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The Pros and Cons of Taxonomy-aligned Green Bonds

Benedetta Pacifico, Senior Associate, Capital Markets, Sidley Austin, explains the key requirements for issuers under the proposed European Green Bond Standard Regulation.

Following the European Commission’s 2018 action plan on financing sustainable growth and part of the European green deal, in August 2021, the European Parliament and the European Council proposed a regulation for a European Green Bond Standard (the EUGBS Regulation) that lays the foundation for a common framework of rules that issuers, whether within or outside the EU, of bonds (including covered bonds and asset-backed securities) must follow if they wish to use the designation ‘European green bond’. There are four key requirements under the EUGBS Regulation:

Alignment with the Taxonomy Regulation

The most noteworthy innovation of the EUGBS Regulation is the requirement for issuers who want to use the EUGBS label to ensure that all of the proceeds of the bond are allocated to economic activities that either meet the taxonomy requirements* under Regulation (EU) 2020/852 (respectively, the Taxonomy Requirements and the Taxonomy Regulation) or will meet the Taxonomy Requirements within a defined period of time (which, as a general rule, is five years but can be extended up to 10 years if justified and documented), in each case as set out in a taxonomy alignment plan to be produced by the issuer.

Determination of taxonomy alignment for eligible assets and expenditure (other than debt) will be made based on the requirements of the Delegated Acts applicable at the time of issuance of the bond. Somewhat controversially, where relevant Delegated Acts are amended following the issuance of a bond, the issuer will be required to apply the requirements of the amended Delegated Act within five years of its entry into application. This introduces an unhelpful level of potential uncertainty for issuers which might be required to incur additional costs in the event that the requirements change during the life of the bond.

It will be interesting to see how the market reacts in structuring bonds in light of this requirement and whether the ‘loss’ of the EUGBS label due to a change in legislative requirements will trigger early redemptions (optional or mandatory) or events of default.


In common with the ICMA Green Bond Principles (ICMA GBPs), the EUGBS Regulation requires transparency with respect to how the proceeds of issue are allocated through detailed reporting requirements.

The key transparency and reporting requirements consist of (i) a green bond factsheet that an external reviewer is required to confirm is compliant with the EUGBS Regulation; (ii) an annual, publicly disclosed report demonstrating that the proceeds of issue have been allocated in accordance with the EUGBS Regulation; (iii) once all the issue proceeds have been allocated, a post-issuance external review; and (iv) publication of an impact report both after the full allocation of the proceeds of issue and at least once (at any time) during the lifetime of the bond, providing information as to the environmental impact of the use of the proceeds.

External review

The EUGBS Regulation requires that the terms of issue of all EUGBS-labeled bonds are checked by an external reviewer to ensure compliance with the EUGBS Regulation and that funded projects are aligned with the Taxonomy Regulation. There is some limited flexibility for sovereign issuers who may obtain pre- and post-issuance reviews from a state auditor or any other public entity that is mandated by the relevant sovereign to assess alignment with the EUGBS Regulation, to which the conditions applicable to external reviewers under the EUGBS Regulation are not applicable.

External reviewers: Supervision by ESMA and other conditions

The EUGBS Regulation imposes conditions for firms wishing to act as external reviewers of EUGBS-labeled bonds, in particular a requirement to be registered with, and thereafter supervised by, the European Securities Markets Authority, ESMA. The EUGBS Regulation also sets out extensive requirements for external reviewers with regard to qualifications, experience, record keeping, transparency, and management of conflicts of interest.

Conclusions and considerations

Although the EUGBS Regulation shares the ICMA GBPs’ core principles of linking green bond labeling to use of proceeds and placing transparency at the core of eligibility, the EUGBS Regulation takes the regulation of green bonds to another level.
The EUGBS Regulation establishes a meaningful label: While the use of this label is voluntary if an issuer intends to market its bonds as green under the EU framework, issuers who do so will be required to comply with the EUGBS Regulation. This is a fundamentally different approach to the market-led ICMA GBPs that provide a set of principles which are merely voluntary. Additionally, by linking the use of proceeds to the Taxonomy Regulation, there is, for the first time, an attempt to define ‘green’ within the context of bond issuances, with the ICMA GBPs always having left the definition of green to be established by the relevant issuer and the market.

The success of the EUGBS Regulation in facilitating the financing of green assets, and therefore accelerating the transition to a low-carbon economy, will depend on whether in practice the right balance has been struck between having a tool that is sufficiently ambitious to avoid claims of ‘green-washing’ and not imposing additional regulatory burdens to a degree that affects market uptake.

The EUGBS Regulation’s introduction of the transition concept, giving issuers a timeframe for compliance, is helpful. Similarly, alignment with the Taxonomy Regulation is very useful, provided that issuers are accountable in terms of disclosing their progress. Although, given the limited applicability of the Corporate Sustainability Reporting Directive (CSRD), this might be harder to ensure when it comes to public-sector issuers or companies with less than 500 employees to which the CSRD does not apply.

With the EUGBS label dependent on compliance with the Taxonomy Regulation, the initial burden of compliance might negatively impact the take-up of the EUGBS label, but it is hoped that once issuers familiarise themselves with the Taxonomy Requirements and overcome the initial burden of reporting in line with the Taxonomy Regulation, using the EUGBS label will become easier.

However, non-European issuers to whom the Taxonomy Requirements would not otherwise apply might find the burden of compliance imposed by the EUGBS label unappealing when compared to the market-accepted, voluntary ICMA GBPs.

*Namely (1) making a substantial contribution to one or more of the environmental objectives set out in Article 9 of the Taxonomy Regulation, (2) not significantly harming any of those environmental objectives, (3) being carried out in compliance with the minimum safeguards laid down in Article 18 of the Taxonomy Regulation, and (4) complying with the technical screening criteria established by the European Commission in accordance with Articles 10(3), 11(3), 12(2), 13(2), 14(2), and 15(2) of the Taxonomy Regulation (the Delegated Acts).

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