An article providing an overview of the recently adopted European Green Bond Standard including the requirements issuers must comply with to be able to use the standard and how the standard is to be supervised. The article will be useful for issuers, investors and other stakeholders as it discusses the standard and the possible advantages as we transition to net zero.
A Guide to the European Green Bond Standard
Green bonds have stolen the limelight in the field of ESG finance. Half a trillion dollars of green bonds were issued in 2022, and the volume of ESG investment products continues to expand. In what may be the largest change to debt capital markets in some years, the adoption of the European Green Bond Standard by the EU now looks to provide a regulatory framework on a previously self-governing asset class.
The standard was first announced as part of the European green deal investment plan in January 2020, as part of the EU's plan to direct financial and capital flows to green investments. The rapid growth in the number of issuances of green bonds has increased demand for standardisation to clamp down on "greenwashing": where a company conveys false information on the environmental impact of its product or practices.
The European Council has adopted the EU Green Bonds Regulation (the Regulation) on 23 October 2023 and this is expected to take effect at the end of 2024 following publication in the EU's Official Journal.
The Regulation sets a standard that issuers can choose when labelling their bonds which raise finance for environmentally sustainable projects. As a condition for use of the European Green Bond (EuGB) label, the proceeds must be used for projects aligned with Regulation (EU) 2020/852 (the EU Taxonomy), and those relating to disclosures when issuing and marketing the bonds. The bonds will also be subject to external review, the framework of which the Regulation establishes and supervises.
Use of the EuGB standard is entirely voluntary; the issuer of a green bond instrument is not required to issue in accordance with the Regulation unless they wish to market their bonds with the EuGB label. Use of the standard is open to all EU and non-EU issuers, including companies and sovereigns.
Title II, Chapter I of the Regulation requires an issuer to invest all proceeds of the debt in economic activities which are aligned with the EU Taxonomy's sustainability objectives:
- Climate change mitigation
- Climate change adaptation
- The sustainable use and protection of water and marine resources
- The transition to a circular economy
- Pollution prevention and control
- The protection and restoration of biodiversity and ecosystems
All proceeds of the EuGB need to be used to finance such activities before bond maturity.
The Regulation provides for a "flexibility pocket" until the EU Taxonomy is fully functional, meaning that at least 85% of the funds raised by the bond issuance must be aligned with the EU Taxonomy, and the remainder can be used where technical screening criteria has not yet been developed. Furthermore, for operating and capital expenditures that will be aligned with the EU Taxonomy shortly after issuance, the issuer shall outline the deadline by which the expenditures will be EU Taxonomy-aligned in a "CapEx plan". In the event that the EU Taxonomy is amended following issuance, the issuer has seven years within which to allocate both unallocated proceeds of the debt and proceeds in the CapEx plan not yet meeting the EU Taxonomy requirements to allocations that are in alignment with the amended technical screening criteria
Issuers who wish to use the EuGB label when marketing a green bond are required to disclose pre-issuance, periodic and post-issuance information concerning:
- how the bond's proceeds contribute to the issuer's EU Taxonomy-aligned turnover, capital expenditure and operating expenditure; and
- how those investments feed into the transition plans of the issuer as a whole.
Title II Chapter II of the Regulation requires an issuer to publish a Green Bond Framework to report on both the allocation and impact of the funds, and the verification of the EuGB standard. The goal is to establish a clear connection with how investing in the bond will result in the intended positive impact on climate change goals. Pre- and post-issuance verifications are mandatory, and it is recommended that impact reporting is verified by an accredited body.
Annex I to the Regulation sets out a EuGB factsheet which is to be completed by the issuer pre-issuance and must be verified by an external reviewer. Annex II sets out an allocation report, to be published yearly until all proceeds are fully allocated. Issuers must also obtain a post-issuance review from an external reviewer after full allocation of the proceeds. Annex III sets out an impact report to be published after all proceeds are allocated, and at least once during the lifetime of the bond, with the option of review by an external reviewer.
The standardised templates may also be used by issuers not using the EuGB label, but who still issue debt instruments with environmental objectives - The advantages of using this template is that this may increase marketability of the bond owing to standardisation of reporting information on EU Taxonomy-alignment of green bonds, and this may also reduce the administrative burden on an issuer.
The EUGB label requires higher levels of transparency to potential investors. For example, when an issuer intends to allocate proceeds to nuclear energy or fossil gas related activities, this should be clearly disclosed on the EuGB factsheet.
Furthermore, non-sovereign issuers would need to publish a prospectus that is compliant with the EU Prospectus Regulation (Regulation (EU) 2017/1129), which is supervised by the national competent authority of the home member state.
Titles III to VI of the Regulation establishes a framework to register and supervise independent reviewers to verify that the EuGB labelled instruments are aligned with the EU Taxonomy. Issuers will be required to engage these reviewers throughout the life cycle of the bond.
The European Securities and Markets Authority (ESMA) is responsible for the registration and supervision of external reviewers of EuGBs, and the national competent authorities of the home member state (in line with the EU Prospectus Regulation) supervises issuers to ensure they comply with the EU Taxonomy criteria. ESMA's supervisory role allows it to investigate complaints, impose fines and withdraw registration. External reviewers will also need to identify and manage conflicts of interest.
There are transitional provisions permitting third country external reviewers to provide their services for an 18-month period without registration, where they have notified ESMA of their intention to provide such services.
The Regulation will come into effect 12 months after publication in the Official Journal and the EU hopes this will influence other jurisdictional standards and expand the sustainable bond market. Europe has been a world leader in sustainable bond market activity, accounting for around 40% of the outstanding international total.
Critics of the new standard have noted its shortcomings: the extra administration of the issuance because of disclosure and the fact that increased monitoring and reporting costs may disincentivise smaller issuers. Other critics state that the EU Taxonomy is difficult to navigate and data is not yet available with regard to the EU Taxonomy criteria. It Is for this reason that issuers may prefer to continue using the ICMA market standard, as is currently done in 97% of issuances, with additional certification available from various providers (e.g. the Climate Bonds Initiative). There may also be fragmentation in the market if the EU Taxonomy is different from other similar standards in other jurisdictions.
However, the trade-off for use of the EuGB label is its high marketability: An issuer can use EuGBs to diversify its investor base and attract ESG-specialist investors. Furthermore, institutional investors would likely place a premium on EuGBs issuances due to its ambitious standards and compliance with other regulatory regimes, offsetting the increased costs of issuance. The standardisation of the disclosure requirements is also attractive for prospective investors, and although extra administration is required for an initial issuance of EuGBs, subsequent issuances would follow the same framework, internal processes and tracking of proceeds. If the issuer is the first EuGB issuer in a particular jurisdiction or sector, this amplifies the potential for that EuGB to provide positive momentum for focus on the issuer's sustainability credentials. On this basis, the EuGB standard may yet be the gold star that ESG-focused issuers and investors will aspire to.