The efficiency of the debt capital markets runs on a high degree of homogeneity and standardisation, which enables market participants to make time-sensitive and informed decisions based on a high degree of comparability within asset classes. While the green bond market has developed exponentially in the last five years with a growth rate of over 60%,1 liquidity is not nearly where the market needs it to be to function as an effective tool to meet the numerous demands from different quarters to channel sufficient funding towards the ambitious environmental and other goals such as those espoused by the EU Sustainable Finance Strategy2 and the UNSDG3. Therefore, it is with great anticipation that the market has been watching the development of both Regulation (EU) 2020/852 (the "Taxonomy Regulation"4) and the European Commission's proposed European Green Bonds Regulation (the "Proposed EuGB Regulation") that the European Commission published on 6 July 2021 which, creates a regulatory defined green bond (the "EuGB")5. It also, very importantly, creates a framework for regulating and supervising second opinion providers and external reviewers. These features in particular, have been the focus of much demand from the market for quite some time as the green bond market has been developing them on a voluntary basis over recent years.

The EU may be the first-past-the-post to deliver a regulatory framework to help increase green bond issuance to the required level with the twin regulations promoting the necessary standardisation, transparency and comparability within this asset class. However, it remains to be seen whether they will usher in a green fortune for the EU capital markets or whether such regulations will turn the EU green bond market into a green fortress. While the Taxonomy Regulation is subject for a different piece6, we discuss the European Commission's Proposed EuGB Regulation in more detail below.

Accentuate the positive

The notably positive features of the Proposed EuGB Regulation are:

  • that after much demand, with the Proposed EuGB Regulation together with the Taxonomy Regulation, green bond market participants now have a regulated standard to model or compare against to help further develop the green bond market to where many participants consider it needs to be;
  • the voluntary nature of the Proposed EuGB Regulation and the EU Commission's intention to ensure its harmonious co-existence with the existing voluntary/non-regulatory green bond market frameworks;
  • the EuGB overlaps and aligns with other green bond market principles7 widely in use. There is a welcomed convergence between, for example, the ICMA 2021 Green Bond Principles and the Proposed EuGB Regulation where, for example, the former now 'encourage' issuers "to provide information, if relevant, on the alignment of projects with official or market- based taxonomies" and the later provides a mandatory requirement for the use of proceeds to align with the Taxonomy Regulation;8
  • the Proposed EuGB Regulation provides flexibility around EuGB use of proceeds relating to economic activities that "meet the taxonomy requirement, or that will meet the taxonomy requirements within a defined period of time set out in the taxonomy alignment plan."9 This adds flexibility to the use of proceeds in an EuGB for activities that may not (at the moment) meet the Technical Screening Standards10 based on the Taxonomy Regulation ("TSC")11 but will most likely meet them once developed; and
  • another positive development the Proposed EuGB Regulation will bring in is a set of rules for external reviewers and their supervision. This was something that market participants have been asking for to help boost transparency and comparability.

There may be troubles ahead

There are areas of the Proposed EuGB Regulation which may hinder adoption by market participants notably:

  • perhaps unsurprisingly, there is a mandatory requirement for the use of proceeds to align with the Taxonomy Regulation (despite the voluntary nature of the proposed EuGB Regulation). This may be difficult or unappealing for non-EU issuers who might not necessarily want to follow the TSC based on the Taxonomy Regulation and might be subject to/prefer to comply with their local or regional taxonomies instead;
  • more problematic is the fact that the EuGB designation under the Proposed EuGB Regulation is not preserved for the life of the EuGB issued under the Proposed EuGB Regulation if the relevant taxonomy criteria change during the life of the bond. In particular, the Proposed EuGB Regulation requires the application of the taxonomy to the allocation of proceeds in line with the TSC12 based on the Taxonomy Regulation. The TSC are intended to be "live", constantly developing and subject to regular updates. The Proposed EuGB Regulation requires allocation of proceeds to be in line with the relevant TSC at the point in time when the EuGB was issued. However, if the relevant TSC are amended, issuers will be required to allocate proceeds to economic activities that meet the taxonomy requirements by applying the amended delegated acts within five years. While the Proposed EuGB Regulation does not grandfather initial EuGB designations, on the positive side, it gives the issuers a five-year grace period to ensure that their EuGB can maintain their designation under the amended TSC. However, it is unclear how the grace period will work in practice.13 Further, it is unclear whether, during this grace period and before the maturity of the relevant EuGB issuers will need to: (i) reallocate the proceeds in line with the amended TSC if the proceeds have been already invested into fixed assets; (ii) modify such fixed assets in line with the TSC; and/or (iii) adapt assets or projects with OpEx and CapEx already funded/in the process of being funded by the EuGB proceeds to comply with the amended TSC. This introduces (unnecessary) uncertainty and practical challenges into a product and market that requires certainty, transparency and comparability from an issuer's perspective;
  • The above may also have an impact on secondary market pricing and liquidity of an EuGB during this grace period, and may incur unplanned/unbudgeted costs for issuers to reallocate/adapt proceeds. In addition, this may bring extra costs or complications for investors to de facto monitor that the EuGB designation is still in place and, if not, they may be forced to liquidate their positions if they are no longer in line with their investment objectives.

These points raise the question of whether this will affect liquidity of both the EuGB market and the non-EuGB market and whether they may inadvertently cause the EU green capital markets to become a green fortress.

Facing the music

In general, market participants may find the Proposed EuGB Regulation a useful tool to add to the green tool box. However, some important details may need to be considered before deciding on where and when to deploy it:

  • the "fact sheet" (which is similar to the Framework in the ICMA Green Bond Principles)14 will need to be completed prior to issuance and it will be subject to a pre-issuance review by the external reviewer. It will also need to include disclosure of the environmental strategy and rationale, as well as intended allocation of bond proceeds and intended qualifying green projects. This is a level of detail that issuers have not been required to include to date (although many choose to voluntarily include it). However, some issuers may not have that level of detail ironed out at the time of issuance. As such, these mandatory requirements may prevent them from issuing under the Proposed EuGB Regulation.
  • an annual allocation report is required until full allocation of the proceeds has been completed. Allocation reports are subject to a post-issuance review by an external reviewer. Most issuers are providing these already on a voluntary basis as per the ICMA Green Bond Principles.15 However, the Proposed EuGB Regulation requires an impact report to be drawn up after the full allocation of proceeds and at least once during the lifetime of the bond to report on the environmental impact of the use of the bond proceeds.
  • the Proposed EuGB Regulation requires the issuer to publish on a website the factsheet, pre-issuance review, allocation report, post-issuance review, and the bond impact report. These can be published on the external reviewer's or other website instead of the issuer's. However, it is not clear whether issuers will need to have a separate EuGB section on their website and/or whether it must be distinct from any of their other ESG financing or whether it can be a sub-section. It will depend on how segregated the EU Commission feels the EuGB 'brand' needs to be and/or if it feels it might be confusing to investors if all of an issuers ESG financing is mixed.
  • requirements for external reviewers are subject to a series of robust rules and sanctions under the Proposed EuGB Regulation (which a largely welcomed by market participants but may require an extra check to make sure the external reviewer has been approved under the Proposed EuGB Regulation):
    • external reviewers will be supervised by ESMA who may request periodic information and require to conduct on-site investigations. Furthermore, fines may be imposed by ESMA and/or the National Competent Authorities for non-compliance or false information.
    • external reviewers will need to be vetted, approved and registered with ESMA before they can conduct reviews in accordance with the Proposed EuGB Regulation, including third country external reviewers. This might result in a smaller pool of approved external reviewers and/or an extra check especially for an issuer with multiple jurisdictional issuances.
    • the requirement to publish external reviewer's reports is no longer just a requirement for the issuer (which it would normally do in the prospectus) but it is an obligation for the external reviewer itself. If it refuses, it needs to state reasons why and it incurs direct liability for failure.

The Prospectus Regulation – lest we forget

There is little detail in the Proposed EuGB Regulation about its practical interaction with the Prospectus Regulation (EU) 2017/1129 (the "PR").16

  • the market reached an understanding about PR compliant prospectuses and their green content. Under the PR, as it currently stands,17 a prospectus should contain information relating to an issuer's credit.18 If under the Proposed EuGB Regulation the factsheet is considered regulated information, it can be incorporated by reference for PR purposes. Accordingly, some further disclosure may be relevant to consider for inclusion in an EuGB prospectus in addition to pure credit items. Certain other types of ESG information might also be relevant, depending on the context, such as: (i) further information on the ESG factors in the use of proceeds information in EuGB; or (ii) ESG information that is integral to the issuer's principal activities.
  • in its next review of the PR, ESMA19 may take the Proposed EuGB Regulation into consideration when reviewing the necessary information to be contained in a PR compliant Prospectus such that certain ESG disclosures may have evolved to now be considered necessary information in relation to PR prospectuses of EuGBs.

Fortune Green or Fortress Green?

The Proposed EuGB Regulation has the potential to become an effective tool to enable the EU green bond market help the EU meet its goals under the EU Sustainable Finance Strategy and the UNSDGs. However, with a large portion of the current green bond market left out especially in relation to non-EU market participants, it remains to be seen whether the Proposed EuGB Regulation will usher in a green fortune for the green EU capital markets or whether the Proposed EuGB Regulation will turn the EU green bond market into a green fortress.