European Green Bonds and Sustainability Derivatives – A Brief Update – Finance and Banking
European Union: European Green Bonds and Sustainability Derivatives – A Brief Update
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Environmental, social and governance (ESG) factors continue to play an increasingly important role in capital markets and have an impact on a range of financial instruments and products. We have already written about green and sustainability instruments and how various stakeholders are shaping the evolution of these products. We have also followed the efforts of the International Swaps and Derivatives Association (ISDA) to develop standards and best practices for financial instruments that integrate or take into account ESG factors. In the first case, for investors who focus on ‘green’ instruments, it may be difficult to determine which activities can be considered truly green if there is no definition or standard benchmark, which has caused some uncertainty within the market. Likewise, ISDA’s work has focused on developing key performance indicators (KPIs) for use in ESG-related financial transactions.
In an effort to set a standard for how investors can determine what is green, and in turn helping companies (or government agencies) issuing green bonds raise capital — taking into account both sustainability and the risk of greenwashing — the European Commission has adopted a proposal for a regulation1 on European bonds, with a view to creating the “European Green Bond Standard”. In short, the proposal establishes a framework for obligations to finance ecologically sustainable activities within the meaning of the taxonomic regulation of the European Union. Before issuing the bonds, issuers will have to publish an externally revised “Green Bond Fact Sheet”, setting out funding and environmental objectives; and after issuance of the bonds, issuers will be required to publish annual reports demonstrating how they allocate the proceeds of the bonds to economic activities that meet sustainability standards under the EU taxonomic regulation. Once adopted, the regulation is expected to set a new standard intended to provide the assurance of a durable and high-quality instrument on which investors can rely and that companies, public authorities and issuers (including those located in outside the EU) can use to increase funds.
As we have written previously, in the context of the European Green Deal and associated sustainable finance initiatives, financial market participants have identified opportunities to integrate ESG measures into the documentation of various financial instruments. In response, ISDA recently published two white papers. The first document focuses on derivatives related to sustainability and provides guidance to end users for writing key performance indicators, which ISDA says are “fundamental to the efficiency and credibility of these transactions.” . The second article covers a series of issues that currently complicate the accounting treatment of these financial products, noting that a “lack of observable data means that ESG characteristics are currently difficult to assess, resulting in information unlikely to be useful. to the readers”.
As with many issues related to the evolving intersection of ESG and financial transactions, stakeholders are looking for reliable and comparable data to support the transactions themselves and any disclosure or other reporting that may accompany those transactions now or in the future. ‘to come up. As a result, ISDA stresses the importance of writing KPIs that can be “objectively verified” and have “legal certainty”. ISDA notes that to date, KPIs have generally been tailored to the specific needs of counterparties and have been designed to encourage or discourage certain behaviors (e.g. reduce emissions) or to monitor alignment with ESG principles of more generally. ISDA fully expects counterparties to develop new areas of interest as these products continue to develop and their use expands. ISDA closes the document by identifying five “general principles” for KPIs: specificity; ability to measure; objectively verifiable; transparency; and adequacy. To address the accounting complexities of these instruments, the second paper focuses on alternative accounting approaches (for example, the International Financial Reporting Standards 9 model) that may provide readers with more useful information.
1 The European standard on green bonds “is a voluntary standard to help increase and increase the environmental ambitions of the green bond market”. The proposal aims to establish a “gold standard” for sustainable finance. It is hoped that the proposal, made up of four key principles (taxonomic alignment, transparency, external review and supervision of the European Securities and Markets Authority) “will be useful to both issuers and investors of green bonds. For example, issuers will have a strong tool to demonstrate that they are funding legitimate green projects aligned with EU taxonomy. “
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