A new “world first” gold standard for EU green bonds

Now that the Regulation (EU) 2023/2631 of the European Parliament and of the Council of 22 November 2023 on European Green Bonds (the EuGBs) and optional disclosure on bonds marketed as environmentally sustainable and sustainability-linked bonds (the SLBs) (the EuGB Regulation) has been published in the Official Journal of the EU, attention will turn to its application and the further measures that the European Commission and the European Securities and Markets Authority (ESMA) are tasked with developing.  Although the EuGB Regulation entered into force in December 2023, there is a 12 month phase-in for most of the provisions so it is expressed to apply from 21 December 2024.

The road to an agreement was particularly lengthy, with the European Commission’s proposal having been published in July 2021. During the legislative process there were particular areas of disagreement between the negotiating positions of the European Commission, the European Council and the European Parliament and the final text represents a compromise among the different positions. The European Parliament wanted a mandatory standard that would cover the entire green bond market whilst the European Council was concerned that this would undermine the development of the nascent green bonds market with possible duplicative requirements. While the rules under the EuGB Regulation are fully voluntary across the board, if market participants decide to use the "gold standard" green bond label that is available if they name their bond “EuGB” or “European Green Bond”, the EuGB Regulation imposes certain requirements that must be met in order to use this label.  The EuGB Regulation, however, also introduces voluntary standards for bonds, including SLBs, that can be used in order to address any greenwashing concerns where the bonds are marketed in the EU as environmentally sustainable.  The hope is that over time these voluntary templates may become market standard.  The European Council expects that this new standard “will foster consistency and comparability in the green bond market, benefitting both issuers and investors of green bonds.”¹

Background

The EuGB Regulation aims to increase transparency by improving market efficiency through harmonised rules and standards  and, where the label “EuGB” is used, by requiring the proceeds of EuGBs to be invested in economic activities that are aligned with the taxonomy requirements under Regulation (EU) 2020/852 (the Taxonomy Regulation). The idea is that this should facilitate comparison for investors and address greenwashing concerns.  In addition, the EuGB Regulation sets out optional sustainability disclosure requirements for bonds that are marketed as environmentally sustainable and SLBs that relate to environmental sustainability objectives. These optional disclosure requirements together with the standard for EuGBs will co-exist with the existing international market standards such as the ICMA Green Bond Principles, which many green bonds have aligned with to date.

Following the provisional agreement reached on 28 February 2023, both the European Parliament and European Council subsequently adopted the EuGB Regulation in October which paved the way for the final publication of the text.

What happens next?

The European Commission and ESMA will be tasked with developing further detailed measures including in relation to external reviewers and third party service providers.  In addition, the European Commission will need to publish guidelines before 21 December 2024 for the voluntary pre-issuance disclosure for bonds marketed as environmentally sustainable or SLBs.

In February 2024 ESMA launched a consultation on draft regulatory technical standards (RTS) and implementing technical standards (ITS) relating to the registration and supervision of external reviewers under the EuGB Regulation.²  After the consultation closes on 14 June 2024, ESMA plans to consider the feedback received before publishing a final report in Q4 and submitting the draft RTS and ITS to the European Commission by 21 December 2024 at the latest for endorsement in the form of Commission Delegated Regulations, which are expressed to enter into force 20 days after publication in the Official Journal of the EU. 

According to the ESMA timeline³, ESMA plans to consult on the remaining technical standards between March and June 2025.

What types of issuances can use the EuGB label?

Compliance with the EuGB Regulation will be mandatory for any bond designated as a “European green bond” or “EuGB”.  The designation “European Green Bond” can only be used in respect of “use of proceeds” bonds (see the next section for more detail): (i) for which a prospectus under the under Regulation (EU) 2017/1129 (the EU Prospectus Regulation) is published; or (ii) that fall within one of the exemptions from producing a prospectus under Article 1(2)(b) and (d) of the EU Prospectus Regulation available for EU sovereign bonds.  All such issuances tagged as “European green bonds” or “EuGB” and offered in the EU must comply with the EuGB Regulation.

In addition to requirements around the allocation of proceeds, there are requirements to produce certain reports in the prescribed format set out in the Annexes to the EuGB Regulation such as the European Green Bond Annual Allocation Report and the European Green Bond Impact Report.

The EuGB designation is available to third country issuers although under Article 9 there is an exclusion for issuers located in one of the countries on the EU list of non-cooperative jurisdictions for tax purposes or high risk third countries.

There are also specific provisions in relation to securitisation transactions, for more information please see our alert EU Green Bond Standard – a panacea for green securitisation?

While use of the EuGB label will impose certain requirements, green-, sustainability- or any other ESG-themed bonds will still be able to use any other label or otherwise market themselves as green or sustainable without complying with the EuGB Regulation.   

Use of proceeds

Under Article 4 of the EuGB Regulation, before maturity, the proceeds of EuGBs must be fully allocated in accordance with the taxonomy requirements to the following activities (or a combination thereof):

1. fixed assets (other than financial assets);

2. capital expenditures (that meet or will meet the taxonomy requirements);

3. operating expenditures with a 3-year look back period (that meet or will meet the taxonomy requirements);

4. financial assets created no later than 5 years after the issuance of the European green bond (which may include subsequent financial assets); and

5. assets and expenditures of households.

In addition, it is important from a practical perspective that proceeds can also be allocated to a portfolio of fixed assets or financial assets, provided that the allocation reports show that the total value of fixed assets or financial assets in the portfolio exceeds the total value of the portfolio of outstanding bonds (the “portfolio approach”).  Issuers are allowed to allocate net proceeds only and can deduct issuance costs. 

Article 5 of the EuGB Regulation provides some flexibility such that issuers can allocate up to 15% of the proceeds to economic activities that comply with the taxonomy requirements with the exception of the technical screening criteria where broadly: (i) there is no technical screening criteria in force for that relevant activity by the date of issuance of the EuGB; or (ii) the activities are in the context of international support that contribute to the environmental objectives of the Taxonomy Regulation. This so-called “flexibility pocket” is a compromise between the position of the European Council that advocated for some flexibility for certain economic activities for which there are no technical screening criteria or for certain activities in the context of international support that contribute to the environmental objectives and the European Parliament, which was not keen on any flexibility, but did want some ability for proceeds to be allocated to a portfolio of financial assets.

EU and third country sovereigns are allowed to issue EuGB to finance public assets or expenditures that meet or are expected to meet the taxonomy requirements within a reasonably short period of time after issuance.

CapEx plans

Where the proceeds are used for capital or operating expenditures, the issuer has to publish a CapEx plan in accordance with Annex I of Commission Delegated regulation 2021/2178. A summary of the CapEx plan must be included in the prospectus, which should list the most significant projects carried out by the issuer, measured as a share of the total capital expenditure covered by the issuer’s Capex plan.  In addition, the issuer will need to publish a report on progress made on the implementation of the plan in the annual allocation report.

Application of technical screening criteria and grandfathering

When issuing an EuGB bond, the issuer must ensure that the proceeds of the bond are allocated in accordance with the technical screening criteria in the Taxonomy Regulation applicable at the date of issuance of the bond. The technical screening criteria are set out in delegated acts under the Taxonomy Regulation.  To date, the technical screening criteria in relation to economic activities that can make a substantial contribution to climate change mitigation and climate change adaptation have been put in place⁴ and more recently the environmental delegated act under the Taxonomy Regulation applied from 1 January 2024⁵.

If the relevant technical screening criteria are amended after the date of the issuance of the bond, there is a grandfathering period of 7 years, by the end of which time, the issuer will need to ensure that the following proceeds are aligned with the amended technical screening criteria:

i. proceeds that have not yet been allocated; and

ii. proceeds covered by the Capex plan that have not yet met the taxonomy requirements.

For assets that are allocated using the portfolio approach, the grandfathering works slightly differently. Issuers will need to make sure that all activities included in the portfolio are aligned with the technical screening criteria that were applicable at some point during the 7 years prior to the publication of the allocation report.

This 7 year grandfathering period was the result of a compromise between the European Parliament’s wish for different treatment for transitional activities, with limited grandfathering, which was a major stumbling block for the European Council. This 7 year period should provide sufficient flexibility for issuers who can adjust the term of their bonds accordingly.

EuGB factsheets and reports

Before issuing an EuGB, the issuer must publish an European Green Bond factsheet using the template in Annex 1 of the EuGB Regulation. The factsheet must be accompanied by a pre-issuance review by an external reviewer.

In addition, issuers must prepare an annual allocation report (using the template in Annex II of the EuGB Regulation) every year, until the date of full allocation.  This should set out the allocation of the bond proceeds and should be reviewed by an external reviewer.  Further, an issuer must obtain a post-issuance review by an external reviewer of the allocation report (except where there is no change to the allocation) drawn up after the full allocation of the proceeds of the EuGB, which should be based on the template in Annex IV of the EuGB Regulation.

Finally, issuers must produce an impact report after the full allocation of the proceeds of the bond, which should be based on the template in Annex III of the EuGB Regulation, although there is no need to subject this report to an external review.

Publication on the issuer’s website

The European green bond fact sheet and the pre-issuance review need to be published free of charge on the issuer’s website before bond is issued.

The annual allocation reports, post-issuance review and the European green bond impact report must be published without undue delay after they are drawn up. There should also be a link to the prospectus, the CapEx plan and the impact report review of the European green bond impact report where applicable and any amendments or corrections to any of these documents.

Optional disclosure for bonds marketed as environmentally sustainable and SLBs

In accordance with Article 20 of the EuGB Regulation, the European Commission will publish guidelines establishing templates for bonds marketed as environmentally sustainable and SLBs in the EU (whether or not such bonds are labelled as EuGB or European green bonds). These templates should include information on whether the issuer intends to use an external reviewer and how the bond proceeds will be used in accordance with the EuGB Regulation.

The content, methodology and presentation of the templates will be set out in delegated acts and issuers will be able to use the templates to make periodic disclosures.

Prospectus disclosure requirements

Any bond that is looking to comply with the EuGB Regulation must be designated as a “European green bond” or “EuGB” throughout the prospectus. In addition, the prospectus must state that the EuGB is issued in accordance with the EuGB Regulation in the use of proceeds section.

Issuers will also need to ensure that they comply with the disclosure requirements under the EU Prospectus Regulation and include any relevant material ESG-related information in the prospectus. It is important to note that the EuGB Regulation does not provide for the mandatory incorporation of the factsheet into the prospectus (as was proposed by the European Parliament), nor stipulate that a binding provision of compliance with the EuGB Regulation must be included in the terms and conditions of the bond (as proposed by the European Council).

Although, at the moment, there are no disclosure requirements under the EU Prospectus Regulation to include any relevant material ESG-related information in the prospectus, changes currently being proposed under the EU Listing Act provide for sustainability disclosure requirements under the EU Prospectus Regulation. In December 2022, the European Commission proposed some changes to the EU Prospectus Regulation as part of the Listing Act package of reforms⁶. Amongst the proposals, the European Commission has the power to adopt delegated acts setting out standardised annexes specifying the ESG-related information that should be included in a prospectus that is advertised as taking into account ESG factors or pursuing ESG objectives. However, it is unlikely that these standardised annexes will be in place before 2025, so after the date the EuGB Regulation applies. 

Supervisory framework for external reviewers

The EuGB Regulation also establishes a new regime for the registration and ongoing supervision of external reviewers by ESMA.  External reviewers  have to comply with certain organisational, process and governance requirements as well as requirements regarding pre-issuances and post-issuance reviews.  There is also a framework for third-country reviewers, by way of equivalence assessment, recognition or endorsement.

As the more detailed level two measures in relation to external reviewers are not yet in place, there are some transitional provisions and external reviewers will need to comply with many of the requirements on a best efforts basis until 21 June 2026.  After that date, external reviewers will need to be registered with ESMA.

Powers of competent authorities and ESMA

There are additional powers for competent authorities and ESMA to issues fines and other administrative sanctions.

Review of the EuGB Regulation

There is a review provision stipulating that the EuGB Regulation must be reviewed 5 years after its entry into force and every 3 years thereafter. The European Commission has to submit a report to the European Parliament and the European Council, accompanied by a legislative proposal where appropriate, including in relation to the disclosure of issuers of bonds marketed as environmentally sustainable and SLBs. However, there is no indication of a review clause that would look at making the EuGB Regulation mandatory in the future, as was proposed by the European Parliament. In addition, within 3 years the European Commission must publish a report in relation to the need to regulate SLBs, accompanied by a legislative proposal, where relevant.

Final thoughts and implementation in the UK

The EuGB Regulation is one of the remaining pieces of the European Commission’s strategy for financing the transition to a sustainable economy⁷. The recitals encourage EU institutions to use the label whilst the European Investment Bank is stated to be committed to gradually aligning its green bond programme with the European green bond standard.  For other market participants, notwithstanding the stringent requirements, the extent to which they can use the standard will depend on the availability of assets that are in alignment with the taxonomy requirements, which to date is fairly limited. The flexibility pocket of 15% will therefore be helpful in this regard. Consequently, at least initially, it is widely expected that only a limited number of issuers will seek to obtain a European green bond designation for their issuances. This may change over time and market participants may want to keep abreast of how the technical requirements under the Taxonomy Regulation develop before the application of the EuGB Regulation.

Market participants who are contemplating using the EuGB label or the voluntary templates should monitor the EuGB Regulation developments and consider how they will be able to meet the various requirements. It will also be interesting to understand the extent to which the new ESG disclosure annexes under the EU Prospectus Regulation will align with the optional templates for bonds marketed as environmentally sustainable and SLBs in the EU. 

Meanwhile, by way of comparison, in the UK, to date there have not been any proposals relating to a UK green bond standard or specific ESG disclosure requirements although the UK Financial Conduct Authority has asked for views⁸ on whether further direction is needed through guidance or content requirements in order to provide issuers with greater certainty as to what should be included in terms of ESG disclosure in the prospectus.

This note is for guidance only and should not be relied on as legal advice in relation to a particular transaction or situation. Please contact your normal contact at Hogan Lovells if you require assistance or advice in connection with any of the above.

Authored by Jochen Seitz, Jennifer O’Connell,  Stefan Schrewe, and Isobel Wright.

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