EU Green Bond Standard – 10 questions

The European Parliament has now approved the long-awaited EU Green Bond Standard (the “EuGBS”).

Hailed as the new “gold standard” for green bonds, the EuGBS aims to increase transparency in the market and combat greenwashing.

In this briefing, we answer ten questions about the EuGBS.

1. What is the EU Green Bond Standard?

It’s a set of rules that an issuer needs to follow if it wishes to label its green bond as an “European Green Bond” or “EuGB”. The rules are contained in a directly applicable EU Regulation (the “Regulation”).

The EuGBS is a voluntary standard, which means issuers in the EU can continue to issue green bonds under other standards, such as the ICMA Principles (“ICMA Principles”) and without complying with the EuGBS requirements.

However, proponents of the EuGBS hope that, over time, it will become a “premium label” for green bonds, denoting those green bonds that comply with the most stringent requirements as to transparency and quality of the green assets that are funded by the bonds.

2. What are the requirements for an EU Green Bond?

There are two main requirements for an EuGB.

Use of Proceeds

The first relates to the use of proceeds. At least 85% of the net proceeds (gross proceeds minus issuance costs) raised by the bond must be invested in “environmentally sustainable” activities aligned with the EU Taxonomy (the “Taxonomy”) prior to maturity of the bond.

These “environmentally sustainable” activities can be financed directly (through paying for assets and expenditures) or indirectly (through financial assets, such as loans). The Regulation also specifically allows for the financing of a portfolio of assets, which reflects the approach currently taken by most green bond issuers in the market. There are also some grandfathering provisions that deal with the situation where the technical screening criteria (“TSC”) of the Taxonomy change over the life of the bond.

Up to 15% of the net proceeds of an EuGB may be allocated to economic activities, for which no TSC yet exist. This is called the “flexibility pocket”. However, such activities must still comply with the other requirements of the Taxonomy.

Verified disclosure and transparency

The other main requirement of the EuGBS relates to disclosure and transparency. The Regulation sets out certain prescribed information that an issuer needs to provide to investors so they can evaluate the use of proceeds and compare EU Green Bonds with each other. Such information also needs to be verified by independent external reviewers (see question 4 below).

3. What documentation is required? 

Issuers who wish to issue an EuGB must publish a prospectus that complies with the EU Prospectus Regulation (“EU PR”), unless they are exempt from the requirement to issue a prospectus, such as EU sovereign or quasi-sovereign issuers. This means in practice that an EuGB will need to be listed on a regulated market and issuers that have in the past listed their green bonds on non-regulated markets would need to bring their disclosure back in line with the more stringent disclosure regime under the EU PR.

The Regulation does not impose any significant disclosure obligations for the prospectus itself. The exception to this is where an issuer chooses to finance opex or capex with the proceeds from an EuGB: in that case, the prospectus needs to include a summary of the issuer’s capex plan. It is worth noting though that the proposed EU Listing Act is expected to require the inclusion of specific ESG-related information in a prospectus for green, social or sustainability-labelled bonds in the form of a new disclosure annex.

Additionally, the Regulation requires issuers to publish on their website certain information both before and after the issue of an EuGB, namely:

• a pre-issuance factsheet, to be published prior to the issue and which sets out, among other things, how the EuGB is expected to contribute to the broader environmental strategy of the issuer and the intended allocation of proceeds to Taxonomy-aligned activities;
• an allocation report, to be published annually until full allocation of the proceeds and which sets out how the proceeds of the EuGB have been allocated to Taxonomy-aligned activities (ideally broken down to the level of individual projects); and
• an impact report, to be published following full allocation of the proceeds, and which describes the positive and negative environmental impacts of the projects that were funded by the EuGB.

The pre-issuance factsheet and the final allocation report, as well as the capex plan (if applicable), will need to be accompanied by a review from an independent external reviewer. Conversely, an external review of the impact report is merely encouraged.

All the required reports as well as the external reviews need to follow standardised templates, which are set out in Annexes to the Regulation.

3. How does the EU Green Bond Standard apply to green securitisations?

For green securitisations, due to the limited existing stock of Taxonomy-aligned securitisable assets, the EuGBS use of proceeds requirement will be applied to the originator of the securitised assets, in relation to the proceeds obtained by the originator from selling the securitised exposures to the issuer, instead of the issuer directly.

Certain securitisations are out-of-scope, such as synthetic securitisations, and securitisations with certain types of underlying exposures, such as those financing certain fossil fuel-related activities.

The European banking, securities market and insurance watchdogs will be required to publish a report on the evolution of green securitisation five years from when the Regulation enters into force. This report will consider whether the volume of Taxonomy-aligned assets has increased sufficiently in order to allow the use of proceeds requirement to be shifted to the securitisation issuer.

4. What is the role of external reviewers?

The Regulation for the first time introduces a mandatory registration and supervision regime for external reviewers.

Following an initial 18-month transition period, companies that wish to act as external reviewers for EU Green Bonds will need to be registered with the European Securities and Markets Authority (“ESMA”).

The Regulation contains detailed requirements that external reviewers need to comply with before they can be registered. For example, applicants need to demonstrate that they have sufficient experience and skill to act as external reviewers and that they have adequate corporate governance arrangements in place to deal with conflicts of interest.

6. What sanctions and penalties apply for breaching the EuGBS?

It will be the EU regulator (the “national competent authority” or “NCA”) that approves the prospectus under the EU PR that will be responsible for overseeing an issuer’s compliance with the EuGBS.

Under the Regulation, the relevant NCA has a range of powers to ensure compliance, including the power to suspend approval of a prospectus, withdraw the EuGBS label or prohibit an issuer from issuing EuGBs for up to a year. The Regulation also includes the power to issue monetary fines of up to 0.5% of an issuer’s turnover and EU member states may choose to impose criminal sanctions for non-compliance.

7. How does the EUGBS apply to other ESG-linked bonds?

The Regulation includes an optional disclosure regime (often referred to as the “EuGB Lite” regime) for (i) green bonds that do not meet the 85%-Taxonomy alignment requirement for use of proceeds and (ii) sustainability-linked bonds (“SLBs”) with pre-defined environmental sustainability objectives. This could encompass green bonds and SLBs issued pursuant to the ICMA Principles.

Issuers of those green bonds or SLBs can voluntarily opt in to publish certain pre- and post-issuance information in line with the Regulation. If they do so, they will come under the supervision of the NCA but they will not be able to label their bonds as “EU Green Bonds”.

8. What are the main challenges for issuers of EU Green Bonds? 

Issuing an EuGB will be significantly more complex than issuing a regular green bond.

There are three main challenges for issuers:

The first relates to the usability of the Taxonomy: companies might struggle to obtain reliable data to prove alignment with the Taxonomy (particularly those looking to fund projects outside the EU), while others operate in sectors that are not yet covered by the Taxonomy. The 15% “flexibility pocket” might therefore be insufficient for some.

The second relates to cost. Obtaining external reviews for pre- and post-issuance reports will likely to be considerably more expensive than getting a second-party opinion under the ICMA Principles. This is because the registration regime for external reviewers is stringent and it is unclear how many registered service providers will be available.

The third relates to liability and reputational risk for an issuer. EuGBs are now regulated products, with NCAs having wide-ranging powers to sanction non-compliance. Issuers will also be exposed to litigation risk from investors.

9. How will the market react to EU Green Bonds? 

It is widely expected that only a limited number of issuers will opt for EU Green Bonds, at least initially. Other than EU institutions, such as the European Investment Bank, green “pure plays”, such as renewable energy companies, are expected to be the first movers in the market. Others (including most non-EU issuers) will probably stick to issuing green bonds under the ICMA Principles for the time being.

A lot will depend on how the first EuGBs perform in the market. If they can be shown to outperform non-EuGBS green bonds (i.e., where issuers can achieve a lower interest rate under EuGBs compared to normal green bonds), other issuers might follow suit. This might particularly be the case where there is growing demand from “deep green” funds for such “gold standard” EuGBs.

10. When will the EU Green Bond Standard come into effect?

Following approval by the European Parliament and the Council, the Regulation is due to take effect in the autumn of 2024.

Please reach out to your usual Freshfields contacts if you would like to discuss any of the issues raised in this blog.