Investor appetite for sustainability linked debt or green bonds remains high as we enter 2023. While there may be concerns about the general health of the global economy, there is no question that this debt class remains popular and continues to gain momentum. However, concerns around “greenwashing” remain prevalent, and both banks and corporates want to ensure that they are not misleading the markets by disseminating disinformation as to the green characteristics linked to their debt offering.
Industry bodies like the International Capital Markets Association (ICMA) provide voluntary criteria for issuers to adhere to in the form of the Green Bond Principles. ICMA last updated their guidance in June 2022, to tighten the standards of what is required for a bond to qualify as “green”, by providing a list of non-binding criteria and expectations. Principally, the proceeds of a green bond should be employed in a “green” project; the application of funds towards those purposes should be managed and controlled; and certain regular reporting obligations should apply.
The revision of the principles in June 2022 allows for “secured green bonds” to be included in the basket of those bonds qualifying as “green”. This could include asset-backed securities, covered bonds or asset-backed commercial paper, illustrating the growth in appetite for green issuances.
The other main market standard is the Climate Bond Standard developed by the Climate Bonds Initiative. The requirements by this industry body are stricter and therefore this standard is used in only about 25% of the world’s green bond issuances. The additional screening criteria includes the requirement of a certificate by an approved external reviewer and reference to a taxonomy which defines green economic activities.
The requirement for external reviews validating the key green characteristics of a bond has grown with the number of green bond issuances. External reviews lend an additional endorsement to the bonds that have applied for them by providing a rating, allowing issuers to feel more comfortable that they have provided all appropriate information to the market. But there remains concern that such ratings provided by external reviewers lack transparency and the number of providers of such ratings invites questioning as to the consistency of the ratings provided.
The European Union (EU) has been considering calls to standardise the criteria applying to green bonds in the form of a green label for those that are satisfying the relevant criteria, and are therefore able to be marketed as environmentally sustainable. The green bond label offers an added degree of integrity and trust to the market and encourage easier access to the market for all parties, whether they are investors, companies or members of the public.
In the EU, requirements for green bonds, first published in July 2021, would include transparency criteria, namely (i) alignment with the EU’s taxonomy legislation on the use of green bond proceeds, (ii) demonstration that green bond issuers have safeguards in place to protect people and the planet, i.e. that they will “do no significant harm”, and (iii) having verified transition plans in place to mitigate and limit the adverse effects of an issuer’s activity.
In May 2022, the Committee on Economic and Monetary Affairs (ECON) published a report with recommendations for the EU Green label, to strengthen the applicability of the EU Green label requirements. For instance, they recommend the label apply to all issuers of green bonds. They also recommend that a factsheet for green issuers setting out funding goals and environmental objectives be fully integrated and a legal part of any prospectus.
EU countries are still negotiating the text for these regulations ahead of a uniform green bond label standard being applied throughout the EU.
Perhaps unsurprisingly, there has been some criticism of the regulatory proposals, as it will create further regulatory compliance hurdles. ICMA published concerns that a mandatory label could result in uncertainty in the market where the label is linked to the EU taxonomy, which is itself an evolving set of criteria. In addition, the intention to have gas and nuclear excluded from the green label, in accordance with the green taxonomy, is a subject that still inspires debate across the continent. The additional level of compliance could also increase costs for issuers, who may not necessarily need the green label to attract funds to the traditional bond markets, especially if they have strong business fundamentals for a bond issuance.
While the green label is seen as a compliance hurdle and only benefits those investors seeking to protect themselves from greenwashing, it won’t be a success. However, if it helps streamline investment into companies with green projects, then it should help continue the rapid growth in the green bond market with a view to achieving the targets set out in the Paris Agreement.
About the Author
Victoria Judd is Counsel at Pillsbury Winthrop Shaw Pittman LLP.
