Adoption of Final Version of European Green Bond Standard: A New Landmark Tool for Sustainable Finance

BACKGROUND 

The EuGB Regulation's stated objective is to afford investors with greater confidence in directing their money toward more sustainable technologies and businesses. This EuGB standard also aims to protect against greenwashing and facilitate comparisons for investors of bonds pursuing environmentally sustainable objectives.

The green bond market has steadily expanded for more than a decade, with significant growth in recent years. By 2020, green bonds had grown to represent some 3-3.5% of overall bond issuance. The biggest-ever half-year of issuance occurred in 2023, with global green bond issuance rising 22.2% to $351.9 billion as compared to the same period in 2022. Moreover, the overall face value stock of green bonds issued by EU general governments amounted to €266 billion by end-2022, equivalent to 1.7 % of EU GDP. The European Commission also notably issued €6 billion of NextGenerationEU green bonds in its fourth syndicated transaction for 2023. 

KEY FEATURES OF EuGB REGULATION

EU Taxonomy

The EuGB Regulation is closely linked with another tool for sustainable finance, the Taxonomy Regulation (Regulation (EU) 2020/852 of June 18, 2020 on establishing a framework to promote sustainable investment ("Taxonomy") and amending Regulation (EU) 2019/2088). The Taxonomy Regulation, which establishes criteria for determining whether an economic activity is considered environmentally sustainable, is used as a measuring stick in the EuGB Regulation, in particular with concerns to the allocation of EuGB proceeds to Taxonomy-aligned activities. 

Transparency

The EuGB Regulation provides for transparency on the allocation of proceeds through detailed reporting requirements. Specifically, issuers must:

• Disclose the intended allocation (before issuance) and progress made in this allocation (yearly); and
• Obtain a positive opinion twice from an external reviewer (once before bond issuance, once upon full allocation). 

EuGB issuers must use standardized templates, as set out in the EuGB Regulation's annexes, which are key to allowing comparability. These EuGB templates can also be freely used by issuers who do not meet the requirements for using the EuGB designation, but who nevertheless seek to demonstrate their ecological aspirations. 

Such reporting must be kept available on the issuer's website for at least 12 months after the bonds have reached maturity, and the issuer must formally notify both its national competent authority and European Securities and Markets Authority ("ESMA") of each such publication in fulfillment of the EuGB's reporting requirements. 

The standardized templates in the EuGB Regulation include:

EuGB Factsheet (Annex I). Prior to issuing an EuGB, the issuer must disclose an EuGB information sheet, accompanied by a pre-issuance review of the information sheet by an external reviewer. This EuGB factsheet is regulated information and will be incorporated by reference into the prospectus for EuGBs.

Annual Allocation Report (Annex II) and Post-Issuance Review of Allocation Reports. The issuer must: (i) draw up an annual allocation report until the full allocation of the proceeds (additionally, where applicable, the annual allocation report is required until completion of the CapEx plan). This report must be published on the issuer's website no later than 270 days following the end of each 12-month period (with the first 12-month period ordinarily beginning on the issuance date); and (ii) obtain a post-issuance review by an external reviewer of the first allocation report that is drawn up after the full allocation of the bond proceeds.

In the event that the allocation of proceeds is corrected subsequent to publishing an allocation report, the issuer concerned must amend the allocation report and obtain a post-issuance review from an external reviewer of such amended allocation report, without undue delay.

EuGB Impact Report (Annex III). The issuer must disclose the environmental impact of the use of bond proceeds by publishing an impact report at least once during the lifetime of the bond, in addition to after the bond proceeds have been fully allocated. Issuers may seek a review of such impact reports by an external reviewer.

TWO APPROACHES TO USING EuGB PROCEEDS

 "Gradual Approach" 

 An issuer using the EuGB label must ensure that 85% of the net proceeds (i.e., after deduction of issuance costs) are allocated to Taxonomy-aligned activities before bond maturity. The proceeds of the EuGB can be allocated to one or more of the following categories: 

• Fixed assets that relate to economic activities that meet Taxonomy requirements; 
• Capital and operating expenditures (operating expenditures must be incurred no more than three years before issuance of the EuGB), provided that these relate to economic activities that meet Taxonomy requirements or that will meet those requirements within a reasonably short period from the issuance of the EuGB concerned; 
• Financial assets (must be created no more than five years after issuance of the EuGB), provided that the proceeds of those financial assets are directly, or indirectly through subsequent financial assets (with a maximum of three subsequent financial assets in succession), allocated to economic activities that meet Taxonomy requirements; and
• Assets and expenditures of households that relate to economic activities that meet Taxonomy requirements. 

The EuGB Regulation permits a 15% margin of flexibility for international climate finance and activities without Taxonomy technical screening criteria. Indeed, up to 15% of the net EuGB proceeds may be allocated to economic activities for which no technical screening criteria under the Taxonomy exist yet, but which otherwise comply with the Taxonomy.

"Portfolio Approach" 

Issuers can also allocate EuGB proceeds to a portfolio of fixed assets or financial assets in accordance with the Taxonomy requirements. In such case, the issuer's allocation reports shall demonstrate that the total value of the portfolio of environmentally sustainable assets exceeds the total value of their outstanding bonds. All outstanding EuGBs must match with Taxonomy-aligned assets on a yearly basis.

OVERSIGHT MECHANISMS

External Reviewers 

External reviewers, as above-mentioned, will review EuGBs to ensure their compliance with the EuGB Regulation and, in particular, alignment with the Taxonomy Regulation. 

External reviewers must comply with certain procedural and governance requirements, as well as requirements regarding pre-issuance and post-issuance reviews. External reviewers must therefore be registered with and supervised by ESMA. ESMA has 24 months after the EuGB Regulation enters into force to establish the various detailed requirements for the authorization and operation of external reviewers. 

Supervision by National Authorities

National competent authorities ("NCAs") will be responsible for compliance with the EuGB standard, notably by ensuring that issuers make correct disclosures and obtain external review. In the event of noncompliance, NCAs may suspend approval of the prospectus, withdraw the EuGB designation, prohibit an issuer from issuing EuGBs for up to a year, and/or impose certain monetary fines.

OTHER BONDS NOT MEETING EuGB STANDARD—ENVIRONMENTALLY SUSTAINABLE BONDS AND SUSTAINABILITY-LINKED BONDS

The EuGB Regulation provides optional pre-issuance and post-issuance disclosure templates for bonds in the EU that do not meet the EuGB standard, but which are marketed as environmentally sustainable bonds ("ESBs") and as sustainability-linked bonds ("SLBs"):

• For ESBs, the issuer provides investors with a commitment or any form of pre-contractual claim that the bond proceeds are allocated to economic activities that contribute to an environmental objective. 
• SLBs have financial and/or structural characteristics that can vary depending on the issuer's achievement of predefined sustainability or environmental, social, and governance objectives.

Competent authorities will supervise the post-issuance periodic disclosures of issuers of such bonds.

POTENTIAL CHALLENGES TO IMPLEMENTING EuGB REGIME

Various challenges may arise during implementation of the EuGB Regulation, such as the below.

Extraterritoriality

The EuGB Regulation aspires to set a global standard, which leads to the question of whether EU issuers can utilize the EuGB standard for issuing green bonds outside the EU. Furthermore, while all non-EU issuers offering green bonds in the EU may avail of the EuGB Regulation, the oversight of such non-EU issuers remains a subject of discussion. As non-EU issuers will be subject to oversight by their respective (non-EU) national regulators, this introduces potential discrepancies in regulatory frameworks and supervisory mechanisms across EU and non-EU regions.

Coexistence of Multiple Green Bond Standards and Labels

The newly introduced EuGB label will coexist alongside other existing green bond standards and labels, such as the ICMA Green Bond Principles. These various standards defining green bonds give rise to a risk of "dual standards and dual speeds." This scenario could result in discrepancies in terms of compliance costs and hurdles to market entry, especially for smaller and mid-sized issuers. Managing the complexities of multiple standards may, in turn, dissuade potential issuers from engaging in the green bond market.

Social Aspects Lagging

The delay in establishing a European standard for social bonds is a notable concern. Without any European standard for social bonds, this could make it a challenge to allocate funds to assets or projects that are both environmentally and socially beneficial, as provided in ICMA's Sustainability Bond Guidelines (covering both social and green bonds). 

Gaps in EU Taxonomy

The Taxonomy is an important step in defining what is considered environmentally sustainable. However, it does not yet cover all economic activities, thereby leaving uncertainties and open questions. In addition, while the EuGB Regulation permits a 15% margin of flexibility for international climate finance and activities without Taxonomy technical screening criteria, this only covers a small part of net EuGB proceeds. This limited margin may therefore prove insufficient in the face of the evolving Taxonomy regime, which could lead to difficulties in aligning investments with ever-changing criteria.