Investors need product sustainability information to combat greenwashing and for their own reporting

ESG disclosure is an increasing feature of debt capital markets transactions for a variety of reasons. Investors increasingly want more information about the sustainable credentials of securitisation assets, whether labelled as sustainable or not, in order to comply with their corporate and investment reporting requirements, manage risks and assess alignment with strategy, including net zero commitments. ESG disclosure is also key to preventing “greenwashing” which remains a significant concern for the market.

Well-established, voluntary industry initiatives, such as the International Capital Markets Association (ICMA) Green, Social, Sustainability and Sustainability-linked Bond Principles (the ICMA Principles¹) are used routinely and promote minimum market standards and transparency. However, although voluntary standards are useful, investors request fuller and more standardised sustainability information about both standardised securitisations and those which have no label to make decisions about their investments and comply with their regulatory obligations.

Although mandatory disclosure requirements are in place in many jurisdictions for in-scope corporates and investment funds, disclosure requirements relating specifically to the debt capital markets, including securitisations, such as the sustainability aspects of securitisations have been limited to date. There are a number of sustainability initiatives in the pipeline which are likely, either directly or indirectly, to impact the securitisation market. Investor due diligence and external verifiers also have a role to play and we discuss these further below.

What are the current main regulations impacting investors?

Over the last couple of years, many of the main investment hubs have introduced sustainability reporting regulations. These regimes broadly require corporate sustainability disclosure to be included in annual reports (for example, the EU Corporate Sustainability Reporting Directive (CSRD) and the UK Task Force on Climate-related Financial Disclosures ((TCFD)-aligned disclosure regime) and investment-related disclosures (for example, the EU Sustainable Finance Disclosure Regulation (SFDR) and the UK Sustainability Disclosure Requirements (SDR)). In the EU, alignment with a classification system for sustainable activities (the EU Taxonomy) is also required for those reporting. The scope of these disclosure regimes varies with some focussing on climate-related risks, whilst others, such as the EU regime, include other environmental factors and social and governance issues.

The amount of sustainability information required is likely only to grow. Recognising that investors increasingly require sustainability information regardless of the purpose of a product, the European Supervisory Authorities’ (ESAs) recent Joint Opinion² on SFDR considered whether products with no sustainability focus should also disclose a minimum level of sustainability information; currently securitisation is not a product within direct scope of the SFDR. The European Securities and Markets Authority (ESMA) published an Opinion³ on the functioning of the Sustainable Finance Framework and recommended a review of products not in scope of the SFDR, suggesting that these should be subject to minimum sustainability disclosure⁴.

The type of information investors (including asset managers) might request from originators depends on internal policy and the regime (mandatory or voluntary) under which they make their sustainability disclosures. These regulations can impact securitisations from a bottom-up perspective as securitisation investors have obligations to report under their relevant regimes and therefore securitisation documentation could evolve over time in a way that facilitates compliance with these requirements. We can therefore expect increasing requests for information, not just about the underlying assets but also the use of proceeds in a securitisation, including the supply chain lying behind those assets. Originators may have to consider to what extent their systems and controls can support this, as well as the format of disclosure.

EU legislation also requires quantitative and qualitative disclosures under Article 449a of Regulation (EU) No 575/2013 (Capital Requirements Regulation⁵) (to be replaced by new requirements under Regulation (EU) 2024/1623 (CRR3⁶)) and product governance requirements under MiFID II.⁷

Soon, larger entities will also be required to comply with the EU Corporate Sustainability Due Diligence Directive (CS3D) which envisages that in-scope companies will carry out due diligence on their supply chains, including outside Europe, to identify adverse impacts of their operations and how to mitigate them. Financial undertakings have a partial exemption under CS3D, meaning that they do not have to carry out due diligence on their downstream activities (for example, lending and investing) but this was a controversial decision and is likely to be reviewed in the next couple of years⁸.

The plethora of ESG-related regulation is, at the moment however, unhelpfully fragmented and complex. This is observed in Mario Draghi’s report on “The future of European competitiveness – A competitiveness strategy for Europe” dated September 9, 2024 (together with the accompanying in-depth analysis and recommendations, the Draghi Report). The Draghi Report identifies challenges faced by the industry and companies in the EU, noting for example that the EU’s sustainability reporting and due diligence framework is a major source of regulatory burden, magnified by a lack of guidance to facilitate the application of complex rules and to clarify the interaction between various pieces of legislation.The Bankverbrand report on “A strong, competitive Europe: unlocking the potential of securitisation” published in September 2024 similarly observes that the complexity of different requirements is hindering progress. Given the detailed recommendations of both the Draghi Report and the Bankenverbrand Report, amongst other recent market and regulatory discussions, it would be surprising if there were no future attempts to align and simplify regulations, in turn facilitating their application to a wider range of products.

Although there are few specific ESG disclosure requirements for originators and issuers, these are set to increase

We discuss below the current securitisation-specific ESG disclosure requirements in the EU and the UK and other potential measures which could enhance future ESG transparency in the market. These aim to ensure that more ESG-related transaction data are available for relevant stakeholders, to allow investors sufficient information to compare financial products and to align securitisation requirements with regulations for other products.

Securitisation Regulation and regulatory technical standards (RTS)

The only specific regulatory reporting requirement for securitisation transaction ESG data is in Regulation (EU) 2017/2402⁹ (the EU Securitisation Regulation) in the EU and, as on-shored in the UK, the UK Securitisation Regulation, (together with the EU Securitisation Regulation, the Securitisation Regulations)¹⁰. The Securitisation Regulations currently require the provision of limited environmental performance metrics (where available) in respect of residential and automotive portfolios for simple, transparent and standardised (STS) securitisation transactions¹¹. The UK Securitisation Regulation has been replaced with effect from November 1, 2024 with a new securitisation framework (the New UK Securitisation Framework) which replicates the previous UK requirements.

In the EU, the RTS on STS securitisations-related sustainability disclosures¹² (Sustainability RTS) entered into force on July 8, 2024. The Sustainability RTS closely align with SFDR disclosures. Under the EU Securitisation Regulation’s STS regime, the ESAs have sought to create efficiencies in reporting (at least for residential loans and automotive loan and leases). This is a welcome initiative, given challenges around lack of clarity as to methodologies and characterisation of principal adverse impacts (PAI) indicators. Whilst this is a move forward for increased transparency, some key points to note are highlighted below.

• The Sustainability RTS are voluntary. It remains possible for originators of STS traditional securitisations and on-balance-sheet securitisations to comply just with the initial disclosure requirements relating to environmental performance set out in first sentence of Article 22(4) (and, in the EU Article 26d (4)) of the EU Securitisation Regulation. Even then disclosure pursuant to Article 22(4) of the EU Securitisation Regulation is only mandatory if relevant data is available to the originator. Note that the EBA’s Final Report on Guidelines on the STS criteria for on-balance-sheet securitisation¹³ (which will be applicable from the date of final translation) published, on May 27, 2024, also clarifies that the information required is subject to it being captured in the originator’s internal database or IT systems. Hence, the majority of the existing STS transactions make no or only partial disclosure pursuant to Article 22(4) of the EU Securitisation Regulation. It is helpful for originators to have the option not to comply with the Sustainability RTS, particularly given the lack of availability of data at the current time, though this means that investors in securitisations might not have all of the ESG information they might request.

• The Sustainability RTS are limited in scope. They apply only to STS traditional securitisations and on-balance sheet-securitisations (and not asset-backed commercial paper (ABCP)) where the underlying exposures are residential loans, automotive loans and leases. This leaves data gaps in relation to other asset classes such as commercial real estate, corporate debt (including trade receivables), small and medium-sized enterprises, consumer loans and credit cards.

• Securitisation is not a financial product under the SFDR. The SFDR does not apply directly to securitisation products as a securitisation does not constitute a “financial product” under Article 2 of the SFDR. Nevertheless, securitisations are indirectly impacted by the SFDR through the entity level disclosure requirements, as PAI indicators under the SFDR cover all investment decisions, including investments into securitisations. Alignment of the Sustainability RTS with the SFDR may be helpful for SFDR-compliant investors, such as asset managers as they seek to harmonise their investment criteria. However, investors and/or originators not otherwise subject to the SFDR are potentially in a difficult position – they may not want to make or receive SFDR-compliant disclosure and may not have systems in place to track this but may nevertheless feel compelled by market practice to disclose in accordance with the voluntary requirements of the Sustainability RTS.

• Limitations of data availability. The voluntary disclosures under the Sustainability RTS may continue to be limited by the availability of consistent and complete data, particularly for legacy assets. Disclosure could be hampered by jurisdictional variations in disclosure requirements, availability of information and lack of effective systems and controls to monitor data. This may be a reason why, at this time, these disclosures remain voluntary; no doubt regulators will keep this under review, as the availability of sustainability-related data and the market for sustainable assets evolves.

• Stand-alone template. The Sustainability RTS provide a stand-alone form of SFDR-aligned template, separate from the current templates, as required by Article 7 of the EU Securitisation Regulation. Sustainability disclosure requirements could be reviewed as part of ESMA’s ongoing template review (as discussed further below).

• An area of EU and UK divergence. The Sustainability RTS do not apply in the UK and the New UK Securitisation Framework does not include any similar provisions.¹⁴ It seems likely that, in order for UK companies to comply with their reporting requirements under the SDR in due course, more disclosure could be sought from the securitisation industry, consistent with investor needs.

It is unclear to what extent originators will comply with the voluntary disclosures under the Sustainability RTS. It appears that there has not been a material uptake in the market for completion of the current environmental fields provided by the EU Securitisation Regulation so it seems possible that it may take some time before the additional voluntary disclosures become more widely adopted, in the near term at least, particularly for legacy assets for which information may not be readily available or currently captured. The impetus has to come from elsewhere, which is why investor demand will play a crucial role in encouraging originators to comply with voluntary disclosures. The evolution in standards in the loan and bond markets and in investor reporting is likely to fuel this engagement.

European Green Bond Standard

In December 2023, the Regulation on European Green Bonds and optional disclosures for bonds marketed as environmentally sustainable and sustainability-linked bonds (the EuGB Regulation) entered into force and is set to apply from December 21, 2024. Whilst the rules under the EuGB Regulation are voluntary, 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”, they will need to comply with the requirements set out in the EuGB Regulation.

In addition, the EuGB Regulation also introduces voluntary guidelines setting out templates for bonds, including sustainability-linked bonds (SLBs) that can be used to address any greenwashing concerns where those bonds are marketed as environmentally sustainable. The European Commission is tasked with publishing these guidelines by December 21, 2024 which will provide more clarity as to alignment with other ESG disclosure requirements, such as those being brought in under the EU Listing Act. There are also a number of other level 2 measures that the European Commission and ESMA need to publish which will provide further insight on some of the finer details.

The EuGB Regulation permits a “use of proceeds” framework applicable to an originator, as opposed to the issuer, of securitisations. This means that securitisations with the EuGB label are not limited to having green collateral at the issuer level and may benefit from the originator sourcing green assets.

In addition to complying with any ESG-related disclosure requirements under the EU Securitisation Regulation, securitisation bonds using the EuGB label will be subject to reporting templates in addition to prospectus disclosure requirements. The securitisation market is already very familiar with disclosure requirements but the EuGB Regulation proposes an additional layer to these rules requiring new disclosure including a factsheet, allocation report and impact report which are subject to external review requirements.

We do not know yet whether the EuGB Regulation disclosure will impact or interact with reporting under Article 7 of the EU Securitisation Regulation, which is subject to possible changes after a consultation by the European Commission (with the templates under review by ESMA) and the Sustainability RTS.

As with existing securitisation reporting requirements, voluntarily-disclosed climate-related data for securitisations under the EuGB Regulation should be available through securitisation repositories, as has been proposed by the ESAs and the European Central Bank (ECB) in the Joint Statement in relation to loan-level data (as discussed further below) and via websites. There are also proposals to make data publicly available via the European Single Access Point¹⁵, which aims to provide a central point for information about EU companies and products.

Given that the EuGB label is designed to be a “gold standard” it is expected that only a limited number of issuers or originators will make use of the label initially, as the EuGB Regulations require alignment with the EU Taxonomy, subject to 15% flexibility pocket for certain specific sectors not currently covered by the EU Taxonomy. Synthetic securitisations are also an exception to the securitisations that can benefit from the standards. It remains to be seen to what extent the new voluntary templates under the EuGB Regulation, that the European Commission is tasked with producing, may be helpful for securitisation transactions.

In its recent consultation paper¹⁶, the UK Financial Conduct Authority (the FCA) has said that the UK does not currently intend to create a bond standard for green, social or sustainability-linked debt. Instead, the FCA hopes to preserve some flexibility for issuers as these markets continue to grow and new products develop and plans to prompt issuers that are marketing these securities to bring more of the content of their bond framework into the prospectus. However, the FCA has introduced an anti-greenwashing rule (AGR) which came into force on May 31, 2024, with detailed new requirements and new risks of litigation and enforcement (see “Disclosure” below for more information).

ESAs and ECB joint statement – voluntary climate-related disclosure

We can see that the EU Securitisation Regulation, related Sustainability RTS and the EuGB Regulation go some way to addressing data provision in relation to environmental risks, but this will apply in relation to only a limited number of scenarios.

As securitisations often include underlying assets that could impact climate, the ESAs and the ECB want to enhance disclosure standardisation for securitised assets and have, in a joint statement on disclosure on climate change for structured finance products¹⁷ (the Joint Statement) called on originators, sponsors and issuers to be proactive and collect data at the time of loan origination that investors need to assess ESG risks and fill in the voluntary climate-related fields in the existing securitisation disclosure templates. The voluntarily disclosed climate-related data should be available through securitisation repositories. This data may be of interest to other stakeholders, such as rating agencies, financial institutions and the general public and is of increasing relevance to regulators. This may also be relevant to covered bonds. It is also worth highlighting that this request only relates to climate-related data and so, similar to the EuGB Regulation, focuses on the “E” of ESG.

Loan-level disclosure templates review

Following the European Commission report on the functioning of the Securitisation Regulation¹⁸, on December 21, 2023 ESMA published its consultation paper on loan-level disclosure for the securitisation disclosure templates under Article 7 of the Securitisation Regulation. ESMA’s review of the disclosure templates considers reducing the disproportionate disclosure on private and third-country securitisations by creating a simplified dedicated template ensuring adequate proportionality of transparency requirements and usefulness of data for proper due diligence. It is possible, however, that ESMA may also take the opportunity, in addition to considering streamlining the templates, to consider where additional data fields might be warranted, such as in relation to climate-related data. This process is currently delayed pending a potential wider review of the EU Securitisation Regulation.

A consultation in the UK on its separate review of the disclosure templates is expected at the end of 2024 or early 2025. The EU and the UK templates are currently substantially similar and we expect that the UK market will raise similar points highlighted in the EU consultation responses.

As discussed above, there are two sources of voluntary disclosure: (i) the Sustainability RTS providing voluntary templates for some limited reporting for PAIs for residential loans, automotive loans and leases (a stand-alone SFDR-aligned template, separate to the existing Article 7 templates); and (ii) the disclosure reporting requirements under the EuGB Regulation.

Other guidance exists which could be adapted for use on a voluntary basis for bespoke investor disclosure purposes where investors request it, for example for social and governance-related data. For example, the SFDR RTS¹⁹ provides templates for PAIs which could be adapted for use. The TCFD, the Taskforce on Nature-related Financial Disclosures (TNFD) and of course the ICMA templates and guidance are informative²⁰.

The sheer number of forms and templates which are available with potentially similar requirements but slightly different data requirements, is also a concern given the burden it places on market participants. The market needs to move towards a more harmonised, standardised approach. We are unlikely to reach a “one size fits all” set of templates, but regulators and the industry should bear in mind that efficiencies will be gained by (i) avoiding duplication and a “battle of the forms” and (ii) using centralised information repositories and interoperable data sets and templates to create harmonisation across the product and geographies.

Issuers and advisors should consider what sustainability-related information should be included in prospectuses, marketing materials and frameworks

Different jurisdictions or regulations may impose additional disclosure requirements however; below are some points to bear in mind when producing investor-related materials.

Prospectus-specific requirements

Article 6(1) of the EU Prospectus Regulation²¹ and the on-shored equivalent UK Prospectus Regulation each require a prospectus to contain the “necessary information which is material to an investor to make an informed decision”. Whether sustainability-related disclosure is material will depend on the circumstances of the issuer and particular type of securities.

In July 2023, ESMA issued a public statement²² on sustainability disclosure in prospectuses complying with the EU Prospectus Regulation. The statement gives guidance and recommendations as to what issuers should take into account when preparing sustainability-related disclosure in prospectuses and sets out certain expectations for debt securities (notwithstanding the upcoming changes under the EU Listing Act, as discussed below) and in particular sets out expectations in relation to debt securities that have a specific ESG component or objective. The statement is addressed to EU National Competent Authorities (NCAs) but ESMA is clear that issuers and advisors should take note of its contents when drawing up prospectuses including sustainability-related disclosure.

Amongst other things, it recommends that issuers should provide the basis for statements concerning their sustainability profile or that of the securities they issue, for example if they purport to adhere to a specific market standard or label or have a particular objective. In relation to use of proceeds bonds backed by cashflows or asset-backed securities, ESMA has said that there should be additional disclosure relating to the criteria used to purchase the underlying assets which are considered to be sustainable and if any of the assets do not meet the criteria, that should be included in the prospectus as well as information on any post-issuance reporting, including information on what will be reported and where this can be obtained.

In April 2024, the European Parliament adopted a package of measures known as the “EU Listing Act”, which includes a proposed regulation to amend the EU Prospectus Regulation amongst other matters. The EU Listing Act package was adopted by the Council of the EU on October 8, 2024 and will enter into force 20 days after publication in the Official Journal of the EU.

The proposals include power for the European Commission to set out schedules specifying the ESG-related information that should be included in a prospectus which is advertised as taking into account ESG factors or pursuing ESG objectives. As mentioned above regarding the increasing the proliferation of forms, it will be important to ensure that these new schedules are consistent with the templates for the voluntary disclosures for bonds marketed as environmentally sustainable or sustainability linked bonds under the EuGB Regulation, as that disclosure will need to be included in the prospectus.

In July 2024, the UK FCA published a consultation paper²³ (CP24/12) in relation to its new rule making powers under the public offers and admissions to trading regime (POATR) which will repeal and replace the current UK Prospectus Regime. Among the proposals, debt securities that are admitted to trading on a UK regulated market that are marketed as green, social or sustainable or issued under a bond framework would need to be identified as such in the prospectus and issuers would be prompted to consider whether any further disclosure would be required in order to meet the necessary information test.

Disclosure

Different jurisdictions or regulations may impose different disclosure requirements; however below are some points to bear in mind when producing investor-related materials.

• All relevant ESG risks should be disclosed and disclosure of relevant ESG information should be accurate and not misleading, complying at least with standards set out in applicable law.

• Avoid ESG-washing, taking into account regulatory and investor demands. For example it should be noted that there is currently no full consensus as to what constitutes, or what the relevant attributes are of, a “green” or "social" or other “sustainable” bond and claims as to meeting particular ESG goals should not be overstated or misleading. Transactions have tended to focus on relevant industry standards, such as the ICMA Principles and related guidelines.

• Particular care should be taken when making forward-looking statements in the context of a “use of proceeds” securitisation. The FCA’s AGR came into force on May 31, 2024, with detailed new requirements in relation to anti-greenwashing and new risks of litigation and enforcement; the new rule also covers social-washing and applies to images in addition to words and the overall impression given in relation to a product. The FCA has confirmed, however, that the AGR clarifies existing requirements. Whilst there are “naming” rules for certain products there are not yet any proposals for specific anti-greenwashing rules in the EU as the EU plans to monitor greenwashing risks in the financial markets and consider whether further legislative steps are necessary.

• Care should also be taken that the prospectus aligns with the relevant marketing materials (this was also noted by ESMA in its public statement on sustainability disclosure in prospectuses). Although the prospectus is subject to regulation as to its prescribed form and content, any misstatement in other marketing materials could potentially result in regulatory sanction and possibly a claim by investors if it can be shown that they relied on this to their detriment (and liability is not otherwise excluded).

• Many transactions involving ESG securitisations adopt ESG frameworks which contain details as to the ESG features of a securitisation: these should not conflict with the prospectus or marketing materials. ICMA provides pre-issuance checklists that help in the development of ESG frameworks and ESG securitisations generally have verification agents and second party opinions to confirm compliance with the relevant industry standards. These ESG frameworks may be modified from time to time and care should be taken where any reference is made to frameworks in a prospectus (the framework should not be incorporated by reference, but may otherwise be referred to) in case these references are deemed to be advertisements and fall within any regulatory ambit, as the FCA has discussed in Primary Bulletin 41²⁴.

Disclaimers

• This may include, for example, language confirming that there is no assurance that the bond will meet the investor’s ESG expectations. Disclaimers are notoriously difficult to draft and care should be taken to ensure that they are clear and cover all relevant areas where parties might want to try to limit liability.

• The reports of external verifiers and reviewers are not incorporated by reference, but disclosure should include whether any regulatory or supervisory regime applies in relation to such verification or reviewer report and statements should also be included as to non-reliance on these reviews. As is usual in the context of the relationship between issuers and professional investors, it should be stated (and understood between the parties) that investors should make their own determinations and, where relevant, that third parties have no liability to noteholders or trustees or other relevant persons.

• Currently, the scope of representations and covenants in transaction documents for ESG transactions varies significantly between transactions, though we expect to see increased standardisation going forward, driven by both regulation and continued use of industry-led principles.

• ESMA has said²⁵ that issuers should not use sustainability-related disclaimers in their risk factors to excuse non-performance of factors over which the issuer exercises control. For example, a disclaimer stating that the proceeds may be invested contrary to the criteria for the particular project in the prospectus is a factor may differ or the notion of sustainability may change according to scientific progress, relevant legislation and/or investor preferences.

Investors require increasing amounts of information to make investment decisions and comply with reporting regulations

The role of due diligence in securitisation

Investors need to be satisfied that a product meets its ESG credentials. They also need the information for their own funding credit and market risk assessments and results of due diligence may inform the size and type of credit given and the type of products investors are willing to purchase.

Investors are increasingly required to comply with and report under various sustainability reporting regulations, such as the SFDR, the CSRD and CS3D. Apart from reporting, these also have an effect on investment strategies and policies and informs the due diligence they carry out and data requirements, as discussed above.

Due diligence of ESG risks in securitisation may include reviewing data templates provided and also raising additional questions. Even on non-ESG securitisations, some originators offer ESG questionnaires anticipating investor questions. The integrity and availability of ESG data is essential for investors to make a robust assessment of ESG risks and real world impact. From a climate change perspective, investors need to determine to what extent a product meets their net zero ambitions and investment policies and be able to benchmark products against others.

No one size fits all at the moment

At present, due diligence practice varies a great deal with the depth and complexity of questions varying from transaction to transaction. There are market and jurisdictional variances depending on nature and type of underlying asset and the target market, for example questions may be guided by internal reporting requirements of PAIs under regulations such as SFDR (as discussed below).

The large amount of guidance and templates on offer remains a challenge here and, although some industry due diligence questions, like those used by the Alternative Investment Management Association are helpful guidelines, many bespoke requirements remain.

The role of external verifiers and reviewers and ESG rating agencies

External verifiers or reviewers

External verifiers are engaged to confirm compliance of prospectuses and frameworks against market standards, such as the ICMA Green Principles. Use of external verifiers is already common and these verifiers and their reports will be of increasing relevance under the EuGB Regulation. As well as providing investors with reports and certifications on particular transactions, they offer tools to compare different types of ESG transactions in the market. Comparability is very important to investors, including to be able to weigh the alignment characteristics of one transaction against their own goals, with another. This can guide investment decisions and help investors pursuing net zero transition pathways, as well as other ESG goals.

ESG rating agencies

Some rating agencies provide specific ESG ratings, as well as “indicators” or “scores” which indicate how ESG factors affect credit ratings or may simply include an analysis of ESG in their ratings reports. Investors often rely on such ratings when they have no capacity to collect the data (or access to it) or perform the analysis themselves. Unlike credit rating agencies, ESG rating agencies, and other reviewers, are currently unregulated.

Regulators and market participants have identified areas of concern with ESG ratings, such as lack of transparency in methodologies used, difficulties in interpreting ESG ratings as well as issues relating to conflicts of interest, bias and governance. Regulators in various jurisdictions are reviewing the provision of ESG ratings²⁶. In the EU, on April 24, 2024 the Council of the EU approved a regulation on the transparency and integrity of ESG ratings. In August 2024, the UK Chancellor Rachel Reeves announced that it would introduce legislation for the regulation of ESG ratings in 2025 (this follows the Code of Conduct for ESG Ratings and Data Product Providers²⁷ developed by the FCA).

What to consider when engaging with exter­nal reviewers, verifiers or rating agencies

Parties should consider appropriate terms of engagement that can provide some comfort as to the parties’ expectations, including as to a reviewer’s expertise and agreeing the extent of reliance on any ratings or reports. In its Primary Market Bulletin 41²⁸, the FCA also suggests that issuers engage with opinion providers to ensure that they adhere to appropriate standards of conduct.

What does the future hold for securitisation ESG disclosure?

As we have seen, there are a number of proposals in the works that could impact the data and disclosure requirements of the securitisation market. We can expect further developments as the market attempts to manage gaps between investors’ obligations and requirements, including for example under legislation such as the SFDR or as part of their internal systems and controls, and the current securitisation framework.

Bespoke framework for securitisation?

Alignment with the EU Taxonomy, and therefore adoption of an EuGB label, will not be possible for some securitisation asset classes, which will not sit neatly within the framework; and of course it is not available for synthetic securitisations. The Sustainability RTS will apply to STS non-ABCP traditional securitisations and are limited as to asset classes covered.

This may leave a large portion of ESG securitisation transactions outside the scope of regulatory proposals, although these could nevertheless choose to adopt similar standards on a voluntary basis. Industry standards, such as the ICMA Principles will continue to have a significant part to play.

The possibility of a bespoke framework, or a formal ESG-securitisation label like the “STS” label, remains an option in the future; inevitably a significant concern would be that holding securitisation to a higher standard compared to other financial products, such as covered bonds, could be harmful but it can’t be ruled out that a bespoke framework may be required in order to propel securitisation further in this area. The EBA and HM Treasury in the UK have each concluded that no dedicated green securitisation framework is expected for the time being, though this could be reconsidered as the market evolves. The EuGB Regulation also contemplates future reviews for the securitisation framework²⁹.

Template and disclosure developments

The review of the current Article 7 templates and proposed introduction of the EuGB label under the EuGB Regulation could be beneficial for market participants but a gap for products not within their scope remains an issue; originators may need to continue to use other market driven templates or adapt templates that are not specifically crafted for securitisations.

Securitisation products will likely be subject to demands for increased disclosure from a multitude of sources as referenced above including as a result of supply chain and corporate sustainability due diligence drivers, as well as the “green” and “social” product regulations and standards as they evolve.

Voluntary versus mandatory requirements?

ESG disclosure and data reporting proposals for securitisation at the moment are almost entirely based on voluntary compliance. Overly prescriptive and/or mandatory requirements are unlikely to be a welcome addition to a market which is already subject to significant reporting requirements and could in fact have the effect of hampering the market in its drive to meet net zero. It is not inconceivable that voluntary reporting could become mandatory over time, particularly if reporting remains inconsistent and as the market becomes increasingly standardised with more available green assets for which information is readily available.

Greater focus on the “S” and “G” of ESG?

As we have discussed, much of the current focus for securitisation is on climate-related data with other environmental factors (such as biodiversity) with social and governance factors not being subject to as much scrutiny. Other regulations impacting investors, such as the SFDR, CSRD and CS3D impose increased reporting obligations with respect to other environmental, social and governance factors and this may be a future area of focus for securitisation.

Jurisdictional divergence

There is a risk of increased divergence in this area that will need to be considered on transactions. It is unknown to what extent the UK will adopt a similar or consistent approach with the EU and there is a risk of divergence with other jurisdictions which can be complicated for parties having to comply with conflicting requirements and risk of arbitrage.

Blockchain and AI

Developments in blockchain technology may be looked at by the market with interest as a possible solution to data monitoring, reporting and verification (MRV), as well as supply chain due diligence, and is an area to watch. Information transfer could be automated, direct and near instantaneous, becoming more transparent and simplified as well as possibly more cost effective due to lack of intermediaries. Real time data reporting would help with investor due diligence and also would be useful for assessment of credit and market risk for purposes of secondary market trading. ESG rating agencies, verifiers and auditors could access source information directly and on an “as needed” basis which would help credibility of ratings, reports and audit avoiding opportunities for data errors and manipulation.

The impact of artificial intelligence (AI) is increasingly becoming recognised as having a larger potential impact than blockchain to transform ESG data production, assessment and handling (including reporting). AI and machine learning (ML) increasingly are expected to combine with blockchain to provide efficiencies. AI could enhance MRV processes, for example taking satellite imagery and analysing it to verify afforestation targets or analyse eDNA data. Whilst there are obvious benefits for securitisation transactions, particularly with the monitoring and processing of data, regulators globally are assessing the risks and challenges associated with AI and ML. In the UK, the Prudential Regulation Authority published DP5/25 Artificial Intelligence and Machine Learning to consider the risks and benefits of AI in financial services, including potential risks to financial stability, and exploring whether specific regulation is required, and on May 21, 2024 the Council of the EU approved a regulation that seeks to harmonise rules on AI. There is no doubt that AI can be useful for efficiencies but the market will be cautious about the novel challenges that arise from its use.

Conclusion

The potential benefits of securitisation in contributing to the wider sustainable economy are acknowledged by regulators, including achieving aims for the EU’s capital markets union. Given the continuing drive from investors and governments in pursuit of ESG goals, including crucially, demands to alleviate the climate crisis and achieve net zero by 2050, there will be an increasing need for green and wider sustainability-orientated products. The ESAs and ECB have stated that, from 2026, only assets from companies within scope of CSRD will be accepted as collateral for its Eurosystem collateral operations, though requirements relating to securitisations, which are not within scope of the CSRD, have not been clarified yet but exposures to assets with ESG characteristics are likely to be subject to scrutiny and disclosure requirements.

We expect demands for improvements on ESG data quality, accessibility and transparency overall, especially as new assets come to market. Specifically in securitisation, for STS securitisations, which already are subject to heavy reporting obligations, increased disclosure requirements might be seen as yet another administrative burden with associated costs. However, it may be that non-STS securitisations effectively begin to “catch-up” here, given that on sustainability factors, clear and proportionate data analysis is of increasing relevance to all parties in the chain in order to contribute to the continuing battle against ESG-washing and bolster confidence.

Market driven efforts have produced some relevant ESG information but not in sufficient quantity. Initiatives to date have resulted in a proliferation of bespoke requirements and many inefficiencies: regulations are coming which should be of assistance in this respect. The devil, as always, will be in the detail of the rules, but market participants will be hopeful that the regulators will strike the right balance between a useful centralised approach that is not unduly prescriptive and that a level-playing field with other green and sustainable financial products can be reached. As acknowledged with a number of recent regulatory and market discussions, including the Draghi Report and the Bankenverbrand Report, there is a need to open up the securitisation market to achieve better funding availability which can help towards the sustainable transition; overly burdensome reporting requirements can prevent the market from driving forward and so vigilance is necessary to promote investor confidence and greater supervisory oversight, whilst helping to give a much-needed boost to the market.

Please also see the following relevant Hogan Lovells Engage articles:

• The UK FCA’s anti-greenwashing rule: ignore it at your peril

• Securitisation disclosure - could less be more?

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

• ESMA statement on sustainability disclosure in prospectuses: impact on prospectuses and final terms

• EU Green Bond Standard – a panacea for green securitisation?

• Talking about a revolution: making ESG securitisations mainstream

• Step forward for green securitisations with standardised STS-related environmental disclosures

This article is for guidance only and is a non-exhaustive summary only of certain aspects of the points discussed and should not be relied on as legal advice in relation to a particular transaction or situation.

Authored by Sven Brandt, David Palmer, Bryony Widdup, Sebastian Oebels, Jane Griffiths, Isobel Wright, Emily Julier, and Deborah Giurgola.

References

1. https://www.icmagroup.org/sustainable-finance/the-principles-guidelines-and-handbooks

2. https://www.eiopa.europa.eu/document/download/5aa8dd9f-c55d-430e-a226-1dbbfff92706_en?filename=JC%202024%2006%20-%20 Joint%20ESAs%20Opinion%20on%20SFDR%20Level%201.pdf

3. https://www.esma.europa.eu/press-news/esma-news/esma-sets-out-its-long-term-vision-functioning-sustainable-finance-framework

4. This follows the recent ESAs’ Joint Opinion on the SFDR which recommends consideration as whether to include other products within scope of the SFDR. [https://www.esma.europa.eu/sites/default/files/2024-06/JC_2024_06_Joint_ESAs_Opinion_on_SFDR.pdf

5. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:02013R0575-20240709

6. https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=OJ:L_202401623

7. In March 2023 ESMA published its final report on guidelines on product governance requirements under Directive (EU) 2014/65 (MiFID II [https://eur-lex.europa.eu/legal-content/EN/TXT/ HTML/?uri=CELEX:32014L0065%20%20]) to reflect developments including the sustainability-related amendments to the MiFID II Delegated Directive which integrated sustainability factors into the product governance obligations and applied from November 2022. Accordingly, manufacturers and distributors have to specify, as part of their target market assessment, any sustainability-related objectives of the product and ESMA proposes some aspects that firms may take into account. In addition, on April 3, 2023 ESMA published Guidelines [https://www.esma.europa.eu/sites/default/files/2023-04/ESMA35-43-3172_Guidelines_on_certain_aspects_of_the_MiFID_II_suitability_requirements.pdf] on certain aspects of the suitability requirements of MiFID II which aim to clarify the application of certain aspects of the MiFID II suitability requirements and to integrate sustainability risks in the investment decision or advisory processes of manufacturers and distributors as part of their duties towards investors and/or clients.

8. There are also other relevant jurisdiction-specific laws on supply chain due diligence that parties may need to take into account, such as the German Supply Chain Law [https://www.bafa.de/EN/Supply_Chain_Act/Overview/overview_node.html], Uyghur Forced Labor Prevention Act [https://www.cbp.gov/trade/forced-labor/UFLPA], Norwegian Supply Chain Transparency Act [https://lovdata.no/dokument/NLE/lov/2021-06-18-99], and the UK Modern Slavery Act 2015 [https://www.legislation.gov.uk/ukpga/2015/30/contents].

9. https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:02017R2402-20210409

10. The UK on-shored the EU Securitisation Regulation with effect from January 1, 2021 with minimum changes.

11. Article 22(4) and Article 26d(4) of the EU Securitisation Regulation. Note that the UK Securitisation Regulation was not further amended to include the optional derogation such that originators may publish the available information related to the principal adverse impacts of the assets financed by underlying exposures on sustainability factors.

12. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=OJ:L_202401700

13. https://www.eba.europa.eu/sites/default/files/2024-05/c2643528-9d43-4f64-863b-053864465f96/Final%20report%20on%20GL%20on%20STS%20criteria%20for%20OBS%20securitisation.pdf

14. In its Review of the Securitisation Regulation: Report and call for evidence response [https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1040038/Securitisation_Regulation_Review.pdf], HM Treasury said that further consideration will be given as to whether it is appropriate to extend the UK Securitisation Regulation’s environmental information disclosure requirements and that it is likely that any additional information required would be subject to availability, as is currently the case. The regulators considered the ESG implications of their proposals for the New UK Securitisation Framework but overall did not consider that their proposals are relevant to contributing to current climate change targets and did not include additional ESG requirements as part of the New UK Securitisation Framework.

15. https://www.europarl.europa.eu/legislative-train/theme-an-economy-that-works-for-people/file-european-single-access-point

16. https://www.fca.org.uk/publications/consultation-papers/cp24-12-consultation-new-public-offers-admission-trading-regulations-regime-poatrs

17. https://www.esma.europa.eu/sites/default/files/library/ESAs_ECB%20Joint%20Statement%20on%20disclosures%20for%20securitisations_FINAL_6%20March%202023_0.pdf

18. https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52022DC0517

19. The RTS under Delegated Regulation (EU) 2022/1288. The European Commission adopted a Delegated Act [https://eur-lex.europa.eu/ legal-content/EN/TXT/PDF/?uri=CELEX:32023R0363] amending and correcting SFDR RTS relating the content and presentation of information in pre-contractual documents and reports for financial produces in ESG.

20. ICMA pre-issuance checklist for Green Bonds/Green Bond Programmes [https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Pre-Issuance-checklist-Green-Bonds_June-2022-280622.pdf]

21. Regulation EU 2017/1129 of 14 June 2017 [https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:02017R1129-20240109]

22. https://www.esma.europa.eu/sites/default/files/2023-07/ESMA32-1399193447-441_Statement_on_sustainability_disclosure_in_prospectuses.pdf

23. https://www.fca.org.uk/publication/consultation/cp24-12.pdf

24. https://www.fca.org.uk/publications/newsletters/primary-market-bulletin-41

25. https://www.esma.europa.eu/sites/default/files/2023-07/ESMA32-1399193447-441_Statement_on_sustainability_disclosure_in_prospectuses.pdf

26. The EU has been contemplating ratings practices relating to ESG since 2018 and to what extent ESG ratings affect credit ratings. No amendments to Regulation (EU) 462/2013 [https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R0462] (the CRA Regulation) were recommended but ESMA issued advice, followed on 18 July 2019 by its Guidelines on Disclosure Requirements Applicable to Credit Ratings [https://www.esma.europa.eu/sites/default/files/library/esma33-9-320_final_report_ guidelines_on_disclosure_requirements_applicable_to_credit_rating_ agencies.pdf]. The International Organization of Securities Commissions (IOSCO) also published recommendations in 2021, including as to publicly disclosed data sources, defined methodologies, management of conflicts of interest, high levels of transparency, and handling confidential information. On February 3, 2022 ESMA launched a call for evidence [https://www.esma.europa.eu/sites/default/files/library/esma80-416-250_call_for_evidence_on_market_characteristics_for_esg_rating_providers_in_the_eu.pdf] on market characteristics for ESG rating providers in the EU. On 4 April 2022, the European Commission published a consultation on the functioning of ESG ratings market in the EU and on the consideration of ESG factors credit ratings [https://finance.ec.europa.eu/document/download/252824ec-def8-457a-a049-4c93511f1242_en?filename=2022-esg-ratings-consultation-document_en.pdf]. AFME and ISDA responded jointly [https://www.afme.eu/Portals/0/DispatchFeaturedImages/AFME%20ISDA%20response%20to%20ESG%20ratings%20consultation-1.pdf]. In the UK, on March 30, 2023 HM Treasury published a consultation paper on the future regulatory regime for ESG ratings providers [https://www.gov.uk/government/consultations/future-regulatory-regime-for-environmental-social-and-governance-esg-ratings-providers] seeking views on whether ESG ratings providers should be brought within the regulatory perimeter and if so, how this should be done.

27. https://www.icmagroup.org/sustainable-finance/icma-and-other-sustainable-finance-initiatives/code-of-conduct-for-esg-ratings-and-data-products-providers-2

28. https://www.fca.org.uk/publications/newsletters/primary-market-bulletin-41

29. HM Treasury’s Review of the Securitisation Regulation: Report and call for evidence response [https://assets.publishing.service.gov.uk/media/61b370f38fa8f503816404eb/Securitisation_Regulation_Review.pdf] and the European Commission’s European Commission report on the functioning of the Securitisation Regulation [https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52022DC0517] each concluded that no green securitisation framework is expected to be established in the immediate future. In its Report on developing a framework for sustainable securitisation [https://ehoganlovells.com/ collect/click.aspx?u=UVYrZ3JmTTFrL2FJS01wcWJDTjFHL1RPbW54SG9Bb TFJMGdZVlNUUkJqcVlQVHdxaExmbTlIZERBbm5Ba 250aGpybmZtaG-s2TGJucDFMNWVoVmFOanA5OUdrZzMyWkJyVzduVWd3RH-d6c3BOcDlrSGVTUmIzNDI3anpqa0VvNmkxZ01Qd0Q1c080SHU0Rm hWZG0zemZJUy9WdUp1Z0M1ZGJkTlZuQ0N2OXArKzc1QS9XSzdXL-3F3UUZOZ3A4TEhPdTJCVUYzTXBNMFU9&rh=ff008ce42a863580d15f1 be6954f8e60d762721e], assessing how to integrate sustainability-related transparency into the EU Securitisation Regulation, the EBA concluded that it is not appropriate to establish a dedicated framework at this time but could be more relevant as the ESG market evolves, though it did suggest safeguards to be considered should a proposal for a green securitisation framework be proposed.