Following the announcement on 28 February 2023 that the European Parliament and European Council had reached a provisional agreement on the Regulation on European Green Bonds (EuGBs) and optional disclosure on bonds marketed as environmentally sustainable and sustainability-linked bonds (SLBs) (the EuGB Regulation), the European Parliament and European Council have now published the final consolidated legal text (which contains various templates in the annexes) on their websites¹. This alert sets out a high level overview of the main points of the final consolidated legal text. There were particular areas of disagreement between the negotiating positions of the European Commission, the European Council and the European Parliament and this final text represents a compromise between the different positions.  The European Parliament wanted a mandatory standard that would cover the entire green bond market whilst the European Council was concerned that this would undermine the development of the nascent green bonds market with possible duplicative requirements, so the EuGB Regulation also includes voluntary standards for bonds marketed as environmentally sustainable and SLBs in the EU in order to address any greenwashing concerns, with the hope that over time these voluntary templates may become market standard.

Background

In July 2021 the European Commission (the EC) published its draft legislative proposal for the EuGB Regulation. The EuGB Regulation establishes a voluntary standard for European green bonds and aims to increase market efficiency through harmonised rules and standards, by requiring the proceeds of EuGBs to be invested in economic activities that are aligned with the taxonomy requirements under Regulation (EU) 2020/852 (the Taxonomy Regulation). The idea is that this should facilitate comparison for investors and address greenwashing concerns.  In addition, the EuGB Regulation sets out optional sustainability disclosure requirements for bonds that are marketed as environmentally sustainable and SLBs which relate to environmental sustainability objectives. These optional disclosure requirements together with the standard for EuGBs will co-exist with the existing international market standards such as the ICMA Green Bond Principles.

What is the likely timing of the EuGB Regulation?

The European Parliament is currently expected to adopt the EuGB Regulation at first reading in September.  Following the European Parliament’s adoption, the European Council is then expected to adopt the Regulation.

The EuGB Regulation will then be published in the Official Journal of the EU and enter into force 20 days after the date of publication, which could be sometime in the autumn.  It will start applying 12 months after its entry into force, which would therefore be later in 2024, although some requirements, which require ESMA or the EC to develop further implementing measures, will apply from the date of entry into force.

What types of issuances can use the EuGB designation?

The designation “European Green Bond” can only be used in respect of use of proceeds bonds: (i) for which a prospectus under the EU Prospectus Regulation is published; or (ii) that fall within one of the exemptions available for sovereign bonds from producing a prospectus under Article 1(2)(b) and (d) of the EU Prospectus Regulation.  All such issuances tagged as “European green bonds” or “EuGB” and offered in the EU must comply with the EuGB Regulation.

Third country issuers are open to use the EuGB designation although Article 7a also stipulates that issuers located in the EU list of non-cooperative jurisdictions for tax purposes or high risk third countries are not permitted to use the EuGB designation.  There are also specific provisions in relation to securitisation transactions, for more information please see our alert EU Green Bond Standard – a panacea for green securitisation?

Voluntary label

Compliance with the EuGB Regulation will be mandatory for any bond designated as a “European green bond” or “EuGB”.  In addition to requirements around the allocation of proceeds,  there are requirements to produce certain reports in the prescribed format set out in the Annexes to the EuGB Regulation such as the European Green Bond Annual Allocation Report and the European Green Bond Impact Report.

Use of the EuGB label will, however, be voluntary: green-, sustainability- or any other ESG-themed bonds will still be able to use any other label or otherwise market themselves as green or sustainable without complying with the EuGB Regulation.   

Use of proceeds

Before maturity, the proceeds of EuGBs must be fully allocated in accordance with the taxonomy requirements to the following activities (or a combination thereof):

• fixed assets (other than financial assets);

• capital expenditures (that meet or will meet the taxonomy requirements);

• operating expenditures with a 3-year look back period (that meet or will meet the taxonomy requirements);

• financial assets created no later than 5 years after the issuance of the European green bond (which may include subsequent financial assets); and

• assets and expenditures of households.

In addition, it is important from a practical perspective that proceeds can also be allocated to a portfolio of fixed assets or financial assets, provided that the allocation reports show that the total value of fixed assets or financial assets in the portfolio exceeds the total value of the portfolio of outstanding bonds.  Issuers are allowed to allocate net proceeds only and can deduct issuance costs. 

Article 4a provides some flexibility such that issuers can allocate up to 15% of the proceeds to economic activities that comply with the taxonomy requirements with the exception of the technical screening criteria where broadly (i) there is no technical screening criteria in force for that relevant activity by the date of issuance of the EuGB; or (ii) the activities are in the context of international support that contribute to the environmental objectives of the Taxonomy Regulation. This so-called “flexibility pocket” is a compromise between the position of the European Council that advocated for some limited flexibility for certain economic activities for which there are no technical screening criteria or for certain activities in the context of international support that contribute to the environmental objectives and the European Parliament that was not keen on any flexibility, but did want some ability for proceeds to be allocated to a portfolio of financial assets.

EU and third country sovereigns are allowed to issue EuGB to finance public assets or expenditures that meet or are expected to meet the taxonomy requirements within a reasonably short period of time after issuance, such as tax relief, subsidies, intermediate consumption.

CapEx plans

Where the proceeds are used for capital or operating expenditures,  the issuer must publish a CapEx plan in accordance with Annex I of Commission Delegated regulation 2021/2178. A summary of the CapEx plan must be included in the prospectus which should list the most significant projects carried out by the issuer, measured as a share of the total capital expenditure covered by the issuer’s Capex plan.  In addition, the issuer will need to publish a report on progress made on the implementation of the plan in the annual allocation report.

Application of technical screening criteria and grandfathering

When issuing an EuGB bond, the issuer must ensure that the proceeds of the bond are allocated in accordance with the technical screening criteria in the Taxonomy Regulation applicable at the  date of issuance of the bond.

If the relevant technical screening criteria are amended after the date of the issuance of the bond, there is a grandfathering period of 7 years, by the end of which time, the issuer will need to ensure that the following proceeds are aligned with the amended technical screening criteria: 

• proceeds that have not yet been allocated; and

• proceeds covered by the Capex plan and that have not yet met the taxonomy requirements.

For assets that are allocated using the portfolio approach, the grandfathering works slightly differently. Issuers will need to make sure that all activities included in the portfolio are aligned with the technical screening criteria that were applicable at some point during the 7 years prior to the publication of the allocation report.

This 7 year grandfathering period was  the result of a compromise between the European Parliament’s wish for different treatment for transitional activities, with limited grandfathering, which was a major stumbling block for the European Council. This 7 year period should provide sufficient flexibility for issuers who can adjust the term of their bonds accordingly.

EuGB factsheets and reports

Before issuing an EuGB, the issuer must publish a European Green Bond factsheet using the template in Annex 1 of the EuGB Regulation. The factsheet must be accompanied by a pre-issuance review by an external reviewer.

In addition, issuers must prepare an annual allocation report (using the template in Annex II of the EuGB Regulation) every year, until the date of full allocation.  This should set out the allocation of the bond proceeds and should be reviewed by an external reviewer.  In addition, an issuer must obtain a post-issuance review by an external reviewer of the allocation report (except where there is no change to the allocation) drawn up after the full allocation of the proceeds of the EuGB, which should be based on the template in Annex IV.

Finally, issuers must produce an impact report after the full allocation of the proceeds of the bond which should be based on the template in Annex III of the EuGB Regulation, although there is no need to subject this to an external review.

Publication on the issuer’s website

The European green bond fact sheet and the pre-issuance review must be published free of charge on the issuer’s website before bond is issued.

The annual allocation reports, post-issuance review and the European green bond impact report must be published without undue delay after they are drawn up. There should also be a link to the prospectus, the CapEx plan and the impact report review of the European green bond impact report where applicable and any amendments or corrections to any of these documents.

Optional disclosure for bonds marketed as environmentally sustainable and SLBs

The EuGB Regulation also includes guidelines for bonds marketed as environmentally sustainable and SLBs in the EU (whether or not such bonds are labelled  as EUGB or  European green bonds).

The European Commission is tasked with publishing guidelines within 12 months after the entry into force of the EuGB Regulation, with a view to establishing pre-issuances templates for bonds marketed as environmentally sustainable and SLBs.  The templates should include information on whether the issuer intends to use an external reviewer and how the bond proceeds will be used in accordance with the EuGB Regulation.

In addition,  the content, methodology and presentation of the templates will be set out in delegated acts that the EC must adopt within 12 months of the entry into force of the Regulation and issuers can use the templates to make periodic disclosures.

Prospectus disclosure requirements

Any bond that is looking to comply with the EuGB Regulation must be designated as a “European green bond” or “EuGB” throughout the prospectus. In addition, the prospectus must state that the EuGB is issued in accordance with the EuGB Regulation in the use of proceeds section.

Issuers will also need to ensure that they comply with the disclosure requirements under the EU Prospectus Regulation and include any relevant material ESG-related information in the prospectus. It is important that, once finalised, the EuGB Regulation does not provide for the mandatory incorporation of the factsheet into the prospectus (as was proposed by the European Parliament), nor stipulate that a binding provision of compliance with the EuGB Regulation must be included in the terms and conditions of the bond (as proposed by the European Council).

In December 2022, the EC proposed some changes to the EU Prospectus Regulation as part of the Listing Act package of reforms².  Amongst the proposals, the EC has the power to adopt delegated acts setting out standardised annexes specifying the ESG-related information that should be included in a prospectus that is advertised as taking into account ESG factors or pursuing ESG objectives.  It will be important to ensure that these new annexes are consistent with the templates for the voluntary standards for bonds marketed as environmentally sustainable or SLBs under the EuGB Regulation.

Supervisory framework for external reviewers

The EuGB Regulation also establishes a new regime for the registration and ongoing supervision of, external reviewers by ESMA.  External reviewers  have to comply with certain organisational, process and governance requirements as well as requirements regarding pre-issuances and post-issuance reviews.  There is also a framework for third-country reviewers, by way of equivalence assessment, recognition or endorsement.

ESMA has 24 months after the EuGB Regulation enters into force to come up with the various detailed requirements for the authorisation and operation of external reviewers.  Although there is a transitional period of 18 months after the EuGB Regulation applies during which time external reviewers can operate without authorisation from ESMA, any such external reviewers will need to comply with the obligations in the EuGB Regulation on a “best efforts” basis, without knowing the full extent of the detail or liability of any of the requirements.

Powers of competent authorities and ESMA

There are additional powers for competent authorities and ESMA to issues fines and other administrative sanctions.

Review of the EuGB Regulation

There is a review provision stipulating that the EuGB Regulation must be reviewed 5 years after its entry into force and every 3 years thereafter. The European Commission has to submit a report to the European Parliament and the European Council, accompanied by a legislative proposal where appropriate, including in relation to the disclosure of issuers of bonds marketed as environmentally sustainable and SLBs. However, there is no indication of a review clause that would look at making the EuGB Regulation mandatory in the future, as was proposed by the European Parliament.  In addition, within 3 years the European Commission must publish a report in relation to the need to regulate SLBs, accompanied by a legislative proposal, where relevant.

Final thoughts

The EuGB Regulation is one of the outstanding pieces of the EC’s strategy for financing the transition to a sustainable economy³ and a development of the idea that the taxonomy serves as a uniform benchmark for the qualification of environmental sustainable activities. To a certain extent, the uptake of the European Green Bond standard amongst market participants will depend on the availability of assets that are in alignment with the taxonomy requirements, which to date is fairly limited. It is helpful that the European green bond standard in this final compromise version at least provides some flexibility in this respect.

Market participants who are contemplating using the EuGB label or the voluntary templates should monitor the EuGB Regulation developments and consider how they will be able to meet the various requirements. It will also be interesting to understand the extent to which the new ESG disclosure annexes under the EU Prospectus Regulation will align with the optional templates for bonds marketed as environmentally sustainable and SLBs in the EU. 

Meanwhile, by way of comparison, in the UK, to date there have not been any proposals relating to a UK green bond standard or specific ESG disclosure requirements although the UK Financial Conduct Authority is currently seeking views⁴ on whether further direction is needed through guidance or content requirements in order to provide issuers with greater certainty as to what should be included in terms of ESG disclosure in the prospectus.

References

1 AG (euroa.eu), pdf (europa.eu)

2 finance-2021-listing-act-targeted (europa.eu)

3 The Strategy for financing the transition to a sustainable economy (2021) builds on the Sustainable Finance Action Plan (European Commission Action Plan:  Financing Sustainable Growth (2018))

4 Non-equity securities – Engagement Paper 4 | FCA