The recent updates to the GBPs do not revolutionize the key concepts underlying the GBPs; rather they reflect recent market and regulatory developments. In the GBPs, ICMA strikes a balance between streamlining market practice in a set of defined guidelines and framing developing practice into an industry-wide standard for green bond disclosure.
The four key GBPs – (i) use of proceeds, (ii) process for project evaluation and selection, (iii) management of proceeds, and (iv) reporting – remain substantively unchanged, but they have been expanded by additional, detailed guidance. Transparency has always been the underlining objective of the GBPs, and this has been enhanced with the introduction of two new recommendations: Green Bond Frameworks and the use of an external reviewer to assess the alignment of green bonds with the GBPs.
1. Use of Proceeds
The cornerstone of green bonds is that the proceeds of issue are used to finance or refinance eligible green projects. The GBPs have been updated to better align them to market practice and now expressly contemplate that the use of proceeds may be used to refinance existing green assets. The GBPs now recommend that where all or part of the proceeds of issue are or may be used to refinance eligible green projects, issue documentation should include an estimate of the proportionate allocation of the use of proceeds between refinancing eligible projects and financing new eligible projects. In addition, disclosure should be provided as to which particular investments or projects may be refinanced and the expected look back period for refinanced eligible green projects. The fact that green bonds have been used to refinance existing eligible green assets, rather than to only finance new eligible green assets has been the subject of some debate around the effective impact of green bonds in financing environmental sustainability. Although the GBPs stop short of imposing any threshold for how much of the proceeds of a green bond can be used to refinance existing projects, the additional guidance is a step forward to increased transparency and helping investors to assess investments.
The GBPs expressly identify five broad environmental objectives (climate change mitigation; climate change adaptation; natural resource conservation; biodiversity conservation; and pollution prevention and control) and several broad categories of eligible green projects that contribute to such environmental objectives, listing the most commonly used types of projects. In a new development, the updated GBPs provide more detail about the uses of proceeds that can be considered of environmental benefit, expanding on what these might include, and placing them within the context of the five broad environmental objectives. This reflects market developments over recent years with the expansion of categories of eligible green assets.
The new use of proceeds categories are
- pollution prevention and control
- environmentally sustainable management of living natural resource and land uses
- climate change adaptation
- circular economy adapted products
- production technologies and processes
- certified eco-efficient products and green buildings.
2. Process for Project Evaluation and Selection
That issuers of green bonds should disclose their decision-making processes for determining the eligibility of proposed uses of proceeds and how the proposed investments fit within the definition of eligible green projects is not a new development under the GBPs. However, the new GBPs are clearer and more prescriptive than previously, providing for issuers to clearly communicate to investors the following information: (i) the applicable environmental sustainability objectives of the relevant eligible green projects; (ii) the process by which the issuer has determined how those projects fit within the eligibility criteria identified in the GBPs; and (iii) complementary information on the processes by which the issuer identifies and manages social and environmental risks associated with the relevant project.
Consistent with the idea that if capital markets are to play a role in the transition to a sustainable economy, green bonds should be issued within the context of broader environmental objectives, then GBPs also encourage issuers to place the above information within the context of the broader sustainability strategy.
In addition, and reflecting the recent development of other industry-wide taxonomies and green standards, the GBPs also now encourage issuers to advise investors as to how the selected eligible projects align with such taxonomies and green standards. They also encourage issuers to establish processes by which they mitigate known material risks of negative social and/or environmental effects from the relevant projects, which to a degree reflects the principle of “do no significant harm” in the EU Taxonomy.1
3. Management of Proceeds
The GBPs provide that the net issue proceeds of green bonds should be “ring fenced” so that they can be tracked by the issuer and that the application of such monies can be monitored and certified in a formal internal process linked to the relevant issuer’s investments in eligible green projects. Furthermore, for as long as a green bond is outstanding, the balance of the tracked net proceeds should be adjusted periodically to reflect the allocation to eligible green projects for a specific period. Under the new GBPs, the previous recommendation that the intended uses for unallocated proceeds of issue be disclosed has been strengthened into a mandatory requirement. In addition, the former position in the GBPs that merely indicated that an external auditor verifying the issuer’s internal tracking method for the flow of funds would enhance the environmental integrity of the green bond has been strengthened into a recommendation that an external auditor be appointed to verify the issuer’s method of tracking the use of green bond proceeds.
Transparency is at the core of the GBPs, being expressed to be “of particular value.” Accordingly, it is no surprise that the principle that issuers should regularly report on the use of proceeds has been expanded. Issuers should make and keep up-to-date information on the use of proceeds, to be reviewed annually until full allocation and in a timely manner in the event of material developments. The GBPs now also provide that the annual report should include a list of the green projects to which proceeds have been allocated as well as a description of those projects and the amounts allocated and their expected impact. A further new development is the requirement for the inclusion of a summary reflecting the characteristics of the relevant green bond and illustrating how it aligns with the four principal components of the GBPs.
As anticipated, the GBPs also include two new, additional recommendations focused on heightened transparency.
Green Bond Frameworks
Issuers should explain the alignment of their green bonds/green bond programs with the four key GBPs in a Green Bond Framework that is made readily available to investors and places said required information in the context of an overarching sustainability strategy. Green Bond Frameworks are increasingly popular with green bond issuers.
The original GBPs included a dedicated section summarizing the various types of independent assurance. The new GBPs take a step forward, specifically recommending that issuers appoint an external reviewer to assess (pre-issuance) the genuine alignment of a purported green bond with the four key principles. This should be seen in conjunction with the recommendation (in relation to the third principle – management of proceeds) to appoint an external auditor to verify the issuer’s methodology for tracking the use proceeds. Much like Green Bond Frameworks, external reviews are increasingly prevalent in green bond transactions. External reviewers are encouraged to publicly disclose their credentials and the scope of the review conducted.
The revised GBPs helpfully reflect recent developments in market practice and place transparency through disclosure at their heart. They clearly address the concern that green bonds should not be instruments issued in isolation but should be issued within the context of an issuer’s overarching environmental objectives, a concern that is increasingly important to market participants given the risk of green washing. Effective disclosure, combined with external independent reviews and a focused definition of what constitutes “green,” should help to combat green washing, all of which will help to build the confidence investors need to finance a more sustainable economy.
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