At a recent Matheson insights event, Brexit Revisited: London Calling, an expert panel considered some specific Brexit-related legal developments under the themes of convergence, divergence and equivalence. One of the key takeaways was that in some emerging areas, a rule book does not exist as yet and so it is open to regulators to create rules as required. Indeed, the panel went on to consider that there is already evidence of divergent regulatory systems and legal practices in the ESG area. The emerging European Green Bond Standard (EuGBS) is voluntary, but it does have the potential to become the leading standard in the international green bond market. The seamless application of this gold standard in a post- Brexit world may need to be carefully considered.
Following Trilogue negotiations, a provisional agreement was announced between the Council and the Parliament on 28 February 2023 on the Commission's proposal for the European Green Bond Standard ("EuGBS") and a provisionally agreed text was published on 10 May 2023. While the EuGBS is voluntary, it does have the potential to become the leading standard in the international green bond market. In this piece, we raise some of the implications from a regulatory perspective post-Brexit.
Proposal for a Regulation of European Green Bonds
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. Despite the potential for green bonds to play an increasingly important role in financing assets needed for the low-carbon transition, to date there is no regulatory standard for green bond disclosures, with the majority of the market relying on voluntary standards published by industry associations such as the ICMA's green bond principles.
On 6 July 2021, the Commission proposed a Regulation on a voluntary EuGBS. This proposal will create a voluntary EU approved standard available to all issuers (private and sovereigns) to help the financing of sustainable investments. As Paul Tang, rapporteur said “…[t]his Regulation creates a gold standard that green bonds can aspire to. It ensures that the money raised must go to green activities and that bonds are vetted by professional and independent third party reviewers. This is a world apart from current market standards." The proposal, therefore, serves both environmental and financial market purposes.
The new EuGBS will be open to any issuer of green bonds, including issuers located outside of the EU. There are four key requirements under the proposed framework. First, the funds raised by the bond should be allocated fully to projects aligned with the EU Taxonomy; Second, there must be full transparency on how bond proceeds are allocated through detailed reporting requirements; Third, all EU green bonds must be checked by an external reviewer to ensure compliance with the Regulation and that funded projects are aligned with the Taxonomy. Specific, limited flexibility is foreseen here for sovereign issuers.
Finally, external reviewers providing services to issuers of EU green bonds must be registered with and supervised by the European Securities Markets Authority. This will ensure the quality and reliability of their services and reviews designed to protect investors and ensure market integrity. We wrote previously about this proposed framework here.
The Legislative Background
The Council published its proposal on 13 April 2022. On 16 May 2022, the ECON committee of the Parliament published its position, proposing substantial amendments to the Commission's proposal aimed at, among other things, strengthening the protections against greenwashing and regulating the entire European green bond market, rather than just those issuers choosing to utilise the EuGBS. Trilogue negotiations began on 12 July 2022. The institutions failed to reach an agreement at the end of 2022, but a provisional agreement was announced between the Council and the Parliament on 28 February 2023.
Under the provisional agreement, all proceeds of EuGBS will need to be invested in economic activities that are aligned with the EU taxonomy, provided the sectors concerned are already covered by it. For those sectors not yet covered by the EU taxonomy and for certain very specific activities there will be a flexibility pocket of 15%. This is to ensure the usability of the European green bond standard from the start of its existence. The use and the need for this flexibility pocket will be re-evaluated as Europe’s transition towards climate neutrality progresses and with the ever increasing number of attractive and green investment opportunities that are expected to become available in the coming years. As regards supervision, the national competent authorities of the home member state designated (in line with the Prospectus Regulation) shall supervise that issuers comply with their obligations under the new standard and provision will be made for a voluntary disclosure framework for issuers of bonds which do not meet all the requirements of the EuGBS.
We wrote about market participants' initial reaction here. The agreement is still provisional as it is subject to legal and linguistic checks and still needs to be confirmed by the Council and the European Parliament before it is final. However, it is expected that this process will conclude later in 2023 and that the legislation will apply c. 12 months after publication in the Official Journal. Market participants can, therefore, look at the current text with a degree of confidence.
Cross-Border Sustainable Financing
We considered the important subject of financing through the ESG lens at a recent Matheson insight event. The transition to a climate-neutral economy and the achievement of the EU’s ambitious targets on the European Green Deal require public and private money to be redirected towards green investments. Green bonds, therefore, can play a crucial role in financing the transition to a low-carbon economy by helping to mobilize the capital needed to achieve ambitious climate and sustainability goals.
The EuGBS Regulation recognises that the green bond market is inherently international, with participants trading bonds across national borders. It, therefore has an internal and an external dimension. Within the EU, by setting a single standard, the Regulation will prevent the fragmentation of the European market for green bonds. Beyond the EU, the market for external reviewers of green bonds is cross-border. In order to preserve a level playing field for the actors providing these services, a centralised registration and supervisory regime for external reviewers of European green bonds is needed at European level. This is coordinated by the European Securities and Markets Authority (ESMA).
Issuers of, and investors in, financial products require common metrics and definitions to determine which projects and activities are environmentally sustainable and the capacity to compare them with each other. The Regulation has advantages for both the issuer and investor. For the issuer, the EuGBS provides a clearly defined protocol for issuing green bonds. Although this may cause extra work, it is more than likely to enhance the issuer’s reputation, while significantly improving the reporting given to investors. For investors, this is a great opportunity for taxonomy-aligned investments and good quality ESG-reporting.
Should any of these issues be of interest to you, please get in touch with your usual Matheson contact in any of our international offices.