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Executive Summary

Proposed by the European Commission on July 6th, 2021[1], the final negotiation phase of the European Green Bond Standard (EU GBS) has begun but several contentious points announce a heated debate. The text is inspired from the Technical Expert Group[2] recommendations published in June 2019.

The EU GBS is built on two distinctive features:

• The alignment of the bond’s Use-of-Proceeds with the requirements of the European Taxonomy (incl. fulfillment of the technical screening criteria);
• The disclosure by EU GB’s issuers of pre-determined information along with a pre- and post-issuance review of these information from a third party, registered with the European Securities and Markets Authority (ESMA).

This new standard is meant to be used on a voluntary basis by all European and non-European green bond issuers in the Commission’s initial proposal.

Following last year’s publication by the European Commission, the text has been submitted to the classic interinstitutional negotiations for the adoption of EU legislation. The Council has agreed its position on April 8th, 2022, and the European Parliament’s Committee on Economic and Monetary Affairs has voted on its own version on May 16th, 2022. The vote in plenary session is expected in the beginning of June 2022. The three institutions now need to reach a consensus. Negotiations between the institutions on legislative proposals take the form of tripartite meetings ('trilogues') between the Parliament, the Council and the Commission.

Source: Natixis GSH

In the continuity of our active monitoring of the latest EU Green Bond Standard developments (see our August 2019 study - TEG 101 – The EU Green Bond Standard - and our November 2021 dedicated article on the EU GBS), Natixis’ GSH has assessed the latest proposals made by the co-legislators compared to the original version.

The Commission, the Council and the European Parliament have divergent views on several contentious points, particularly Taxonomy-alignment of the Use-of-Proceeds, grandfathering clause and transition plans at issuer-level. In a nutshell, the Parliament has proposed to extend and reinforce EU GBS requirements, while the Council has advocated for more flexibility for issuers.

The Parliament proposes several minimum sustainability disclosure requirements for all bonds marketed as environmentally sustainable, including sustainability linked-bonds (which is very odd in our view). It also wants transition plans to be systematically created at issuer-level. Nonetheless, some concessions have been made by the rapporteur of the text, Paul Tang, notably the withdrawal of its mandatory status for all green bonds and the exclusion of taxonomy-aligned gaseous and nuclear activities from the Standard scope, both were initially evoked.

Meanwhile, the Council has proposed to create a flexibility pocket (20% of the proceeds) for the required Taxonomy-alignment of the Use-of-Proceeds and to delete the partial grandfathering clause initially included by the Commission.

 

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Contents

I   - Disclosure requirements "for all": a meaningful but untimely extension proposed by the Parliament

II  - The creation of transition plans would bring confusion and be burdensome for issuers

III - Taxonomy-alignment of UoP: the Council calls for flexibility pocket

IV - Last but not least, the grandfathering clause

V  - Trilogue negotiations as a last chance to combine usability and stringency in the EU GBS

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I - Disclosure requirements “for all”: a meaningful but untimely extension proposed by the Parliament

The main divergence between the co-legislators relates to the mandatory disclosure provisions applying to all types of environmentally sustainable bond issuers, i.e. not only to issuers willing to align with the EU-GB Standard (i.e. also applicable to issuers of ICMA aligned Green Bonds).

Disclosure requirements in the text have been largely changed and reinforced at both issuer- and bond-level by the Parliament.

According to the Parliament’s proposal, all “bonds marketed in the Union as environmentally sustainable as well as sustainability-linked bonds” should be comparable, and hopefully benchmarked by investors. As the EU GBS is focusing on environmental features, the assessment of bonds mixing environmental and social categories under the EU GBS will be complex.

Issuers of such bonds should consequently disclose in their pre-contractual disclosures:

Table 1 – EU-GBS Parliament’s pre-contractual disclosures proposal

Pre-contractual disclosure requirements	Natixis GSH analysis
A “clear and reasoned” explanation of how the bond takes account of principal adverse impact (PAI)[3] on sustainability factors[4];	The level of assessment of the principal adverse impact must be clarified (at issuer-level or use-of-proceeds allocation)
Information on how the environment characteristics of the bond are met;	This proposal derives from the requirements existing for SFDR Article 8 funds but may never be accepted by market participants.
The intended allocation of bond proceeds;	The expected level of granularity should be clarified (breakdown per type of activities, data on TSC fulfillment).
The % of expected taxonomy alignment of the Use-of-Proceeds of the bond.	This alignment ratio is an answer to the criticism about the binarity of the Taxonomy and its “elitism”. It would create granularity in terms of information, and not only 100% alignment versus “none”. This information could guide investors and create emulation. Issuers with too low ratios may be disincentivize to issue or at least in Europe.

Source: Natixis GSH

Furthermore, the Parliament requires a reporting per bond, prohibiting the portfolio approach, which largely contrasts with current market practices and would put many issuers in a difficult position. Thus, individual bond factsheets, allocation reports, and impact reports must relate to an individual sustainable bond. By derogation, an EU-GB factsheet, allocation report or impact report concerning an allocation of a portfolio of EU-GB to a portfolio of financial assets may relate to several EU-GB issuances.

The explicit exclusion of gaseous and nuclear activities from the Standard scope has been removed as the Parliament’s rapporteur has decided to focus obstruction efforts on the Complementary Delegated Act. However, transparency requirements related to nuclear and gas have been added with the amount and proportion of proceeds intended to be allocated to nuclear energy and fossil gas related activities to be disclosed.

Leveling the playing field is always welcomed, especially regarding disclosure. Nevertheless,  it may be too early due to low maturity Taxonomy data and inconsistent verification procedures. This is also premature because of the classification loopholes (absence of criteria for some sectors, this is why the Council advocates flexibility pocket). The impact of the EU GBS requirements could be double-edged: either the stringency of disclosure requirements may encourage issuers and investors to use it, or these additional requirements may dissuade some actors from issuing green bonds on the European market.

II - The creation of transition plans would bring confusion and be burdensome for issuers

The Parliament suggests requiring issuers of European green bonds and of sustainability-linked bonds to create, before issuance, transition plans indicating how they will reach climate neutrality by 2050 at the latest. Plans must be certified with a positive opinion by an auditor on their alignment with climate neutrality (issuers “shall be required to have received a positive opinion by an auditor on the alignment of the transition plan with the objective to achieve climate neutrality by 2050 at the latest”). The weblink to the issuer’s transition plan must be provided. Information on how and to what extent the issuance of the bond is intended to reduce the environmental impact of the issuer in view of the targets set out in the transition plan must be disclosed.

The notion of transition plan is a cornerstone upon which many expectations and provisions are resting, it should help guaranteeing the consistency between green bond issuances and issuers’ strategies. Although we welcome the intention to reinforce consistency and accountability between the issuer’s whole strategy and a given issuance, it is inadequately defined so far and there is a risk to multiply plans and be burdensome for issuers. As per its current definition by EU legislators, it is highly theoretical and aspirational, therefore hardly verifiable by auditors, especially looking far in time in 2050. The first elements of definition presented in the November 2021 Parliament[5] version are not mentioned anymore in the last version. It creates uncertainty regarding transition plans requirements. Therefore, it is highly likely that auditors will refrain to express an opinion on such transition plans. This verification is thus uncertain and possibly detrimental in its effects.

The stated intent is to weed out “brown companies” from the green bond market, which is dogmatism at the expense of the climate emergency. It could create “a niche effect” and simply “displace” greenwashing practices to other “unregulated” market pockets.  Indeed, the vagueness regarding these mandatory transition plans makes de facto eligible pure players but not the actors who have to achieve transition. The fact of publishing transition plans is therefore relevant but the lack of clarity regarding these plans and their requirements adds to the confusion, which may dissuade some issuers from using the EU GB standard. In order to detail transition plans and make them more usable, several indicators deserve to be specified: intermediate targets, CapEx, R&D and human resources allocated etc.

III - Taxonomy-alignment of UoP: the Council calls for flexibility pocket

While the European Commission and the Parliament require the Use-of-Proceeds to be 100% aligned with the Taxonomy, the Council proposes to create a flexibility pocket. By way of derogation, up to 20 % of the proceeds of EU-GB may be allocated to economic activities that comply with “Do no significant harm” (DNSH) criteria[6] and minimum social safeguards[7], with the exception of the technical screening criteria (TSC)[8]. This derogation process encompasses both sovereigns and corporates and follow several strict conditions to be authorized: activities must not have any technical screening criteria already into force and the issuer must include a statement in the factsheet explaining how these activities will comply with the Article 3[9] of the Taxonomy Regulation (“internal taxonomy”). This derogation in alignment with the Taxonomy also includes activities in the context of international support[10] at some European countries’ request.

Flexibility pockets are meant to be temporary and limit the effects of the Taxonomy uncomplete scope, but they could in the end further increase the complexity and fragmentation of the market.

For economic activities that are expected to meet the taxonomy requirements (within a 5 to 10-year timeframe), issuers must publish a taxonomy-alignment plan[11]. The taxonomy-alignment plan shall describe the actions and expenditures that are necessary for an economic activity to meet the taxonomy requirements within the specified period of time as set out in a CapEx Plan.

The Parliament has amended these Taxonomy-alignment plans in a relevant way in our view:

• The Commission shall adopt a delegated act listing the economic activities that qualify for the application of the extended period of up to ten years;
• CapEx plans relating to transitional economic activities shall meet the taxonomy requirements within a period of time that does not exceed two years;
• The allocation reports include information on the CapEx plan progress made and shall be externally reviewed. Where annual steps are not achieved twice, the issuer shall publicly disclose that its bond does not comply with the EU GBS anymore.

IV - Last but not least, the grandfathering clause

‘Grandfathering’ is a provision in which an old rule continues to apply to some existing situations while a new rule will apply to all future cases.

In its proposal, the European Commission specified that in the event of a change in the EU Taxonomy Technical Screening Criteria (TSCs) after bond issuance, issuers can make use of pre-existing criteria for five more years. Due to the time constraint, this clause is defined as a “partial" grandfathering.

The Parliament agrees to keep it partial but clarifies that allocated bond proceeds shall not be required to be reallocated following a change to the delegated acts while the Council proposes to fully delete it. We agree with the stance of the Council as a grandfathering clause may create uncertainties for issuers that always risk to undergo change in delegated acts.

The Climate Delegated Act of the Taxonomy is a living document evolving over time reflecting technological progress and aligned with the European decarbonation objectives. Technical screening criteria are dynamic and will be subject to regular review. A partial grandfathering clause of five years may create uncertainties for issuers that always risk undergoing changes in delegated acts.

In a paper published in January 2022[12], the European Parliamentary Research Service (EPRS) recalled that the European Central Bank (ECB), the Federation of European Securities Exchanges (FESE), the European Banking Federation (EBF) and Insurance Europe advocated to be in line with the initial TEG’s recommendation in favour of full grandfathering. It would help to have financial stability and certainty for bond issuers and investors and consequently to facilitate the functioning and growth of the EU-GB market.

V - Trilogue negotiations as a last chance to combine usability and stringency in the EU GBS

Altogether, if adopted, the Parliament’s provisions would very likely lengthen Green Bond Program Structuring, unleash new liability risks around hardly verifiable requirements, and possibly discourage issuers to go to the market or if no auditor approves their transition plan.

The Council’s proposals aim at creating flexibility allowing to ease the Standard adoption by market participants without watering it down too much. The flexibility pocket may require additional work to be defined more specifically to avoid misinterpretation or even misusage, but it would enable activities that are not covered yet to be included.      

Furthermore, several elements need to be clarified such as the timeframe of the standard attribution, in particular aspects related to potential loss of the “EU Green Bond” standard. The alignment with the standard could be certified when the bond is issued but then revised or even withdrawn when assessing/verifying the proceeds allocation. What would be the implication for the bond issuer vis-à-vis its investors? And for the external reviewer regarding issuers and investors? Such a loss of the aligned status could generate less attractiveness for future issuances, the outflow of pure green funds that seek to maximize their ratios and a kind of green downgrade of the issuers for investors. In case of non-respect of rules related to the EU GBS, the Parliament has proposed a possible prohibition of issuing bonds using the EU GB Standard for the natural person or entity responsible for a period of time no exceeding one year.

Ensuing Parliament’s vote on its own version in plenary session, the trilogue negotiations between the Commission, the Council and the European Parliament are expected to begin in June 2022. Once every contentious points previously evoked will be lifted, the co-legislators will deliver the final version of the text for adoption (or not) by the Commission. Depending on the length of this dialogue, EU Green Bond Standard final version might be released by the end of 2022 and the legislative proposal may enter into application in 2023 or 2024.