EU Green Bond Standard – a panacea for green securitisation?

Background

The EU Parliament and the EU Council have recently published the final compromise text on the Regulation on European Green Bonds (“EuGB”) and optional disclosures for bonds marketed as environmentally sustainable and sustainability-linked bonds (the “EuGB Regulation”). For further information on the general requirements of the EuGB Regulation, please see also Engage article A new "world first" gold standard for EU green bonds - Hogan Lovells Engage.

Whilst the final text is not yet agreed, securitisation market participants will be pleased to see that modifications to the EuGB Regulation, contained in Chapter IIa, Article 13a, propose permitting a use of proceeds framework applicable to an originator, as opposed to the issuer.  This would mean that, rather than being limited to including green collateral at the issuer level, a securitisation may now benefit from looking at the originator’s role in sourcing green assets and allowing transactions to use the designation “European green bond” or “EuGB”.

What type of securitisations are within scope?

The EuGB Regulation only applies where a prospectus is published under the EU Prospectus Regulation or if one of the exemptions from publishing a prospectus for sovereigns applies, i.e. bonds sold into the EU using the exemption to QIs would not be caught

The EuGB Regulation requires alignment with Regulation (EU) 2020/852 (the “EU Taxonomy Regulation”) which, together with Commission Delegated Regulation (EU) 2021/2178 (the “Delegated Act supplementing Article 8 of the Taxonomy Regulation”) and the Commission Delegated Regulation (C/2021/2800 final) (the “Taxonomy Climate Delegated Act”), provides a framework for what is considered “green” (the “EU Taxonomy”).  Therefore only securitisations where the use of proceeds relates to climate or environmental activities can adopt the relevant designation.  Securitisations with a social or governance focus are therefore not included within the framework (though inclusion of some social metrics is included in the European green bond impact report).  With this approach the EU Parliament and the EU Council acknowledged that an EuGB securitisation market, where all of the underlying exposures should be EU Taxonomy-aligned would face considerable growth constraints in the current situation of scarcity of such EU -Taxonomy-aligned assets fit for securitisation. Applying the use of proceeds requirement to the securitisation originator, instead of the securitisation special purpose entity (“SSPE”), is an efficient and pragmatic approach in the transition phase, until the EU economy has generated adequate volume of taxonomy-aligned assets.

Synthetic securitisations are not permitted to adopt this designation.  However, the European Supervisory Authorities (“ESAs”) will review and report on possible changes to this exclusion within five years of entry into force of the EuGB Regulation subject to which the European Commission may produce a further a report, and possibly a legislative proposal.

What assets are included?

The securitised exposures must comply with the EU Taxonomy, as for other green bonds.  Article 13c provides for certain exclusions for securitised exposures in relation to certain fossil fuel processes, provided that exposures relating to electricity, temperature and power generation or products, and that meet the “Do No Significant Harm” criteria of the EU Taxonomy, may be included.

Conditions for a securitisation bond to use the European green bond or “EuGB” designation

• Use of EuGB in securitisation

Chapter IIa, of the EuGB Regulation sets out the conditions for a securitisation.  Where the securitised exposures are created by multiple originators, the requirements apply, where relevant, on a pro rata (use of proceeds) or joint basis (transparency):

• The requirements for the use of proceeds in accordance with Articles 4 to 7 of the EuGBS (i.e. allocation of proceeds to specific assets, CapEx plans, technical screening criteria, grandfathering and non-cooperative jurisdictions) apply to each originator on a pro rata basis, with reference to their share in the pool of the securitised exposures;

• the requirements in relation to the European green bond factsheet and pre-issuance review, allocation reports and post-allocation reports, European bond green impact report, publication on website, ESMA and competent authority notification, exclusions for securitised exposures and additional disclosure requirements (Articles 8, 9, 10, 13, 13c and 13d of the EuGBS) apply to all originators jointly, requiring clear indication as to how each originator has complied with its respective requirements;

• the requirements to obtain an external review set out in relation to the European green bond factsheet, pre-issuance review and allocation reports and post-issuance review (Articles 8 and 9) shall be fulfilled by all originators jointly; and

• where multiple originators decide to obtain external review referred to in Article 10(2b) (European green bond impact report), they shall all comply with the requirements, in relation to the review, jointly.

• Disclosure requirements

  • Reporting

The securitisation market is already very familiar with disclosure requirements and the EuGB Regulation proposes another layer to existing and proposed requirements, necessitating  new disclosure templates, a “European green bond factsheet” and “European green bond allocation report.  Securitisation is contemplated in the Annexes of the EuGB Regulation.  There will also be new voluntary templates for bonds marketed as environmentally sustainable and sustainability-linked bonds for which the EC will publish guidelines within 12 months so there remains some work to be done in this area.  We do not know yet to what extent, if at all, the EuGB Regulation disclosure will impact or interact with reporting under Article 7 of the EU Securitisation Regulation, which is currently under review by ESMA, or as proposed in the Final Report on draft Regulatory Technical Standards on STS securitisations-related sustainability disclosures published by the Joint Committee of the ESAs on 25th May 2022 (“Final RTS”).

• Additional securitisation-specific prospectus disclosure for prospectuses set-up in accordance with Regulation (EU) 2017/1129 (the “EU Prospectus Regulation”).

The prospectus shall include a statement that the bond is a securitisation bond and that the responsibility for fulfilling the commitments undertaken in the prospectus regarding the use of proceeds falls on the originator.

In order provide transparency about the green characteristics of the securitised exposures, there are also proposed additional disclosure requirements in relation to the share of securitised exposures and relevant taxonomy-aligned economic activities.  This information shall also be included in the “European green bond factsheet” and updated annually in the “European green bond allocation report”.

The information must be provided on a best efforts basis and to the best of the originator’s ability using available data such as data gathered in the originator’ internal database or IT system.  This is consistent with the requirements for disclosure of information set out in the Final RTS and in the proposed amendments to the Guidelines for non-ABCP securitisation EBA consultation guidelines for on-balance-sheet comparison of changes to non-ABCP provisions for on-balance sheet securitisation (“Guidelines Consultation”).  “Best efforts” is potentially an onerous standard, particularly where the accessibility of information in relation to underlying assets could be a challenge.  Please see our Engage article, ESG securitisation disclosure – a moveable feast for more information on disclosure risk.

• Publication of information

The ESAs want information to be widely accessible to investors, other financial participants, as well as the general public.  Information is therefore to be made available via the ESMA-authorised securitisation repositories and via websites.  There are also proposals to make data publicly available via the European Single Access Point, which aims to provide a central point for information about EU companies and products.

• Co-operation between supervisory authorities

Consistent with other recent securitisation discussions, including the Guidelines Consultation, the regulators are concerned to ensure effective co-ordination between competent authorities.  It is proposed that national competent authorities designated to supervise STS securitisations under the EU Securitisation Regulation will supervise originators under the EuGBS and co-ordinate with the competent authority of the SSPE. 

United Kingdom divergence

The UK has not yet set forth proposals as to any changes to the prospectus requirements for ESG or any green bond standard.  However, the FCA has indicated that it might consider a framework for ESG-securities in due course as part of its overall UK regulatory framework review relating to ESG integration in UK capital markets and HM Treasury in the UK also concluded that no dedicated green securitisation framework is expected for the time being, though this could be reconsidered as the market evolves.  Meanwhile, the FCA has encouraged issuers of ESG-labelled “use of proceeds” securities to consider voluntarily applying relevant industry standards, such as the ICMA Principles and related guidelines.

What happens next?

The EuGB Regulation is unlikely to apply until the end of 2024 and there are quite a few level 2 measures that the European Commission and ESMA need to provide and which will provide further clarity as to some of the finer details.  Within five years of the EuGB Regulation entering into force and, where appropriate, every three years afterwards, the ESAs will report on the evolution of the securitisation bonds market; in particular, considering any increase in volume of Taxonomy-aligned assets eligible to be securitised.  The European Commission can then present a report, and possibly a legislative proposal.  No dedicated framework for securitisation is proposed at this stage. 

Final Thoughts

Whilst going some way to maintaining a level-playing field with other green financial products, it remains to be seen how far the EuGB Regulation will facilitate a dynamic shift in green securitisation.  Given the nature of the assets underlying securitisations, it may not always be easy for securitisation structures to align with the EU Taxonomy; a large portion of securitisation transactions will fall outside the EuGB Regulation requirements.  Complying with the requirement of “Do No Significant Harm” has proved problematic for some in interpreting Regulation (EU) 2019/2088 (the “Sustainable Finance Disclosure Regulation”) and this could be a challenge for securitisations that need to meet this standard.

Undoubtedly the EuGB Regulation is a significant step forward but the debate may rumble on as to whether a bespoke regime for securitisation may be needed in due course.  In the meantime, we expect that bonds, not within scope of the EuGB Regulation, will continue to develop green credentials via alternative routes, including continued use of relevant industry standards and principles. 

Please also see other Engage articles below for further information on some of the topics discussed above:

ESG securitisation disclosure – a moveable feast

Talking about a revolution: making ESG securitisations mainstream

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

EU Corporate Sustainability reporting - impact on non-EU entities

UK: FCA update on SDR and investment labels consultation

UK: Updated Green Finance Strategy 2023

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 Sven Brandt, Sebastian Oebels, and Jane Griffiths.