The new green bond standard aims to hit EU Green Deal targets, address environmental challenges, and increase investment in sustainable activities.
The European Commission (the Commission) recently issued two key announcements relating to the newly published EU Sustainable Finance Strategy (the Strategy) and the new EU Green Bond Standard (the EUGBS). This blog will highlight key areas of focus in the Strategy and will explore anticipated dynamics in the green bond market and between the EUGBS and the International Capital Market Association’s (the ICMA’s) Green Bond Principles (the GBPs).
What Is the EU Sustainable Finance Strategy?
The Strategy provides a more ambitious roadmap for the development of sustainable finance in the EU and aims to achieve the targets laid down in the EU’s European Green Deal (the Green Deal). The Strategy sets out several initiatives to address environmental challenges and to increase investment in sustainable activities, including from retail investors and SMEs.
The Strategy was considered particularly necessary given the focus on sustainability as the central feature of the EU’s plan for recovery from the COVID-19 pandemic, and places considerable focus on the inclusiveness of the proposals.
What Is the Focus of the Strategy?
The Strategy includes six actions:
- Develop a more comprehensive framework to support transition financing, particularly in the energy sector
- Support the access of SMEs to sustainable finance
- Enhance the resilience of the economic and financial system to sustainability risks, including through financial reporting standards, credit ratings, and stress tests for financial institutions and insurers
- Increase the financial sector’s contribution to sustainability, including through sustainability disclosure by financial institutions, investors’ fiduciary duties to consider sustainability in investment decision making, and by comparing ESG ratings
- Ensure the integrity of the EU financial system and monitor its orderly transition to sustainability, including to avoid greenwashing and to ensure that the supervisory powers and capabilities of relevant competent authorities are fit for purpose
- Develop international sustainable finance initiatives and standards, and support EU partner countries
The Commission will develop specific measures to execute these actions and to support the Strategy, with a report on the implementation of the Strategy due by the end of 2023. However, the Strategy does not address certain unresolved questions, including if, or the extent to which, nuclear power and natural gas projects should play a role in the EU’s energy transition. These questions remain the subject of political debate between Member States and European politicians.
What Is the EU Green Bond Standard?
The Green Deal clarifies that significant investment is required across all sectors of the economy to transition to a climate-neutral future and to reach the EU’s environmental sustainability objectives. From 2021-2030, the EU’s current 2030 climate and energy targets will, according to the EU’s own calculations, require energy system investments (excluding transport) of €336 billion per annum, equivalent to 2.3% of the bloc’s GDP. The private sector will need to provide a substantial portion of these financial flows. Despite vigorous market growth, issuance of green bonds remains at a fraction of overall bond issuance — about 4% of overall corporate bond issuance in 2020 — and the Commission believes that further growth in the market for high quality green bonds will provide significant green investment, thereby helping to close the European Green Deal investment gap.
The European Green Deal Investment Plan, announced on 14 January 2020, included a proposal for an EU green bond standard, which is designed to accelerate growth in the green bond market. Fast-forward 18 months and the Commission has proposed a Regulation to create such a standard (the EUGBS).
The Commission hopes the EUGBS will be a useful tool, both for issuers of green bonds who wish to demonstrate that they are funding projects aligned with the EU Taxonomy, and for investors who will be able to more easily see that their investments are sustainable, thereby reducing the risk of greenwashing.
EUGBS compliance will initially be voluntary (i.e., issuers will still be able to market bonds as “green” in the EU without being EUGBS compliant) and the standard is not expressly intended to replace the GBPs, even in the EU. Nevertheless, the Commission appears to have positioned the EUBGS as the “gold” standard to which green bond issuers should aspire.
What Are the Key Features of the EUGBS and How Do They Compare to the GBPs?
Use of proceeds:
- The EUGBS is intended to provide additional certainty around the use of proceeds (the UoP) of the green bonds. Under the EUGBS, the UoP must align with the EU Taxonomy, but no such requirement exists under the GBPs (the bonds must instead satisfy specific GBP eligibility criteria). A consequence of this requirement of EU Taxonomy-alignment is that, in addition to making a “substantial contribution” to one of the EU’s six climate and environmental objectives in accordance with the relevant technical screening criteria, “green projects” to which proceeds are allocated must not significantly harm any of these objectives and must meet minimum social safeguards. For more information on the EU Taxonomy, please see Latham’s previous blog post.
- The EUGBS is explicitly intended to support transition activities (as defined in the EU Taxonomy) and long-term transition projects that are EU Taxonomy-aligned. All of the proceeds of the green bonds must be allocated to economic activities that satisfy EU Taxonomy requirements by no later than the time the bond matures.
- A pre-issuance external review confirming alignment of the “green bond factsheet” prepared by the issuer (both in the form annexed to the EUGBS) with the requirements of the EUGBS will be required. Under the GBPs, a pre-issuance external review (a Second Party Opinion or SPO) is only a key recommendation.
- A post-issuance external review regarding the allocation of proceeds (in the form annexed to the EUGBS) will be required at least once upon full allocation of proceeds. Under the GBPs, a post-issuance external review is only a key recommendation.
- The EUGBS creates a new regime for the registration and supervision of external reviewers, with or by the European Securities and Markets Authority (ESMA). The external reviewers must be registered with ESMA and must satisfy specified eligibility criteria. ICMA does maintain a list of external reviewers in relation to the GBPs, but has a limited supervisory function in relation to these providers.
- Similar to the GBPs, under the EUGBS, the issuer must provide annual allocations reports (in the form annexed to the EUGBS) until all proceeds are allocated (with at least one report being published during the tenor of the bond).
- The EUGBS require that at least one impact report (in the form annexed to the EUGBS) is published, whereas the publication of an impact report is a key recommendation under the GBP.
- Under the EUGBS, the bond’s green bond factsheet, the pre-issuance external review, the annual allocation reports, the post issuance allocations external review, and the impact report must be published on the issuer’s website for the duration of the life of the green bonds. This requirement is substantively similar to that in the GBPs.
What Is Next?
The Regulation proposing the EUGBS will now be sent to the European Parliament and European Council for approval, which is expected in 2022. During that time, it will be interesting to see the extent to which the EUGBS will be adopted in the green bond market, and if, when, and to what extent issuers (both inside and outside of the EU) will chose to align with the EUGBS. While issuers will not be under any obligation to use the EUGBS for now, it remains to be seen if or for how long the standard remains completely voluntary.
Issuers that wish to be EUGBS-compliant will need to adapt to the new requirements of the EUGBS . Further, ensuring that all proceeds are EU Taxonomy-aligned may prove challenging, particularly while the EU Taxonomy itself is still under development, with the technical screening criteria for the four non-climate environmental objectives in the EU Taxonomy, and guidance on transition activities, yet to be published. Nevertheless, some issuers have already shown that issuing EU Taxonomy compliant green bonds is possible.
Interestingly, the EU has indicated that its own NextGenerationEU (NGEU) green bonds, which are due to be issued shortly, will not be EUGBS-aligned. To maintain the credibility of the EUGBS, the Commission aims to prepare a NGEU framework aligned “to the greatest extent possible” with the EUGBS.
Going forward, it will interesting to track the extent to which investors, both inside and outside of the EU, will demand that issuers align with the EUGBS (rather than the GBPs), whether EUGBS will result in divergence in the green bond market between the EU and the rest of the world, and how the proposed implementation of the EUGBS will affect the rate of growth of the green bond market inside and outside the EU.
This post was written with the assistance of James Bee and Aleksandra Dulska in the London office of Latham & Watkins.