The proposed EU Green Bond Standard - will this transform the market for green bonds?

The European Commission has published its long-awaited proposal for a regulation on European green bonds, the European Green Bond Standard (EU GBS). This proposal was published as part of a broader new EU strategy for financing the transition to a sustainable economy.

So, what is the EU GBS, and how might this proposal change existing market practice documentation and processes for European green bonds (EU GB)?

What is the EU GBS?

The EU GBS is a new voluntary ‘gold standard' for green bonds with a common framework of rules, intended to help finance sustainable investment whilst addressing concerns around greenwashing.

The proposal as put forward by the European Commission will:

• Establish a voluntary standard for green bonds made available to investors in the EU, where the proceeds are used to finance green assets or projects that pursue, and are fully aligned with, environmentally sustainable objectives under the EU Taxonomy Regulation, or that contribute to the transformation of activities to become environmentally sustainable; and
• Increase transparency by establishing a new system for registering and supervising external reviewers for green bonds aligned with the framework, and require issuers of EU GBs to obtain a pre- and post- issuance review from an external reviewer that is registered and supervised by the European Securities Markets Authority (ESMA).

Which issuers can adopt the EU GBS label?

The EU GBS designation is available to public and private sector bond issuers, including financial undertakings, non-financial undertakings and sovereigns. It can be used by issuers based outside the EU, and it may be used by any bond issuer (including issuers of covered bonds, project bonds and securitisations with an SPV issuer).

Are there restrictions on use of proceeds?

The European Commission proposal requires issuers of a European green bond to ensure that the full proceeds of the bond are, before maturity of the bond, exclusively and fully allocated only to financing eligible fixed assets, eligible operating or capital expenditures or eligible financial assets (debt or equity), or a combination thereof (without deduction of costs). The use of proceeds must relate to ‘green economic activities’ in accordance with the EU Taxonomy Regulation. This requirement creates a link between the EU taxonomy, which sits at the heart of EU’s sustainable finance strategy, and the EU GBS.

How does this help reduce the risk of greenwashing?

By linking the EU GBS to the EU taxonomy, the proposed new standard is intended to address the lack of consistent and common definitions of environmentally sustainable economic activities, which creates uncertainty about whether bonds are being used to finance activities that can be considered to be legitimately green. This could expose issuers to accusations of greenwashing and related reputational risks, especially in transitional sectors.

Will there be an impact on documentation or processes?

The EU GBS requires the following mandatory information to be published in connection with an EU GB:

• EU GB factsheet - an EU GB may only be offered to the public in the EU after prior publication of an EU GB factsheet. Based on the current proposal, the EU GB factsheet has some similarities to green bond frameworks that are already used in connection with green bonds. An issuer will need to ensure that the EU GB factsheet has been subject to a pre-issuance review with a positive opinion by an external reviewer. The EU GB factsheet will constitute ‘regulated information’ and so may be incorporated by reference into an EU Prospectus Regulation prospectus.
• Annual allocation reports - these must be published every year until the full allocation of the proceeds of the bond, and be made public within three months of the end of the reference year, to demonstrate that the proceeds of EU GBs have been allocated as required.
• Post-issuance review report - issuers must obtain a post-issuance review by an external reviewer of the first allocation report following full allocation of bond proceeds. The post-issuance review report must assess whether the issuer has allocated the proceeds of the bond in compliance with the EU GBS requirements and complied with the intended use of proceeds as set out in the EU GB factsheet.
• Impact report - issuers will need to draw up an impact report on the environmental impact of the use of proceeds, after the full allocation of the proceeds and at least once during the lifetime of the bond.
• Prospectus requirements - where a prospectus is to be published pursuant to the EU Prospectus Regulation, that prospectus must clearly state in the use of proceeds section that the bond is issued in accordance with the EU GBS.

The EU GB factsheet, pre- and post- issuance reviews, allocation reports and impact report will need to comply with standardised disclosure requirements, the form of which is prescribed in templates set out in the Annexes to the proposal. These documents will need to be published and maintained on the website of the issuer, in a distinct section entitled 'European Green Bonds', until the maturity of the bonds. These documents will also need to be notified to an issuer's national competent authority without delay after publication and notified to ESMA within 30 days of publication.

What about existing market-based principles?

Currently, the green bond market is largely self-regulated, with market participants adhering to voluntary standards and principles, such as the Green Bond Principles. The Green Bond Principles were updated in June 2021 – see our recent blog for further information about this development: Sustainable finance – helpful evolution of the Green Bond Principles and Social Bond Principles in response to market feedback.

These existing market-based standards set out high-level process-based guidelines or recommendations, but the European Commission comments that the underlying definitions of green projects are insufficiently standardised, rigorous, and comprehensive; and this prevents investors from easily identifying bonds whose proceeds are aligned with or are contributing to environmental objectives (e.g. under the Paris Agreement) and from comparing different green bonds on the market. This proposal therefore builds on the existing market best practices and puts in place additional requirements based on relevant legislation already in place, such as the EU Taxonomy Regulation.

How does this proposal relate to the EU Taxonomy Regulation?

As mentioned, this proposal for the EU GBS is anchored to the EU Taxonomy Regulation. The EU Taxonomy Regulation sets out a classification of economic activities as environmentally sustainable, with various defining criteria including principles of 'do no significant harm' and compliance with minimum social safeguards. That framework can be used as a benchmark to classify whether an economic activity and, by extension, related assets or projects are green.

How will transparency be strengthened?

The EU-GBS framework aims to strengthen transparency towards investors particularly focussing on the alignment of bond proceeds with the taxonomy requirements. It establishes a registration framework with ESMA, which requires that external reviewers will have to meet certain criteria, in relation to the qualification and experience of their senior management, experience and training of analysts and their internal arrangements ensuring compliance with the EU GB, on an ongoing basis. ESMA is mandated to develop draft regulatory standards specifying those criteria. Furthermore, ESMA will have the power to refuse the application for registration of external reviewers if they will not meet the criteria to be developed by ESMA.

What happens next?

This proposal from the Commission is only the first step in a lengthy EU legislative process, and it could be 18 months or more before it becomes binding EU law. For the time being, market participants will continue to follow market-based principles in relation to green bonds.

Given that the EU GBS will be a voluntary framework, it remains to be seen whether there will be significant take up of the EU GBS by issuers based on investor demand, or whether sanguine investor sentiment will mean that issuers continue to frame their green bonds around less restrictive market based principles.

In a related development, the UK Financial Conduct Authority has recently published a consultation paper, seeking views on whether it, alongside HM Treasury, should consider the development and creation of a UK green bond standard. It remains to be seen how closely any proposed UK green bond standard will align with the proposed EU GBS – and whether any significant differences will lead to a bifurcation in the green bond market.

Feel free to reach out to your usual Freshfields contact if you would like to discuss this development, or the implications for your green bond financing, in more detail.