The European Union (EU)'s Technical Expert Group on Sustainable Finance ("TEG") recently revised their proposed EU Green Bond Standard ("EU-GBS"). The proposed standard stipulates the activities that may and may not be financed, the requirements for a green bond framework, the scope and format of allocation and impact reporting, and the requirements for external verification by accredited verifiers. What are the implications of this emerging standard on green financing market practice in the EU and beyond?
In furtherance of the European Commission's Sustainable Finance Action Plan on financing sustainable growth, the TEG released its report on Green Bond Standard ("EU-GBS Report") on 18 June 2019. This is its updated report on the subject to "enhance the effectiveness, transparency, comparability and credibility of the green bond market",1 following its interim report in March 2019 which proposed the first iteration of the EU-GBS. Following public feedback on the draft, the TEG has now revised its proposed EU-GBS.
The TEG has recommended that the EU-GBS be voluntary and comprise the following components:
- Green Projects
Proceeds from EU Green Bonds (ie bonds that meet the requirements of the EU-GBS) shall be allocated only to finance or refinance green projects ("Green Projects") defined, subject to confirmation by an accredited verifier, as contributing substantially to at least one of the environmental objectives as defined in the EU Taxonomy Regulation ("Environmental Objectives").
The EU Taxonomy will be a legally mandated classification system of environmentally sustainable activities which sets out authoritatively what is environmentally sustainable. The proposal for a regulation on the establishment of a framework to facilitate sustainable investment ("Taxonomy Regulation") was released by the European Commission in May 2018 and after its first reading in the European Parliament in March 2019, is currently awaiting its first reading in the European Council. As the Taxonomy Regulation currently stands, after amendment by the European Parliament, the Environmental Objectives are:
- climate change mitigation;
- climate change adaptation;
- sustainable use and protection of water and marine resources;
- transition to a circular economy, including waste prevention and increasing the uptake of secondary raw materials;
- pollution prevention and control; and
- protection of biodiversity and healthy ecosystems, and restoration of degraded ecosystems).
The Green Projects must also not significantly harm any of the other Environmental Objectives and must comply with the minimum social safeguards set out in the eight fundamental conventions, identified in the International Labour Organisation's declaration on Fundamental Rights and Principles at Work. These cover freedom of association and the right to collective bargaining; the elimination of forced or compulsory labour; the abolition of child labour; and the elimination of discrimination in respect of employment and occupation.
Where Technical Screening Criteria have been developed under the EU Taxonomy for specific Environmental Objectives and sectors, the financed or refinanced projects or activities must also meet these criteria. Delegated regulations will have to be adopted by the European Commission to specify the Technical Screening Criteria after the Taxonomy Regulation comes into force. The TEG recently submitted its Taxonomy Technical Report proposing for the Commission's consideration, technical screening criteria for a number of activities that can make a substantial contribution to climate change mitigation based on compatibility with a 2050 net zero carbon economy (without causing significant harm to other Environmental Objectives). It also proposed for consideration, a qualitative process-based methodology to identity location and context specific climate adaptation activities.
An accredited verifier must either confirm the alignment of projects with the Technical Screening Criteria, or alternatively in cases where no technical screening criteria have been developed, that the projects nonetheless are aligned with the EU Taxonomy.
Expenditures that may be financed by EU Green Bonds include, any capital expenditure and selected operating expenditures of green assets that either increase the lifetime or the value of the assets, as well as research and development costs. While capital expenditure on green assets qualify without a specific look-back period, eligible green operating expenditures only qualify for refinancing with a look-back period of up to three years before the issuance year of the bond.
- Green Bond Framework
The issuer must produce a Green Bond Framework ("GBF") which confirms the voluntary alignment of the green bonds issued, following the GBF with the EU-GBS and provide details on the key aspects of the proposed use of proceeds and on its green bond strategy and processes, such as:
- the Environmental Objectives of the EU-GBS and how the issuer's strategy aligns with such objectives, as well as their rationale for issuing;
- the process by which the issuer determines how Green Projects align with the EU Taxonomy;
- a description of the Green Projects to be financed or refinanced by the EU Green Bond;
- the process for linking the issuer's lending or investment operations for Green Projects to the EU Green Bond issued;
- information on the methodology and assumptions to be used for the calculation of key impact metrics; and
- a description of the reporting.
- Allocation and impact reporting
Issuers must report at least annually, until full allocation of the bond proceeds to Green Projects and thereafter, in case of any material change in this allocation. The allocation report must include:
- a statement of alignment with the EU-GBS;
- a breakdown of allocated amounts to Green Projects; and
- the geographical distribution of Green Projects.
Verification is only required for the final allocation report.
Issuers must report on the impact of Green Projects at least once during the bond lifetime, after full allocation of the bond proceeds to Green Projects and thereafter, in case of material changes in this allocation. The impact report must include:
- a description of the Green Projects;
- the Environmental Objective pursued by the Green Projects;
- a breakdown of Green Projects by the nature of what is being financed, the share of financing and refinancing;
- information (and when possible metrics) about the project's environmental impacts; and
- information on the methodology and assumptions used to evaluate the Green Projects impacts.
Verification of the impact reporting is not mandatory.
- Verification by accredited verifiers
Issuers must appoint an external verifier to confirm:
- before or at the time of issuance, through an initial verification, the alignment of the GBF with the EU-GBS; and
- after full allocation of proceeds, through a verification, the allocation of the proceeds to green eligible projects in alignment with the allocation reporting.
Verifiers must be formally accredited and supervised. Verification providers must disclose their relevant credentials and expertise and the scope of the review conducted in the verification report.
The ball is now in the EU Commission's court, to decide whether and how to take the TEG's recommendations on the EU-GBS Report forward.
Compatibility with GBP
The TEG created the EU-GBS as a standard that most green bond issuers can comply with over time and that could become an international best practice standard. To this end, the standard is designed to maximise its impact and acceptance in the European and international bond markets and is underpinned by best market practice and relevance to all stakeholders. The EU Taxonomy also builds on the classifications that have been developed for the international bond market, rather than departs from these classifications. Therefore, it is not surprising that the EU-GBS as currently proposed is by design compatible with the International Capital Market Association's Green Bond Principles ("GBP").
Compared to the EU-GBS, the GBP recognizes broad categories of green projects, but does not stipulate what projects may or may not be financed from green bonds aligned with the principles. The principles require the process for project evaluation and selection to be communicated, but do not formally require a green bond framework. External review of the alignment of the green bond or green bond programme with the GBP is also recommended but not mandatory.
The EU-GBS adds clarity to the GBP and streamlines and standardises some of the different practices under the principles.
Implications for the Singapore Green Finance Market
The EU-GBS is being proposed as a voluntary standard. This means that issuers need not issue their bonds as EU Green Bonds. Nevertheless, there are good reasons to adopt it. It clarifies the universe of eligible projects and assets and expenses that can be financed; streamlines and standardizes the verification process and reports; and creates an accreditation process that clarifies the role and responsibilities of external verifiers. The additional clarity and authoritative standardisation also lays the ground for policy makers to design incentives for mainstreaming of green financing. The TEG has also recommended a series of measures to support the implementation and uptake of the standard.
Furthermore, the EU Taxonomy is intended to be mandatory, and under the proposed Taxonomy Regulation as it currently stands, credit institutions or issuers offering within the EU financial products as environmentally sustainable investments or as investments having similar characteristics, will be required to disclose the relevant information allowing them to establish whether the products they offer qualify as environmentally sustainable investments, in accordance with the criteria in the Taxonomy regulations. Any measures adopted by EU Member States or the EU itself that set out any requirements on financial market participants in respect of financial products or corporate bonds that are marketed within the EU as environmentally sustainable, must also apply the Taxonomy Regulation criteria for determining the degree of environmental sustainability of economic activities under these measures. Thus, even credit institutions or issuers who wish to offer or even market green financial products in the EU cannot ignore the EU-GBS completely, as they may still have to at least apply the Taxonomy Regulation criteria, if not, also the other requirements of the EU-GBS.
Beyond direct application to EU Green Bonds, the emerging EU-GBS, suitably modified, will almost certainly influence the evolution of other green financial products, such as green bonds offered and marketed outside the EU, and green loans and sustainability-linked loans offered or marketed within, as well as outside the EU. Whether or not they are contemplating EU Green Bonds, green financing market players will want to follow the developments of the emerging EU-GBS closely.
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