Green Bond Principles and the EU framework for green finance
by Stefano Padovani
The Agreement signed by 195 countries in December 2015 at the Paris Climate Conference (COP21) aims to promote private investments in the “green economy“. The Paris Agreement aims to “strengthen the global response to the threat of climate change” among others “by making financial flows consistent with a pathway towards low greenhouse gas emissions and climate resilient development“.
It is foreseen that the private sector will have a key role to play. The proposal for a European Green Deal adopted by the European Commission on 11 December 2019 recognizes that “the private sector will be key to financing the green transition” and that “long-term signals are needed to direct financial and capital flows towards green investment and avoid stranded assets“.
As Green finance is becoming more and more central in finance we need a clear definition of what it means.
Generally speaking, the terms “green loans” and “green bonds” refer to loan and capital market instruments issued to finance projects with a positive impact on the environment (green projects).
It is worth noting that Italian, European and international law does not give us a uniform and binding definition of green loans and green bonds. The initiatives promoted by public or private bodies in this sector have produced mere “recommendations” and “guidelines” to be adopted on a voluntary basis: Green Bond Principles (or “GBPs”), developed by the International Capital Market Association (or “ICMA”), are certainly the most important voluntary process guidelines related to the issuance of green bonds.
The European Union is in the process of establishing a framework for green finance. The first step towards this goal was made in March 2018, when the European Commission adopted a comprehensive plan to promote sustainable finance (Action Plan on sustainable finance) and set up the Technical Expert Group on Sustainable Finance (“TEG“), which developed a first draft of the EU Green Bond Standard. In addition, by the end of 2020 the “Taxonomy Regulation” (proposal COM/2018/353 final) should enter into force, setting-up a binding and unified classification system for sustainable activities, and enabling the development of future Union policies in support of sustainable finance.
National legislators are moving fast in this direction too. As regards Italy, on 2 April 2020 the Italian Government set up a “Working Group on Sustainable Finance” with the aim of developing both a credit network for green SMEs and a rating system for the evaluation of green investments. The first proposals of the Working Group are expected by 30 June 2020.
Green Bond Principles
As of today, GBPs remain voluntary process guidelines for the issuance of Green Bonds.
According to GBPs, Green Bonds are any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance, in part or in whole, new and/or existing eligible Green Projects and which are aligned with the four core components of GBPs, namely:
- Use of Proceeds;
- Process for Project Evaluation and Selection;
- Management of Proceeds; and
Use of Proceeds. The proceeds of the bond must be invested in Green Projects that pursue one of the five environmental objectives set forth in the Green Bond Principles, namely:
- climate change mitigation;
- climate change adaptation;
- natural resource conservation;
- biodiversity conservation; and
- pollution prevention and control.
An illustrative and non-exhaustive list of Green Project categories is provided by the GBPs, specifying that Green Projects may also include related and supporting expenditures, such as R&D. However, a detailed assessment of the technical characteristics of sustainable activities is left open by the GBPs so reference is made to taxonomies developed by other recognized international organizations acting in the green finance sector (such as the European Investment Bank, the Climate Bond Initiative and TEG).
Process for Project Evaluation and Selection. Issuers must disclose to potential bondholders which criteria have been applied so as to qualify their projects as “green”. External auditors can provide support in assessing the environmental sustainability of the project, although their involvement is not mandatory. A review by an external auditor is nevertheless encouraged by ICMA and expressly required for listing on some stock exchanges, including the Italian Stock Exchange.
Management of Proceeds. Green Bond issuers must implement adequate internal processes (including one or more dedicated accounts) in order to track the proceeds. Tracking is also necessary for Reporting, which requires issuers to maintain, and promptly make available to bondholders – whenever necessary and in any case on a yearly-basis, updated information on the use of the proceeds.
The Taxonomy Regulation
The Taxonomy Regulation establishes a legal framework for a harmonized and unified classification system for sustainable activities in the EU. An economic activity shall be considered environmentally sustainable when it complies with the following four criteria (Article 3):
Substantially contribute criterion. Economic activities must substantially contribute to one or more of the environmental objectives set out in Article 5 of the Regulation, namely:
- climate change mitigation;
- climate change adaptation;
- sustainable use and protection of water and marine resources;
- transition to a circular economy
- pollution prevention and control;
- protection and restoration of biodiversity and ecosystems.
Sustainable activities are those that directly contribute to one of these objectives. However, the Regulation also takes into account activities that directly enable other economic activities to substantially contribute to one or more of these objectives (so called “enabling activities”) and the “transitional activities“, i.e. economic activities for which there is no technologically and economically feasible low carbon alternative, but for which measures can be taken to support the transition to a climate-neutral economy.
No significant harm criterion. Economic activities must be carried out in a way that do not significantly harm (Article 12) any environmental objectives (climate-neutral activities). Such criterion may be relevant when it comes to activities which produce negative externalities, such as nuclear energy.
Minimum safeguard criterion. Economic activities must be carried out in compliance with certain minimum standards provided in the Regulation (Article 13) for the safeguard of human rights and workers’ rights.
Technical screening criterion. The Commission must develop technical standards to be complied with in order to achieve one or more of the environmental objectives, through consultation of a Platform involving a wide range of stakeholders (Article 14). These standards are expected to be regularly reviewed by the Commission, thus requiring investors and issuers to be constantly updated.
The Regulation also defines its scope of application. Indeed, Regulation shall apply to:
- financial market participants making available financial products, as defined in Regulation (EU) 2019/2088 (Disclosure Regulation). Information about the sustainability of the investment relating to the product offered shall be provided in pre-contractual information and periodic reports;
- undertakings subject to the 2014/95/EU (Non-financial reporting Directive) must provide additional information about the sustainability of their activities; and
- measures adopted by Member States or by the Union setting out any requirements on financial market participants or issuers in respect of financial products or corporate bonds that are made available as environmentally sustainable.
EU Green Bond Standard
In line with the approach outlined in the Action Plan on sustainable finance, TEG has drawn up a European standard for the issuance of European Green Bonds (the European Green bond Standard or “EU GBS“).
The EU GBS defines the EU Green Bond as any type of bond instrument meeting the following requirements:
- the issuer shall provide the “EU Green Bond Framework”, i.e. a document through which, among others, the issuer confirms the adoption of, and the compliance with, the EU GBS (also with the support of an accredited verifier) and describes the EU Green Project as well as the environmental objectives to be achieved through the investment;
- proceeds shall be used exclusively to finance or refinance, in whole or in part, new and/or existing “EU” Green Projects; and
- The alignment of the bond with the EU GBS shall be assessed by an accredited verifier appointed by the issuer.
EU Green Project. The key difference between the GBPs and the EU GBS lies in the notion of a Green Project. While GBPs do not require the issuer to use a specific taxonomy to assess the sustainability of its project, the EU GBS requires the issuer to use only the criteria set forth in the Taxonomy Regulation. Consequently, EU Green Bonds can be defined as those bonds the proceeds of which are used to finance or refinance, in whole or in part, new or existing “EU” Green Projects, meaning projects which can be deemed to be green under the Taxonomy Regulation.
Framework and Reports. A further difference concerns the documents to be provided to bondholders by the issuer. The issuer, before or at the time of the issuance, must make available to the investors the Green Bond Framework.
The Issuer must also make available the Allocation Report (which includes a breakdown of the amounts allocated to Green Projects) and the Impact Report (which includes information on the environmental impact of the project).
Accredited verifier. The third difference between GBPs and EU GBS is the mandatory appointment of an accredited verifier: the issuer must appoint an accredited verifier to confirm the alignment of the Green Bond Framework with the EU GBS, and provide a Verification of the Final Allocation Report (which shall be published by the issuer upon full allocation of the proceeds).
When can an EU Green Bond be issued?
As the EU GBS requires the issuer to assess the sustainability of its EU Green Project in accordance with the Taxonomy Regulation, EU Green Bond can be issued only when (i) the Taxonomy Regulation has been entered into force; (ii) the Commission has decided to adopt the EU GBS; and (iii) the Commission has established a method – even temporary – for the accreditation of verifiers.
As of April 2020, the European Council and Parliament have only reached a political agreement on the Taxonomy Regulation: it can only enter into force after completion of the entire European legislative process. Progress is being made. On 15 April 2020 the European Council approved its first reading of the Taxonomy Regulation.
Once finally adopted, the Commission will decide whether to adopt the EU GBS, and how to establish an accreditation process for verifiers. The Commission will decide also whether the EU GBS shall apply on a voluntary or mandatory basis.
After entry into force of the Taxonomy Regulation the Commission will adopt delegated acts in order to develop the technical aspects (such as the technical screening criteria) of the new law. As a result, the Regulation will only apply de facto after the implementation of the delegated acts (from 31 December 2021 or 31 December 2022, depending on the environmental objective referred to).
According to the TEG, once the Taxonomy Regulation has been entered into force, and the Commission has both defined an accreditation method for external auditors and adopted the EU GBS, it will be possible to issue “European Green Bonds” in accordance with general principles set out in the Taxonomy Regulation.
This means that EU Green Bonds may be issued even before the adoption of the delegated acts by the Commission. The TEG acknowledges that the criteria used by issuers at this stage may not be aligned with the technical screening criteria which will be further adopted by the Commission. However, if the issuer has acted with adequate transparency and justification as to the Green Project, and the issuance has been supported by the assessment of an accredited verifier, the bond can still be deemed to be EU GBS aligned.
The content of this article has only informative value and does not constitute a professional opinion. For further information contact Stefano Padovani.
This article first appeared on the website of the Banking Law Committee of the Legal Practice Division of the International Bar Association, and is reproduced by kind permission of the International Bar Association, London, UK. © International Bar Association.
 Article 2, paragraph 1
 As regards Green Loan, The Loan Market Association has published the Green Loan Principles, whose provisions are similar to the provision of the GBP.
 TEG suggests to keep it voluntary.