New regulation on European green bonds

EU negotiators on 28th February struck a deal creating the first best in class standard for the issuing of green bonds. It is a political agreement between the European Parliament and the Council on the Commission's proposal for a European green bond regulation (“Regulation”). This Regulation, which is an integral part of the European Green Deal, will establish an EU voluntary high-quality standard for green bonds. The European Green Bonds Standard (“EUGBS”), which companies issuing a bond can choose to comply with, will primarily enable investors to orient their investments more confidently towards more sustainable technologies and businesses. It will also give the company issuing the bond more certainty that their bond will be suitable to investors seeking green bonds in their portfolio. The standard aligns with the more horizontal Taxonomy legislation which defines which economic activities can be considered as environmentally sustainable. The EUGBS will be available to companies and public entities that wish to raise funds on capital markets to finance their green investments, while meeting tough sustainability requirements. The deal will enable investors to identify high quality green bonds and companies, thereby reducing greenwashing, clarify to bond issuers which economic activities can be undertaken with the bond's proceeds, set in place a clear reporting process on the use of the proceeds from the bond sale, and standardise the verification work of external reviewers which will improve trust in the review process. Background The European Union strongly supports the transition to a low-carbon, more resource-efficient and sustainable economy. This is part of the EU's efforts to achieve its climate and energy goals in line with the Paris Agreement and the 2030 UN Sustainable Development Goals (SDGs). To deliver on climate, environmental and social sustainability goals, major private and public investments are needed. The EU and its member states are the largest provider of public climate finance in the world, with € 23.04 billion provided in 2021. The European Green Deal further underlined the need to mobilise private financial and capital flows to green investments. The COVID-19 pandemic has led to severe health, financial and economic challenges. At the same time, recovery from the pandemic offers the opportunity to rebuild better and more sustainably by strengthening public policies favourable to climate action such as: carbon pricing; discouraging environmentally harmful and economically inefficient subsidies; shifting towards sustainable investments. In the EU's recovery plan Next Generation EU (NGEU), 37% of the € 672.5 billion Recovery and Resilience Facility is being spent on climate-related objectives. An overall climate target of 30% applies to the total amount of expenditure from the long-term EU budget for 2021-2027. Environmentally sustainable bonds are one of the main instruments for financing investments related to green technologies, energy efficiency and resource efficiency as well as sustainable transport infrastructure and research infrastructure. The Commission presented its proposal for a Regulation establishing European green bonds on 6 July 2021. The EUGB proposal aims to regulate the use of the designation “European green bond” or EUGB for bonds that pursue environmentally sustainable objectives. It aims to establish a system for the registration and supervision of entities acting as external reviewers for EUGBS and to regulate the supervision of issuers of EUGB. The Council set its position on the proposal on 13 April 2022. Trilogue negotiations started on 12 July 2022 and ended with the provisional agreement reached on 28th February. The agreement is provisional as it still needs to be confirmed by the Council and the European Parliament, and adopted by both institutions before it is final. It will start applying 12 months after its entry into force. Green bonds can play a crucial role in financing the transition to a low-carbon economy, and can help to mobilize the capital needed to achieve ambitious climate and sustainability goals. The green bond market has seen exponential growth since 2007 with annual green bond issuance breaking through the USD half trillion mark for the first time in 2021, a 75% increase on 2020. Europe is the most prolific issuance region, with 51 % of the global volume of green bonds being issued in the EU in 2020. Green bond issuance is however small compared to total bond issuance, representing about 3 to 3.5 % of overall bond issuance. Transparency According to the agreement, all companies choosing to use the standard when marketing a green bond will be required to disclose much information about how the bond's proceeds will be used, but are also obliged to show how those investments feed into the transition plans of the company as a whole. The standard therefore requires companies to be engaging in a general green transition. The adoption of the standard will also guarantee to investors that the bond is taxonomy aligned. The disclosure requirements, set out in template formats, will also be open to be used by companies issuing bonds which cannot fulfil all the requirements to qualify for the EUGBS. These companies would thereby subject themselves to ambitious transparency requirements and, as a result benefit from better trust among investors. Flexibility Until the taxonomy framework will be fully up and running, legislators agreed to allow 15% of the proceeds from a green bond to be invested in economic activities that comply with the taxonomy requirements but for which no criteria would have yet been established to determine if that activity contributes to a green objective (technical screening criteria). External reviewers The Regulation establishes a registration system and supervisory framework for external reviewers of European green bonds – the independent entities responsible for assessing whether a bond is green. Equally importantly, the Regulation stipulates that any actual or even potential conflicts of interest are properly identified, eliminated or managed, and disclosed in a transparent manner. Technical standards may be developed specifying the criteria to assess the management of conflicts of interest.