On 10 May 2023, the Council of the European Union (the "Council") submitted a draft for a European Green Bonds Regulation (the "Draft EuGB Regulation") to the European Parliament for review and approval.
The Draft EuGB Regulation introduces "European Green Bond" or "EuGB", a designation which can be used for unsecured bonds and traditional asset-backed securities on a voluntary basis if certain requirements are satisfied (the latter referred to as "EuGB ABS"). Through this legal framework, the Council aims at increasing market efficiency, decreasing investors' costs regarding the assessment of "green" bonds, and sending a positive signal to institutions which have included green assets in underlying portfolios of traditional securitisations. Furthermore, the Council also intends to promote standardisation and consistency in the use of the "green securitisation" designation.
To prepare originators and arrangers for EuGB ABS transactions, this client alert provides a regulatory overview of requirements applicable to EuGB ABS, recent guidance regarding sustainability disclosure in prospectuses from the European Securities and Markets Authority ("ESMA"), and potential liability risks which originators and arrangers of EuGB ABS should be aware of.
Requirements for EuGB ABS
To use the designation "European Green Bond" or "EuGB", asset-backed securities made available to investors in the European Union need to satisfy certain requirements with respect to the underlying exposures, the use of proceeds and transparency.
Taking into account the lack of available green assets to securitise and the fact that the legal framework for (unsecured) European green bonds has not yet been adopted, the "green true sale securitisation framework" was included as a separate chapter in the Draft EuGB Regulation, rather than in a distinct regulation only providing for green securitisations. Similar to the approach chosen when the framework for simple, transparent, and standardised (STS) securitisations was first established, the legislator has again opted to exclude synthetic securitisations from the scope of regulation as of now. The focus of the legislator on public asset-backed securities also means that other private segments such as ABCP securitisions and private non-ABCP securitisations which do not involve a prospectus are excluded from the EuGB standard.
Underlying exposure requirement
Due to the scarcity of taxonomy-aligned assets fit for securitisation, legislators have acknowledged that requiring all underlying exposures of EuGB ABS to be taxonomy-aligned would cause the EuGB ABS market to face considerable growth constraints.1 However, legislators need to provide safeguards preventing originators from including exposures financing brown industries (e.g. exploration, mining, extraction, production, processing, storage, refining or distribution of fossil fuels) in green securitisations. When regulating such safeguards, legislators must also take into account the predominant purpose of the underlying exposures and not capture exposures where the link with fossil fuel activities is only marginal or incidental.
Hence, the Draft EuGB Regulation provides the following requirements regarding underlying exposures:
Securitised exposures shall not comprise exposures financing the exploration, mining, extraction, production, processing, storage, refining or distribution, including transportation, and trade of fossil fuels.
Securitised exposures financing electricity generation from fossil fuels, co-generation of heat/cool and power from fossil fuels, or production of heat/cool from fossil fuels may be included in the pool of securitised exposure if such economic activity meets the Do No Significant Harm criteria (i.e. one of four conditions which an economic activity must satisfy to be considered as an environmentally sustainable economic activity under Regulation (EU) 2020/852 ("Taxonomy Regulation")2).
Use-of-proceeds requirements
Proceeds that an originator obtains from selling the securitised assets to a securitisation special purpose entity ("SSPE") must be fully allocated to assets and expenditures of environmentally sustainable economic activities.
An environmentally sustainable economic activity is an economic activity:
- Contributing substantially to an environmental objective ("Limb A");
- not significantly harming the environmental objective ("Limb B");
- being carried out in compliance with the minimum safeguards3 ("Limb C"); and
- complying with technical screening criteria established by the European Commission ("Limb D").
Assets and expenditures encompass assets (including fixed assets and financial assets), expenditures (including capital expenditures and operating expenditures), assets and expenditures of households, and/or portfolios of fixed assets and financial assets.
Alternatively, an originator may allocate at least 85% of the proceeds to assets and expenditures of environmentally sustainable economic activities, if the remaining (i.e. up to 15% of the proceeds) are allocated to (i) economic activities satisfying at least Limbs A, B, and C of environmentally sustainable economic activities or (ii) activities in the context of international support.4
The approach to allow for the use-of-proceeds requirement to be satisfied on the level of the originator, rather than on the SSPE level as originally requested, is a positive signal for green securitisations. In particular in the current market circumstances, where sufficient amounts of green assets are often not (yet) available, this approach will set incentives for originators to source green assets in order to benefit from the EuGB designation.
Transparency requirements
Prospectus
The designation "EuGB" shall only be used for asset-backed securities issued within the scope of Regulation (EU) 2017/1129 ("Prospectus Regulation").
In addition to the disclosure requirements under the Prospectus Regulation, the prospectus published in connection with EuGB ABS shall include (i) information on the designation of the asset-backed securities as EuGB ABS issued in accordance with the Draft EuGB Regulation, (ii) information on the originator's compliance with the use-of-proceeds requirements, (iii) information on the green characteristics of the securitised exposures and (iv) a summary of the CapEx plan (in case the proceeds are allocated to expenditures of environmentally sustainable economic activities).5
As further set out in Article 13d of the Draft EuGB Regulation, this information shall be provided on a best efforts basis and to the best of the originator's ability, based on available data in the originator's IT systems, rather than on a strictly mandatory basis.
Mandatory disclosure
In addition to the disclosure requirements under the current legal framework, originators are required to prepare the following documents:
- Pre-issuance: European green bond factsheet and CapEx plan (if applicable), and
- Post issuance: Annual allocation report and impact report.
To provide investors with a cost-effective access to reliable information about EuGB ABS, the Draft EuGB Regulation requires originators to appoint independent external reviewer(s) to review three of the aforementioned documents.
Mandatory pre-issuance review: The European green bond factsheet must be reviewed by an external reviewer regarding compliance with the use-of-proceeds requirements and the template provided in Annex I of the Draft EuGB Regulation. The conclusion of the pre-issuance review with a positive opinion issued by the external reviewer is a condition for the issuance of EuGB ABS.
If the opinion by the external reviewer is positive, the pre-issuance review will include a statement that the asset-backed securities are expected to meet the requirements of the Draft EuGB Regulation in relation to the use of proceeds. If the opinion by the external reviewer is negative, the pre-issuance review will include a statement that the asset-backed securities do not meet the requirements of the Draft EuGB Regulation in relation to the use of proceeds, and that the designation EuGB ABS can only be used if the asset-backed securities are submitted for a new review and obtain a positive opinion.
Mandatory post-issuance review: The CapEx plan (if applicable) and annual allocation reports must be reviewed by external reviewer(s) after the issuance of EuGB ABS. The CapEx plan will be assessed in terms of taxonomy-alignment of expenditures funded by the proceeds. The annual allocation reports will be assessed in terms of compliance with the use-of-proceeds requirements. Similar to the pre-issuance review, the external reviewer will express a positive or negative opinion in the respective mandatory post-issuance review.
Optional post-issuance review: The impact report may be reviewed by external reviewer regarding alignment of the EuGB ABS issuance with the originator's broader environmental strategy and environmental impact of the proceeds. The external reviewer will not express a positive or negative opinion in the impact report review. However, the impact report review will include the external reviewer's opinion on assessment of whether the issuance of the EuGB ABS is in line with the broader environmental strategy and rationale of the originator and assessment of indicated environmental impact of the proceeds. Although an external reviewer's review of the impact report is optional, impact report review may serve as a useful tool to mitigate against threats of greenwashing risk.
Timing and location of publication
Before the issuance of EuGB ABS, the prospectus (as approved by the relevant competent national authority), the European green bond factsheet and pre-issuance review issued by external reviewer, and the CapEx plan (if applicable) must be published on the website of the originator or the SSPE, securitisation repositories, and, after its establishment, the European Single Access Point.6
After the issuance of EuGB ABS, the originator must procure publication of annual allocation reports, the impact report, and post-issuance reviews (including mandatory and optional post-issuance reviews) issued by an external reviewer on the website of the originator or the SSPE, securitisation repositories, and, after its establishment, the European Single Access Point.
All documents in connection with the transparency requirements must remain available to the public until at least 12 months after the maturity of the EuGB ABS. The originator or the SSPE must notify ESMA of publication of these documents within 30 days.
ESMA’s public statement on sustainability disclosure in prospectuses
In addition to the above, the statements, publications and recommendations of European and national competent authorities should be taken into account when drawing up a prospectus, including a prospectus for the issuance of asset-backed securities. In this context, the statement on sustainability disclosure in prospectuses published by ESMA on 11 July 2023 ("ESMA Statement") needs to be taken into account. The ESMA Statement was published with a view to promote a coordinated action by national competent authorities regarding the sustainability-related disclosure.
Amongst others, ESMA recommends that originators provide the basis for any statements concerning their sustainability profile or that of asset-backed securities. To the extent the originator states in a risk factor that its sustainability expectations may differ from those of an investor or that the notion of sustainability may change according to scientific progress, relevant legislation and/or investor preferences, such sustainability-related disclaimers should not be used to excuse non-performance of factors over which the originator exercises control.
The ESMA Statement aims at achieving more consistent market practice across the Europe Union with regard to the sustainability disclosure in prospectuses. Supervisory authorities in Member States may provide further guidelines to implement requirements on sustainability disclosure in prospectus in accordance with the ESMA Statement in the future. The further development and reactions of competent authorities and market standards in this area should be closely observed over the coming months.
Liability of originators and arrangers in connection with EuGB ABS
Deviations of disclosure
If material sustainability-related disclosure is provided in materials other than the prospectus and the European green bond factsheet, e.g. other regulatory documents, voluntary disclosures, and marketing documents, while omitted in the prospectus and the European green bond factsheet, originators and/or arrangers may be held liable for incomplete disclosure. To mitigate this risk, the parties should consider inclusion of all material sustainability-related disclosure provided in such other materials in the prospectus and/or the European green bond factsheet and consistency across all materials.
Material mistakes and inaccuracies in prospectus
If sustainability-related disclosure provided in the prospectus and/or the European green bond factsheet is materially incorrect or inaccurate, the originator, SSPE and/or arranger may be held liable under prospectus liability. To mitigate this risk, the parties should carefully prepare, draft, and review the disclosure set out in the prospectus and the European green bond factsheet. Aspects to consider in this context are, amongst others, the risk that the relevant green securitisation framework might change further, and that certain investors' investment guidelines and criteria might not be satisfied, even if the EuGB ABS are issued in line with the principles set out above.
Greenwashing allegations and reputational risks
In addition, originators and arrangers should critically assess the relevant sustainability-related disclosure with a view to avoiding greenwashing allegations which could, potentially, result in reputational damage if proven correct. Considering the typically longer maturities of asset-backed securities and the presence of replenishment periods, originators and arrangers should carry out such assessment with a prudent and forward-looking perspective as it can be anticipated that the sustainable finance legal frameworks will progress at a fast pace and the public is likely to shift towards stricter environmental, social, and corporate governance standards.
Conclusion
While it is yet unclear how much the EuGB Regulation – once finalised – will facilitate green securitisations and result in an increase in e.g. the sourcing of green assets by originators, it surely can be seen as a positive and crucial step towards functioning and coherent European green securitisation markets. The fact that the use-of-proceeds requirement can be satisfied on an originator level is a step in the right direction. Ultimately, the success of the green securitisation framework will depend on the upcoming level 2 measures as well as, in the longer term, the adoption of the framework also in the context of non-public securitisations.
1 A taxonomy-aligned asset is an asset in connection with an economic activity that satisfies all conditions to be considered as an environmentally sustainable economic activity.
2 See below for a description of the four conditions („Limb A – D") according to Article 3 of Taxonomy Regulation.
3 Article 18(1) of Taxonomy Regulation defines minimum safeguards as procedures implemented by originators to ensure the alignment with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights.
4 With this approach, the legislator provides originators with limited flexibility to allocate a part of the proceeds on (i) economic activities for which there are no technical screening criteria that have entered into force and (ii) activities in the context of international support that contribute to the environmental objectives of the Taxonomy Regulation.
5 A CapEx plan is a plan to expand taxonomy-aligned economic activities or to allow taxonomy-eligible economic activities to become taxonomy-aligned. A CapEx plan is prepared in accordance with Annex I, point 1.1.2.2, point (b), and point 1.1.3.2, point (b), of Commission Delegated Regulation (EU) 2021/2178. A taxonomy-eligible economic activity is an economic activity that satisfies Limb A of criteria applicable to an environmentally sustainable economic activity.
6 The European Single Access Point will be established in accordance with Draft Regulation on establishing a European single access point providing centralised access to publicly available information of relevance to financial services, capital markets, and sustainability.
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