European Commission publishes new standard on green bonds and unveils its latest sustainable finance strategy
The new standard on green bonds aims to meet the objectives of the EU’s Green Deal, address environmental challenges and increase investment in sustainable activities.
The European Commission (Commission) recently published two key announcements regarding the new EU Sustainable Funding Strategy (the Strategy) and the new European standard on green bonds (EUGBS). This blog will highlight the main areas of focus of the strategy and explore the expected dynamics in the green bond market and between EUGBS and the International Capital Market Association (ICMA) Principles of green bonds (the GBP).
What is the EU’s sustainable finance strategy?
The strategy provides a more ambitious roadmap for the development of sustainable finance in the EU and aims to achieve the objectives set in the EU’s European Green Deal (the Green Deal). The strategy sets out several initiatives aimed at tackling environmental challenges and increasing investment in sustainable activities, especially from retail investors and SMEs.
The strategy was deemed particularly necessary given the emphasis on sustainability as central to the EU’s plan for recovery from the COVID-19 pandemic, and places a strong emphasis on inclusiveness offers.
What is the objective of the strategy?
The Strategy includes six actions:
- Develop a more comprehensive framework to support the financing of the transition, in particular in the energy sector
- Support SMEs’ access to sustainable finance
- Improve 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 disclosure of sustainability by financial institutions, investor fiduciary obligations to take sustainability into account in investment decision making and by comparing ESG ratings
- Ensure the integrity of the EU financial system and monitor its orderly transition to sustainability, in particular to avoid green laundering and to ensure that the powers and supervisory capacities of the 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 expected by the end of 2023. However, the strategy does not address some unresolved issues, notably whether, or to what extent, who, nuclear energy 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 European standard on green bonds?
The Green Deal specifies that significant investments are needed across all sectors of the economy to move to a climate neutral future and to meet the EU’s environmental sustainability goals. From 2021 to 2030, the current EU climate and energy targets for 2030 will require, according to the EU’s own calculations, investments in energy systems (excluding transport) of € 336 billion per year, or 2, 3% of the EU’s GDP. The private sector will have to provide a substantial part of these financial flows. Despite strong market growth, green bond issuance remains below a fraction of total bond issuance – around 4% of total corporate bond issuance in 2020 – and the Commission estimates that ‘Further growth in the high-quality green bond market will provide significant green investments, thus helping to close the investment gap of the European Green Deal.
The European Green Deal investment plan, announced on January 14, 2020, included a proposal for a European standard for green bonds, designed to accelerate the growth of the green bond market. Fast forward 18 months and the Commission has proposed a regulation to create such a standard (EUGBS).
The Commission hopes that EUGBS will be a useful tool, both for green bond issuers who wish to demonstrate that they are financing projects aligned with the EU taxonomy, and for investors who will more easily see that their investments are sustainable, thus reducing the risk of greenwashing.
Compliance with EUGBS will initially be voluntary (that is to say, 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 GBP, even in the EU. Nevertheless, the Commission seems to have positioned EUBGS as the “gold” standard to which issuers of green bonds should aspire.
What are the main features of EUGBS and how do they compare to GBP?
- EUGBS is intended to provide additional certainty regarding the use of the proceeds (UoP) of green bonds. Under EUGBS, UoP must align with EU taxonomy, but such a requirement does not exist under GBP (instead bonds must meet eligibility criteria specific to the EUGBS). GBP). A consequence of this requirement for EU taxonomic 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 selection criteria, the “Green projects” to which the funds are allocated must not significantly harm any of these objectives and must respect minimum social guarantees. For more information on EU taxonomy, please see the previous article by Latham blog post.
- EUGBS is explicitly intended to support transition activities (as defined in EU taxonomy) and long-term transition projects aligned with EU taxonomy. All proceeds from green bonds must be used for economic activities that meet the requirements of EU taxonomy by the maturity of the bond at the latest.
- An external pre-issue review confirming the alignment of the “green bond information sheet” prepared by the issuer (both in the form annexed to EUGBS) with EUGBS requirements will be required. . In the context of GBP, an external pre-issue review (a Second Party Opinion or SPO) is only a key recommendation.
- A post-issue external review of product allocation (in the form annexed to EUGBS) will be required at least once during full product allocation. In the context of GBP, a post-issue external review is only a key recommendation.
- EUGBS creates a new regime for the registration and supervision of external examiners, with or by the European Securities and Markets Authority (ESMA). External assessors must be registered with ESMA and must meet the specified eligibility criteria. The ICMA maintains a list of external reviewers with respect to GBP, but has a limited oversight function in relation to these providers.
- As with GBP, under EUGBS the issuer must provide annual allocation reports (in the form annexed to EUGBS) until all revenue is allocated (with at least one report published during the term of the obligation).
- EUGBS requires that at least one impact report (in the form annexed to EUGBS) be published, while the publication of an impact report is a key recommendation under the GBP.
- Within the framework of EUGBS, the information sheet on the bond’s green bonds, the pre-issue external review, the annual allocation reports, the external review of post-issue allocations and the impact report must be published on the website of the issuer throughout the life of the green bonds. . This requirement is substantially similar to that of GBP.
What is the next?
The regulation proposing EUGBS will now be sent to the European Parliament and the European Council for approval, which is expected in 2022. Meanwhile, it will be interesting to see to what extent EUGBS is adopted in the green bond market, and if, when and to what extent issuers (both inside and outside the EU) will choose to align with EUGBS. Although issuers are not required to use EUGBS at this time, it remains to be seen if and for how long the standard will remain fully voluntary.
Issuers wishing to comply with EUGBS will have to adapt to the new requirements of EUGBS. In addition, ensuring that all products are aligned with the EU taxonomy can prove difficult, especially while the EU taxonomy itself is still under development, with the selection criteria. guidance for the four non-climate environmental objectives in the EU taxonomy and guidance on transition activities yet to be published. However, some issuers have already shown that it is possible to issue green bonds that comply with EU taxonomy.
Interestingly, the EU has indicated that its own NextGenerationEU Green Bonds (NGEU), which are expected to be issued shortly, will not be aligned with EUGBS. In order to maintain the credibility of EUGBS, the Commission aims to prepare an NGEU framework aligned “as far as possible” with EUGBS.
Going forward, it will be interesting to see to what extent investors, both inside and outside the EU, demand that issuers match EUGBS (rather than GBP). , whether EUGBS will cause a divergence in the green bond market between the EU and the rest of the world, and how the proposed implementation of EUGBS will affect the growth rate of the green bond market within and outside the EU.
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