THE European Union Technical Expert Group (TEG) on Sustainable Finance recently published its report on a usability guide for the EU Green Bond Standard (EU GBS), taking another step forward towards establishing a green bond label.
Unlike with regulations on covered bonds, or simple, transparent and standardized (STS) securitizations, the GBS is voluntary - and in addition issuers from anywhere in the world will be able to use the label if they comply with the requirements. The first bond offerings could be launched in 2021.
Thus, it could be a first step towards some sort of global standardization on definitions of green bonds, which currently vary widely.
Many global issuers, including from China, will want to have access to the very large and growing pools of dedicated environmental, social and governance (ESG) investment portfolios within the EU, and also from Norway, which lies outside the EU but nonetheless follows many of its standards and leads the way on ESG investing.
The usability guide published on March 9 by the TEG aims to support potential issuers, verifiers and investors of EU green bonds.
The TEG proposes that any type of listed or unlisted bond or capital market debt instrument issued by a European or international issuer that is aligned with the EU GBS should qualify as an EU green bond. It proposes that the use of EU GBS remains voluntary. Issuers of green bonds that do not want to use the term ‘EU green bond’ and prefer opting for other market practices are not obliged to follow the components of the EU GBS.
The proposed draft model links the use-of-proceeds of EU green bonds to the EU taxonomy regulation, which has set up a classification system for environmentally sustainable economic activities. The final recommendations on the classification system were published by the TEG in a separate report on March 9.
The so called taxonomy is a detailed set of criteria for different industries, specifying limits on carbon emissions, energy efficiency in industrial processes etc. Large corporates will have to begin reporting in 2022, and the data will assist in the fight against greenwashing.
The taxonomy regulation sets out three groups of taxonomy users: financial market participants offering financial products in the EU, including pension providers; large companies who are already required to provide a non-financial statement under the non-financial reporting directive (NFRD); and the EU and member states when setting standards, for example for green bonds.
The NFRD covers many large companies, including listed companies, banks and insurance companies. All companies subject to this requirement will include a description of how, and to what extent, their activities are associated with taxonomy-aligned activities. For non-financial companies, the disclosure must include: the proportion of turnover aligned with the taxonomy; and capital expenditure (capex) and, if relevant, operating expenses (opex) aligned with the taxonomy.
This disclosure should be made as part of the non-financial statement, which may be located in annual reporting or in a dedicated sustainability report. By June 1 2021 the European Commission will adopt detailed rules on how these obligations should be applied in practice.
For corporates, taxonomy reporting will look at both existing sustainable activities, as well as whether capital expenditure is moving the company in a more sustainable direction.
One example would be a cement company which wants to renovate and adapt two of its biggest plants that contribute 50% of its turnover. The taxonomy sets detailed performance thresholds (technical screening criteria), in this case including the energy efficiency of the cement making process.
In this example provided by the TEG, the renovation of the cement company facilities amounts to 500 million euros, which represents 80% of the company’s capital expenditures.
The company needs to raise funds in the capital market, and can issue a green bond based on the EU GBS, which takes into account capital expenditure as companies transition to become greener.
Once the works related to climate change mitigation are finalized, the company could classify all turnover generated from those two facilities (50% of its turnover) as aligned with the taxonomy, and 80% of its capex.
The EU taxonomy regulation does not prohibit investment in, for example, coal or oil related equities, bonds or loans. Instead sets out some clear definitions of which activities can be considered sustainable, and introduces transparency for investors.
Political agreement between the European Parliament and EU Council was reached last December on the taxonomy regulation. The regulation will soon be voted on by the European Parliament in a plenary session.
The final report published on March 9 is simply a set of recommendations from the TEG to the EU Commission, rather than the finished rules. However, market participants expect it to be adopted as the final version of the technical screening criteria.
Complying with the GBS, which in turn relies on the technical criteria in the taxonomy, will be a complex process for issuers wishing to tap the EU green bond market.
There are already international ESG rating agencies such as Sustainalytics, which certify that a corporate or green bond issuer has a framework in place, and is likely to correctly allocate the proceeds.
For example, in January Polish telecoms company Cyfrowy Polsat did its debut green bond, raising 1 billion złoty (235 million euros) to refinance its investments in energy efficiency. The European Bank for Reconstruction and Development (EBRD) supported the deal by buying a 200 million złoty piece, as part of its strategy to promote green finance.
The green bond framework prepared by the company is aligned with the green bond principles, and supported by an opinion from Sustainalytics, which states that the Cyfrowy Polsat framework “is credible and impactful and aligns with the four core components of the green bond principles”.
Sustainalytics is likely to use its existing database and IT systems in order to provide clients with assessments that they are aligned with the EU taxonomy, and other ESG rating agencies around the world are likely to do the same.