EU Green Bond Standard Regulation.
Where does it leave green securitisation?
The final agreed text of the proposed EU Green Bond Standard Regulation has been published. (You may find it here). What does it hold for securitisation?
The EU GBS
The EU GBS is a proposed green designation for bonds. It is voluntary. The regulation contains no prohibition on marketing as “green” or “sustainable” a bond which does not meet the requirements of the EU GBS and so far, no such prohibition is being proposed. The EU GBS is a designation that can but need not be chosen by an issuer seeking to tap the market for green investments.
Secondly, and differently from the STS standard for example, the use of the EU GBS designation is not limited to EU issuance. UK, US, Australian, Chinese bonds, etc,,, can be marketed in the EU with a EU GBS label.
Skipping over the details – and, as with all things green in the EU, there are many, many details – the essence of the EU GBS is two-fold: first, use of proceeds and secondly, external independent verification.
To meet the EU GBS standard, the proceeds of the bond must be used for green purposes. “Green purposes” are basically defined as those complying with the EU Taxonomy.
Also, to meet the EU GBS standard, the terms under which the proceeds will be used for taxonomy compliant purposes must be the subject of a verification by a new type of regulated verification agent. The EU GBS text contains extensive rules for the regulation of these agents by the European Securities and Markets Authority (ESMA).
What about securitisation?
First, securitisation is not only mentioned in the final text but has fairly extensive and specific rules attached to it. This means that there can be no doubt that a securitisation can be awarded EU GBS designation.
Secondly, the big question regarding securitisations under the EU GBS has been answered definitively. Should an EU green securitisation be a securitisation of green assets or a securitisation whose proceeds go to fund green purposes? PCS has written about this extensively and, for reasons this is not the place to rehearse, emphatically supported the latter approach. We are therefore happy to report that the EU GBS final text now makes it clear that a securitisation will be eligible for EU GBS status based on the use made by the originator of the proceeds generated by the securitisation irrespective of the "greeness" of the assets. This aligns the securitisation rules with those for all other bonds thus maintaining a level playing field.
Thirdly, and somewhat unfortunately, the co-legislators have seen fit to add specific and additional burdens on securitisations seeking to be EU GBS compliant. First, a limited set of financial assets connected to fossil fuels cannot be securitised under the EU GBS banner. (The list is in article 13(c)). Secondly, notwithstanding that the “greenness” of a securitisation is based on the use of its proceeds, the co-legislators have mandated additional disclosure as to the sustainability of the securitised assets, to the extent that the originator has this information.
PCS is opposed in principle to such additional rules falling solely on securitisations as, in our opinion, they unfairly tilt the playing field. In practice though, we suspect that they will not be a material impediment to the growth of an EU GBS securitisation market since (a) there are very few, in any, securitisations of fossil fuel receivables and (b) disclosure is only required in cases where the originator actually has the information.
In a provision that is bound to disappoint some market participants though, synthetic securitisations are explicitly prohibited from achieving the EU GBS designation.
So what next?
Now that the text has been agreed by the Parliament and Council, it will proceed to a vote. Although nothing is impossible, it is exceedingly unlikely that this will not pass on the text that has been published. This should occur sometime in the next few weeks. So, the EU GBS will come into force, in all likelihood, around mid-2023. But it will not be applicable, and so EU GBS bonds could not be issued, until 12 months later – by mid-2024.
However, we note that EU GBS bonds cannot be issued unless they are verified by an ESMA authorised verification agent. But the text provides ESMA with 24 months to come up with drafts of key provisions without which it is not possible to authorise green verification agents. Providing an additional 3 months from ESMA’s presentation of these drafts to the draft becoming a level 2 law, then time for aspiring verification agents to digest the requirements and apply – at the very least, another 3 months – and we could easily not see a fully authorised verification agent for 30 months. The rules do allow aspiring verification agents to operate without ESMA authorisation for 18 months from the EU GBS regulation becoming applicable (ie 12 months after coming into force). But they must do this on a "best efforts" basis of complying with the law. Whether they are volunteers for this somewhat nebulous obligation and liability remains unanswered.
So, unless ESMA accelerates their drafting, we could possibly wait until early-to-mid 2026 for the first EU GBS.
Finally, some question marks hang over the whole endeavour: meeting the EU GBS standard is onerous. It requires amongst other things, wading through the complexities of the taxonomy, getting a verification, reporting via mandatory templates and becoming liable to sanctions. But it is currently a voluntary standard. Will issuers seek it or will they market green bonds on other standards already accepted by investors? Will investors insist on this standard and the EU taxonomy, or elect to craft their own? Will there be volunteers to become verification agents?
This, in turn, leads one to ask how long the EU institutions will leave the EU GBS as a truly voluntary standard?
For securitisation (excepting synthetics), although the EU GBS final text is not perfect, it is as good as could be hoped for. It provides a broadly level playing field that should allow securitisations to find their place in the ecology of EU GBS issuance and fully play their role in financing the transition of the European economy to a sustainable structure.
For green issuance though, there is very little visibility both as to timing and the shape of the EU GBS path forward.