree on the use of each of the key components outlined by the TEG. Further questions in the document cover the following issues:
Suggested Content of a Green Bond Framework
The TEG recommendations include the necessity for issuers of an EU GBS-compliant green bond to publish a Green Bond Framework. A Green Bond Framework is used by an issuer to provide disclosure and information to investors, and demonstrate an issuance’s alignment with a certain standard (in this case, the EU GBS). Green Bond Frameworks are already popular in the green bond market, and can refer to a specific issue of bonds or to “green” issuances by the issuer more generally. However, the TEG’s recommendations require that an EU GBS-compliant Green Bond Framework contain information including how the projects that will be financed by the proceeds of the issuance(s) have been/will be selected and align with the EU Taxonomy, and how and when the issuer will need to report and verify its use of proceeds. This requirement suggests that “pure play” green bonds, whereby an issuer states that all of its expenditures are green, and therefore it can issue a green bond for general corporate purposes, seem to be prohibited under the EU GBS.
100% Use of Net Proceeds
A key feature of the TEG recommendations is the requirement that 100% of the net proceeds of green bonds be used to finance or refinance assets or expenditures that are defined as green by the EU Taxonomy. Whilst broadly in line with existing market standards such as the Green Bond Principles, this approach excludes green striped bonds, or sustainability-linked bonds, from meeting the requirements of an EU GBS. Green striped bonds and sustainability-linked bonds are structurally different to green bonds. The key difference is that the proceeds may be used for general corporate purposes, with the coupon rate being determined by the issuer’s performance in a sustainability-related key performance indicator in the case of sustainability-linked bonds, or that only a certain proportion of the proceeds is required to be allocated to green projects in the case of green striped bonds.
consider newer and more innovative products such as sustainability-linked and green striped bonds an important way in which the environmental finance market can expand, as the increased flexibility allows more issuers to access the environmental finance market and also helps ensure that issuances can be of large enough size to provide sufficient liquidity to be an attractive investment (many potential issuers do not have enough potential green expenditures to justify a green bond).
The consultation document contains questions on the possibility that grandfathering bonds that were EU GBS compliant when issued stop meeting the relevant criteria at a point between issuance and maturity, given the fact that the criteria for being “green” under the EU Taxonomy will be periodically reviewed. Options include: (i) full grandfathering, where the bond is allowed to remain EU GBS-compliant throughout its term, (ii) immediate noncompliance of the bond once revised criteria come into force, and (iii) a set period of time after the criteria change when the bond can be deemed compliant. The possibility that bonds will be compliant when issued but subsequently fail to meet necessary criteria is a key risk that standards such as the EU GBS introduce, so the final approach to such grandfathering will be a significant aspect of the EU GBS, and its potential attractiveness to issuers.
Social bonds, and in particular COVID-19 bonds, shot to prominence in the first half of 2020, with the value of social bond issuances to 23 June 2020 being 69% higher than the total value of such issuances in 2019, according to Environmental Finance’s database. The consultation document seeks stakeholder input on a number of social bond-related questions, including how important stakeholders consider social bonds to be in achieving social objectives.
In addition, stakeholders are asked whether the Commission should develop further guidance on social bonds, whether that be in the form of separate non-binding social bond guidance, an official EU Social Bond Standard, or a “Sustainability Bond Standard”, which would combine social and environmental objectives.
The consultation is open for all stakeholders until October 2020. The move to formalise green bond regulation through an official EU standard will be welcomed by some in the industry as a definitive standard by which issuances that purport to be green can be referenced. However, such a standard may also have the unintended consequence of choking innovative products (such as sustainability-linked or green striped bonds), and failing to keep pace with evolving understandings of what business activities are considered green.
Latham & Watkins will continue to monitor events in this area.
This post was written with the assistance of James Bee in the London office of Latham & Watkins.