ESG Update: EU Council and Parliament Adopt Green Bond Standards Regulation

Initially announced as part of the EU’s Green Deal Investment Plan in January 2020 and envisaged in the European Commission’s 2018 Sustainable Finance Action Plan, the Council of the EU formally adopted the Regulation of the European Parliament and of the Council on European Green Bonds and optional disclosures for bonds marketed as environmentally sustainable and for sustainability-linked bonds (the “Green Bond Regulation”) during its meetings held on 23 and 24 October 2023. This follows the formal adoption of the Green Bond Regulation by the European Parliament on 5 October 2023. The Green Bond Regulation will come into force 20 days after its publication in the Official Journal of the EU (expected in November 2023) and will start to apply 12 months from its entry into force.

The EU “Gold Standard”: Voluntary standard available to EU and Non-EU Issuers

During the course of its legislative discussion and adoption, proposals regarding the Green Bond Regulation have taken many forms, with the final text being somewhat watered down from the mandatory standard proposed by the European Parliament in 2022. The final adopted text, more aligned to the EU Commission’s initial proposal in 2021, provides for a voluntary standard, providing uniform requirements for issuers that wish to use the designation "European green bond", or "EuGB". These designations are available for bonds that meet the requirements of the Green Bond Regulation and are offered to the public or admitted to trading on an EU regulated market. The designation is open to both EU and most non-EU issuers.¹

The Council of the EU notes that it views the Green Bond Regulation as "a further step in implementing the EU’s strategy on financing sustainable growth and the transition to a climate-neutral, resource-efficient economy…The new standard will foster consistency and comparability in the green bond market, benefitting both issuers and investors of green bonds".²

While using the designations set out in the Green Bond Regulation remains voluntary for issuers, its supporters hope that it will become the “gold standard” for green bond issuances in Europe. The Green Bond Regulation also provides for a five-yearly review by the EU Commission to, among other things, assess the volume of bonds marketed as European green bonds and the need for any amending legislative proposals over time.

What is a European green bond and how does it differ to the existing green bond offering?

According to statistics published by the International Capital Markets Association (“ICMA”), 98% of sustainable bonds globally were aligned with ICMA’s green bond principles, social bond principles, sustainability bond guidelines or sustainability-linked bond principles in 2022.

Whether or not the European green bond standard will attract sufficient uptake to become widely-used and displace the popularity of ICMA’s principles, particularly in Europe, will most likely depend upon how initial European green bonds fare in the market, including whether they are perceived or treated differently to non-European green bonds (i.e., with some form of higher (or any) “greenium”). Any such treatment may, in turn, encourage more issuers to seek the European green bond designation.

The process to issue a European Green Bond is more complex than the issuance of green bonds under ICMA’s principles. In summary, the Green Bond Regulation requires the following:

• Proceeds of European green bonds must be invested in economic activities that are aligned with the EU Taxonomy for Sustainable Activities. The EU Taxonomy Regulation³ acts as a reference point for the EU’s sustainability-based standards and definitions. Article 3 of the EU Taxonomy Regulation provides that an investment or economic activity will qualify as environmentally sustainable where it:

(i) contributes substantially to environmental objectives set out in Article 9 of the EU Taxonomy Regulation;⁴

(ii) does not significantly harm any of the environmental objectives set out in Article 9 of the EU Taxonomy Regulation;⁵

(iii) is carried out in compliance with the minimum safeguards laid down in Article 18 of the EU Taxonomy Regulation;⁶ and

(iv) complies with technical screening criteria set out therein.

Article 9 of the EU Taxonomy Regulation sets out environmental objectives of: (A) climate change mitigation; (B) climate change adaptation; (C) the sustainable use and protection of water and marine resources; (D) the transition to a circular economy; (E) pollution prevention and control; and (F) the protection and restoration of biodiversity and ecosystems.

The Green Bond Regulation requires that the net proceeds of a European green bond are invested (either directly or indirectly (i.e., through loans and other financial assets)) in economic activities that are aligned with the EU Taxonomy Regulation, provided the sectors concerned are already covered by the EU Taxonomy’s technical screening criteria. For those sectors not already covered and for other specific activities,⁷ there is a “flexibility pocket” of 15% of the net proceeds, although the other requirements of the EU Taxonomy must still be fulfilled.⁸ The Green Bond Regulation also provides for ‘grandfathering’ provisions where the technical screening criteria of the EU Taxonomy change over the life of the bond.

In addition, where the proceeds of a European green bond are to be allocated to capital or operating expenditure that will, in the future, be aligned with the EU Taxonomy Regulation, the issuer will be required to publish a “CapEx plan”.⁹ Such plan must specify a deadline before the European green bond reaches maturity, by which all the capital and operating expenditure funded by the proceeds of the issue is aligned with the EU Taxonomy Regulation. Certain exemptions or variations are provided in the Green Bond Regulation for sovereign issuers, who may, for example, finance public assets or expenditure that are expected to meet EU Taxonomy requirements within a ‘reasonably short period’ from the date of issue.¹⁰

The use of proceeds requirements under the Green Bond Regulation are more extensive than under the ICMA green bond principles, notably by mandating compliance with the EU Taxonomy Regulation, as well as the imposition of a more stringent and specific criteria for green projects. Indeed, compliance with the EU Taxonomy Regulation alignment requirements may not be easy for certain issuers, in particular for those who are unable to demonstrate compliance with the alignment requirements due to issues, for example, with reliable data collation, or for issuers that operate in sectors not yet covered by the EU Taxonomy Regulation's technical screening criteria where the “flexibility pocket” may not be sufficient.

For green securitisations, the European green bond proceeds requirements will be applied to the originator of the securitised assets rather than the issuer directly. Certain securitisations are also out of scope of the Green Bond Regulation, such as synthetic securitisations,¹¹ as well as securitisations whose underlying exposures finance certain activities.¹²

• Issuers will need to provide both pre- and post-issuance reporting for a European green bond. Unlike the simpler initial second party opinion and post-issuance (until full allocation) annual reporting under ICMA’s green bond principles, the Green Bond Regulation sets out prescribed information that issuers must provide to investors for their evaluation of the use of proceeds and comparability with other European green bonds both pre- and post-issuance. This information must be verified by an independent external reviewer. In summary:
  • prior to the issuance, a European green bond “factsheet” (in the form annexed to the Green Bond Regulation) must be provided and reviewed and opined on by an external reviewer (see below);
  • for each 12-month period until the net proceeds of the European green bond are fully allocated, an “allocation report” (in the form annexed to the Green Bond Regulation) must be provided and reviewed and opined on by an external reviewer; and
  • following the full allocation of the proceeds, at least once during the tenor of the European green bond, the issuer must complete an “impact report” (in the form annexed to the Green Bond Regulation) detailing the environmental impact of the proceeds of the European green bond. It is encouraged that this reporting is conducted or reviewed by an external reviewer, although an external review is not required. 

Each of the above reports, together with the accompanying external review reports, must be made available free of charge on the issuer’s website. Where applicable, any CapEx plan, as well as a link to the prospectus for the European green bond, must also be made available.

The requirement for multiple external review opinions from registered providers (see below) is likely to be materially more expensive than the cost of obtaining a second-party opinion under ICMA’s green bond principles (and any engagement with an external auditor or other third party on the annual reporting as recommended thereunder). Issuers will thus have to balance whether such additional costs are outweighed by any reputational, pricing or other benefits when considering whether to issue a European green bond or an ICMA green bond principles-compliant green bond.

• External reviewers of European green bonds will be subject to supervision and registration. The introduction of a mandatory supervisory regime for external reviewers of European green bonds is one of the key departures from the approach adopted by ICMA in its green bond principles. Under the Green Bond Regulation, following an initial 18-month transition period, external reviewers will need to be registered with the European Securities and Markets Authority (“ESMA”) and demonstrate ESMA’s required level of experience and skill. The Green Bond Regulation provides that ESMA will produce further detailed operational and authorisation requirements for registered external reviewers. Thirdcountry (or non-EU) external reviewers will be permitted to provide review services, provided that they are registered with ESMA, declared to be “equivalent” by the EU Commission or have their reports endorsed by an ESMA-regulated external reviewer. One side effect of the relatively stringent requirements for ESMA registration may be increased costs for review services being passed on to the issuer for European green bond transactions, as compared to the fees for second party opinions currently provided by entities in respect of ICMA green bond principles-compliant offerings.
  
  
• In order to obtain the European green bond designation, green bonds must be subject to an approved prospectus. The requirement for European green bonds to be subject to an EU Prospectus Regulation-compliant prospectus (unless issued by an exempt issuer under the EU Prospectus Regulation (i.e., EU Member States and quasi-sovereign entities in the EU)), make European green bonds a “regulated product”. Accordingly, those issuers that have historically issued securities on exchange-regulated markets or MTFs¹³ in the EU (such as Luxembourg’s Euro MTF market, or Ireland’s Global Exchange Market) may be deterred from seeking a European green bond designation due to the more stringent disclosure requirements set out under the EU Prospectus Regulation and required for securities to be admitted to trading on an EU-regulated market, as well as increased prospectus liability.
  
  
• EU competent authorities have a number of sanctioning powers for non-compliance with the Green Bond Regulation. The national competent authority that reviews and approves the prospectus for a particular European green bond offering will also be responsible for overseeing the issuer’s compliance with the Green Bond Regulation. Such authority also has a number of powers under the Green Bond Regulation for handling issues of non-compliance, including withdrawal of the European green bond label, prohibiting issuances of European green bonds by an issuer for up to one year and power to suspend approval of a prospectus, as well as monetary fines of up to 0.5% of an issuer’s total annual turnover.¹⁴ The Green Bond Regulation also provides that EU Member States may choose to impose criminal sanctions for instances of non-compliance with the Green Bond Regulation. By contrast, non-compliance with the ICMA green bond principles is largely a reputational issue for issuers, so the increased risk involved in issuing a European green bond may be a factor issuers will consider when choosing the best structure for their needs.

The “European Green Bond lite” regime

For those issuers that wish to label their bonds as “environmentally sustainable” or “sustainability-linked” but that do not meet the requirements for the European green bond designation, the Green Bond Regulation provides for an optional disclosure system, often referred to as the “European Green Bond lite” regime. Pursuant to this regime, issuers of green bonds that do not meet the EU Taxonomy Regulation alignment requirement for use of proceeds, or sustainability-linked bonds that have certain environmental sustainability objectives (as set out in the Green Bond Regulation), may voluntarily opt-in to publish certain pre- and post-issuance information under the Green Bond Regulation. Notably, bonds issued under ICMA’s sets of ESG-bond principles may be eligible for this disclosure regime. Such voluntary disclosure would be subject to the supervision of the EU national competent authority (see above), but issuers would not be entitled to designate the bonds as “European green bonds”. Whether or not issuers seek to make these voluntary disclosures will likely depend on whether they become standard in the market and important for bond investors in terms of comparability across the market.

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The Green Bond Regulation attempts to introduce a regulatory framework to foster a sense of increased credibility for European green bonds, to increase comparability among the product offering and to help combat greenwashing. The voluntary nature of the standards means that it is open to issuers whether or not they wish to follow this more stringent approach to green bond issuances. At least initially, it is widely expected that only very few EU issuers will seek to obtain a European green bond designation for their issuances. Whether the standards set out in the Green Bond Regulation can gain traction in the short term and meet its aims of becoming the “gold standard” for green bond issuances will, in large part, depend upon whether the market and investor classes will afford issuers of European green bonds more favourable pricing, access to wider investor pools or other treatment so as to make the expected increased cost and complexity of issuing a European green bond worth it for green bond issuers.

The authors would like to thank Alexandra Zintl for her contribution to this OnPoint.

Footnotes

1. The European green bond designation is not open to non-EU issuers from countries deemed by the EU to be either non-cooperative tax jurisdictions or high-risk jurisdictions. Recital 19 and Article 9 of the Green Bond Regulation exclude the countries listed in Annex I to the Council conclusions on the revised list of non-cooperative tax jurisdictions, and the high-risk countries listed in the Commission Delegated Regulation (EU) 2016/1675.
2. https://www.consilium.europa.eu/en/press/press-releases/2023/10/24/european-green-bonds-council-adopts-new-regulation-to-promote-sustainable-finance/
3. Regulation (EU) 2020/852 (the “Taxonomy Regulation”).
4. To be carried out in accordance with Articles 10 to 16, the Taxonomy Regulation, Article 3(a).
5. To be carried out in accordance with Article 17, the Taxonomy Regulation, Article 3(b).
6. The Taxonomy Regulation, Article 3(c).
7. Activities in the context of international support reported in accordance with internationally agreed guidelines, criteria and reporting cycles, including climate financing reported to the Commission under the United Nations Framework Convention on Climate Change as referred to in Article 19(3) of Regulation (EU) 2018/1999, and official development assistance reported to the Development Assistance Committee of the Organisation for Economic Cooperation and Development. Green Bond Regulation, Article 5(1)(b).
8. It will not be possible to use this “flexibility pocket” for economic activities in sectors already excluded by the EU Taxonomy criteria (such as energy, manufacturing, transport and buildings).
9. Green Bond Regulation, Article 7(1).
10. Green Bond Regulation, Recital 15. Sovereigns may also allocate the proceeds of European green bonds to, amongst other things, tax relief, subsidies, intermediate consumption and international cooperation, provided the proceeds are allocated in accordance with EU taxonomy requirements. Green Bonds Regulation, Article 4(3).
11. Green Bond Regulation, Article 17.
12. Such as the exploration, mining, extraction, production, processing, storage, refining or distribution, including transportation and trade of fossil fuels. Green Bond Regulation, Article 18(1).
13. Examples of exchange regulated markets/multi-lateral trading facilities include the Global Exchange Market in Ireland and the Euro MTF in Luxembourg, and issuers of securities admitted to trading on such markets are not required to prepare a Prospectus Regulation-compliant prospectus for such securities, as compared to regulated markets such as Euronext Dublin in Ireland and the Bourse de Luxembourg in Luxembourg.
14. Member States may also provide additional penalties or higher administrative fines under Article 49(5) of the Green Bond Regulation.