As mentioned in our briefing on 11 July 2019, the European Commission’s ("EC") technical expert group on sustainable finance ("TEG") published three new important reports:
1. a taxonomy technical report which aims to provide practical guidance for policy makers, industry and investors on how best to support and invest in economic activities that contribute to achieving a climate neutral economy (the “Taxonomy Report”);
2. a report on EU Green Bond Standards which recommends clear and comparable criteria for issuing green bonds (the “EU GBS Report”); and
3. a report on benchmarks which sets out the methodology and minimum technical requirements for indices that will enable investors to adopt a climate-conscious investment strategy, and address the risk of greenwashing. The report also sets out disclosure requirements for benchmark providers in relation to environmental, social and governance (“ESG”) factors and their alignment with the Paris agreement (the “Benchmarks Report”).
This briefing is the second instalment in a series of three and considers the EU GBS Report in greater detail. The first briefing, which focuses on the Taxonomy Report, is available here.
EU Green Bond Standard
In its EU GBS Report, which follows the publication of its interim report in March 2019, the TEG makes ten recommendations, three of which relate to the establishment of the EU GBS, with the other recommendations relating to how European governments, European institutions, market participants and other stakeholders can support and monitor the implementation of the EU GBS through both demand and supply-side measures.
In relation to the establishment of the EU GBS, the TEG recommends that the EC creates a voluntary standard to enhance the effectiveness, transparency, comparability and credibility of the green bond market without disrupting the market, and to encourage the market participants to issue and invest in EU green bonds. A proposal for such a standard is presented in Annex 1 to the EU GBS Report.
In order to respond to market demand, the TEG further recommends that the EU GBS should be created through an EC communication or recommendation to be published as soon as practically feasible, and at the latest at the moment when the Taxonomy Regulation has been agreed by the co-legislators. The TEG recommends that an EU green bond could be any type of listed or unlisted bond or capital market debt instrument issued by a European or international issuer that is aligned with the EU GBS.
The TEG recommends that that the EU GBS should comprise four critical elements:
- alignment with EU-taxonomy: proceeds from EU green bonds should go to finance or refinance projects/activities that:
- contribute substantially to at least one of the six environmental objectives outlined in the draft Taxonomy Regulation;
- do not significantly harm any of the other objectives;
- comply with the minimum social safeguards; and
- where technical screening criteria have been developed, finance projects or activities that meet these criteria, allowing however for specific cases where these may not be directly applicable;
- publication of a Green Bond Framework for use by bond issuers. This framework confirms the voluntary alignment of green bonds issued with the EU GBS, explains how the issuer’s strategy aligns with the environmental objectives, and provides details on all key aspects of the proposed use-of-proceeds, processes and reporting of the green bonds. The EU GBS expands and formalises what needs to be included in a Green Bond Framework to make it a comprehensive document for the information of investors and other market participants;
- mandatory reporting on use of proceeds (allocation report) and on environmental impact (impact report); and
- mandatory verification of the Green Bond Framework and final allocation report by an external verifier.
The TEG further recommends that external verifiers are formally accredited and supervised with the European Securities and Markets Authority (ESMA) being identified as the most suitable European authority to design and operate such an accreditation regime. Given the time it will take to implement this regime, the TEG recommends that an interim registration process be established for external verifiers of green bonds for a transition period of up to three years.
In relation to the development of the EU GBS, the TEG acknowledges that it has used the Green Bond Principles produced by the International Capital Markets Association (“GBP”) as a starting point for the EU GBS on the basis that it embodies best market practice. The report contains an informative table setting out key features of the EU GBS when compared to the GBP. Key points to note are as follows:
- Use of proceeds: a description of the use of proceeds is mandatory under the EU GBS and must be described in the legal documentation (base prospectus or final terms). Under GBP, a description of the use of proceeds was recommended although usually included in practice, whether by a cross-reference to the accompanying framework or otherwise.
- Eligibility criteria: whereas the GBP set out high level categories for eligible green projects, the EU GBS requires alignment with the EU Taxonomy together with the development of a Green Bond Framework (in line with the template included in the EU GBS Report). Specific requirements in relation to capital and operating expenditures as well as look-back periods are set out in the EU GBS.
- Disclosure on refinancing: disclosures relating to refinancing were recommended under the GBP but are required under the EU GBS with specific technical requirements included in the EU GBS together with a reporting template.
- Impact monitoring and reporting: impact monitoring and reporting was recommended under the GBP but is required under the EU GBS with a reporting template included in the EU GBS.
- External review requirements: an external review was recommended under the GBP (either partial or full) but is required under the EU GBS with verification of the Green Bond Framework and the final allocation report to be by an accredited verifier with detailed requirements set out in the EU GBS.
- Publication of external verification: the publication of external verification was recommended under the GBP but is required under the EU GBS.
In relation to existing green bonds, the TEG suggests that current green bond issuers should have the option to align their existing bonds with the EU GBS at their discretion.
The next EC will be in charge of deciding whether to take the TEG’s recommendations forward and how. In addition, the TEG’s mandate has been extended until the end of the year during which time it will advise the EC on linking the EU GBS to the Taxonomy and also on designing/setting up the temporary, voluntary registration system of approved external verifiers.
Given the continuing growth of the green bond market, the proposed introduction of the EU GBS is an exciting prospect. It is encouraging to see that the TEG is building on the existing standards used in the market (especially ICMA’s GBP) and worth noting that the TEG proposes making these standards even more robust, making many actions which were recommended under the GBP mandatory under the EU GBS. Ultimately, the introduction of a workable standard for green bonds endorsed by the EU will be an important step towards the maturation of the green bond market.