1. Introduction
On March 1, 2023, the Council of the European Union and the European Parliament announced a provisional agreement on the EU green bond standard ("EU GBS") proposed by the European Commission. The content of the EU GBS is much more stringent than the Green Bond Principles ("ICMA GBP") [1] of the International Capital Markets Association ("ICMA") and the Green Bond Guidelines ("J-GBG") [2] of the Japanese Ministry of the Environment. Looking ahead, the EU GBS may indicate the standard rules for green bonds and, further, the overall direction of sustainable finance regulation.
Considering its profound implications, we look at how the provisional EU GBS differs from the ICMA GBP and J-GBG, which are currently used by many Japanese companies, and what impact the legislation of EU GBS may have on Japanese companies that are involved in or will be involved in sustainable finance, such as green bonds and green loans.
In this paper, I first present an overview of the ICMA GBP and compare it with the characteristics of the J-GBG, which was created based on the former. We explain the differences between these guidelines and the rules set forth in the provisionally agreed EU GBS and, finally, discuss its impact on sustainable financing by Japanese companies.
It should be noted that since the detailed content of the provisionally agreed EU GBS has not yet been disclosed, it is impossible to conduct a detailed and comprehensive analysis at this point, and the discussion will be limited to an analysis of future direction.
2. ICMA GBP
(1) Background
The J-GBG was developed by the Japanese Ministry of the Environment in accordance with the ICMA GBP, from the viewpoint of uniformity of global standards. It is common practice for Japanese companies to issue green bonds with considering their compatibility with both the ICMA GBP and J-GBG.
(2) Contents
First, below is an overview of the ICMA GBP.
i. Non-binding
The ICMA GBP is not legally binding and, thus, even if violated by an issuance, does not entail legal consequences. In other words, no default or penalty can occur.
ii. Components
Overall, the ICMA GBP consists of four components: ① Use of Proceeds; ② Process for Project Evaluation and Selection; ③ Management of Proceeds; and ④ Reporting. The details are as follows.
①Use of Proceeds
The ten eligible green projects categories are "Renewable Energy," "Energy Efficiency," "Pollution Prevention and Control," "Environmentally Sustainable Management of Living Natural Resources and Land Use," "Terrestrial and Aquatic Biodiversity," "Clean Transportation," "Sustainable Water and Wastewater Management," " Climate Change Adaptation," "Eco-efficient or Circular-economy-adapted Products, Production Technologies, and Processes," and "Green Building" [3].
Currently, "taxonomies,” which refer to classification systems applicable to "environmentally sustainable economic activities," are being discussed with the aim of preventing greenwashing. Such systems are recommended as further guides [4].
②Process for Project Evaluation and Selection
Issuers should clearly communicate the following matters to investors:
- The environmental sustainability objectives of the eligible project;
- The process by which the issuer determines whether a project is eligible; and
- The criteria by which the issuer determines the soundness of the eligible project.
Issuers are encouraged to explain the above information, in the context of their overarching environmental sustainability objectives, strategies, and policies, to investors.
Issuers are also encouraged to provide investors with information on the alignment of the project with official or market-based taxonomies and related eligibility criteria, and to disclose the green standards or certificates referenced in the selection process of the project.
③Management of Proceeds
Issuers should track and manage all the proceeds using an appropriate method.
Such tracking and management methods should be made known to investors in advance.
④Reporting
Issuers should disclose information on the proceeds annually after issuance or in case of material developments. Such information should include a list of projects to which the proceeds have been appropriated, a summary for each project, the amount of proceeds allocated, and the expected impact.
iii. Obtaining External Reviews
Obtaining external reviews is encouraged but not obligatory.
Depending on the type of an external review body, it should assess: ① the positive environmental impact of a project for which proceeds were allocated; ② the conformity to the four components; and ③ the potential significant environmental risks.
In June 2022, guidelines on external reviews and recommendations were added [5].
(3) Summary
As described above, all four components of the ICMA GBP are recommendations, and they are intended to expand the green bond market while respecting the degree of freedom enjoyed in green bond issuance. The use of taxonomies is also only a recommendation.
3. Japanese Ministry of the Environment's Green Bond Guidelines (J-GBG)
(1) Basic Concept
The basic content of the J-GBG is the same as that of the ICMA.
The J-GBG was formulated in 2017, under the leadership of the Ministry of the Environment, in keeping with the global development of the green bond market. Thereafter, the Ministry of the Environment, in 2020, revised the J-GBG to align with the ICMA GBP developed by the ICMA in 2018, and in July 2022, again revised the J-GBG to align with the updated version of the ICMA GBP and its appendices and the pre-issuance checklist [6].
In other words, the J-GBG was created in alignment with the ICMA GBP, the fundamentals of which are almost the same as those of the former, and details accounting for the current situation and development of the Japanese green bond market have been added [7].
(2) Content
The general information on the J-GBG is as follows
i. Non-binding
The J-GBG, like the ICMA GBP, is not legally binding. In this regard, the J-GBG clearly stipulates that "even if an action does not comply with the matters stated in this guideline (including items described with the word “should”), no legal or regulatory penalties will be imposed. (However, it is necessary to bear in mind that when an action infringes upon any other laws or regulations, it may be punishable pursuant to such laws and regulations)" [8].
ii. Components
The J-GBG consists of four components, as is the case for the ICMA GBP. The general framework of the four components has been described in the ICMA GBP section above, and the following is devoted to describing some of the distinctive guidelines added to the J-GBG.
①Use of Proceeds
In cases where a project has an incidental negative effect on the environment or society, regardless of its organic environmental benefits, the issuer should communicate the evaluation of the negative effect and possible countermeasures so that investors and other market participants can properly evaluate the impact [9].
②Process for Project Evaluation and Selection
Issuers should disclose relevant information and the environmental standards or certifications referenced (e.g., taxonomy or other environmental standards or certifications) when establishing criteria for preventing potential negative environmental or societal impact that the project may cause [10].
③Management of Proceeds
External auditors or third-party organizations should complement the issuer to verify the internal tracking method, appropriation of proceeds procured through green bonds, and the management of such proceeds [11].
④Reporting
The following items should be disclosed: [12]
- A list of green projects to which proceeds have been allocated;
- A description for each Green Project (including progress);
- The amount of funds allocated to each Green Project;
- The expected environmental benefits of each Green Project; and
- If there are proceeds yet to be allocated, the amount or percentage thereof, the expected timing of appropriation, and the usage during the unappropriated period.
iii. Obtaining External Reviews
In addition to obtaining external reviews, it is also recommended that issuers engage external auditors and other third-party organizations to verify the internal tracking and appropriation of funds from proceeds to green projects after the issuance of green bonds [13].
(3) Summary
As described above, the J-GBG is highly similar to the ICMA GBP in terms of its broader framework. It provides information particular to Japan and serves as easily comprehensible guidance for practitioners.
4. Regarding the EU Green Bond Standard (EU GBS)
(1) Background
So what are the differences between the EU GBS, ICMA GBP, and J-GBG?
The EU GBS was first announced by the European Commission in July 2021 as a regulatory proposal to set the standards for "EU green bonds" (EuGB), in response to technical expert groups’ reports, public comments, consultations, etc.
At that time, the issuance of green bonds was based on private industry standards, and the risk of greenwashing came under the spotlight, with reference being made to the lack of sufficient standardization and a common definition of eligible projects. As a result, the European Commission, with the goal of boosting investor confidence in green bonds, proposed to set legal rules, namely the EU GBS.
As stated at the beginning, the specific content of the provisional agreement reached in March 2023 has yet to be disclosed, so we will conduct an analysis based on the EU GBS released in July 2021.
(2) Content
The general information on the EU GBS is as follows [14].
i. Legally Binding
The EU GBS is legally binding. However, the use of it is “voluntary,” and the standard is only applicable to European green bonds or green bonds issued as EuGB (Article 1 and Article 3 of EU GBS). It should be noted that the issuance of green bonds that do not meet the EU GBS is not impermissible.
The EU GBS is scheduled to start applying 12 months after its entry into force [15].
ii. Components
The EU GBS comprises a total of 64 articles and is not defined in a form similar to the four elements of the ICMA GBS.
However, for the purpose of comparison, we will now use the four elements of the ICMA GBP to examine the major differences between the ICMA GBP and the EU GBS.
①Use of Proceeds
To be eligible under the EU GBS, projects need to comply with the EU Taxonomy Regulation [16] (Article 6 of EU GBS).
The EU Taxonomy Regulation stipulates six environmental objectives: "Climate Change Mitigation," "Climate Change Adaptation," "Sustainable Use and Protection of Water and Marine Resources," "Transition to a Circular Economy," "Pollution Prevention and Control," and "Protection and Restoration of Biodiversity and Ecosystems" [17].
To qualify as environmentally sustainable, an economic activity must meet the following requirements (hereinafter referred to as "Sustainable Requirements") [18]:
a) Contributing to one or more of the six environmental objectives
b) Causing no serious harm to any of the other five environmental objectives (DNSH [19])
c) Complying with minimum safeguards (OECD Guidelines for Multinational Enterprises, Guiding Principles on Business and Human Rights, etc.)
d) Complying with the technical screening criteria (TSC)
The TSC mentioned above is to be defined by a complementary delegated act, and a "Technical Expert Group on Sustainable Finance" (TEG) has been established to make such determination. Among the six environmental objectives, the TEG has already developed a delegated act, approved by the European Commission, as the TSC for "Climate Change Mitigation" and "Climate Change Adaptation."
However, TSC for the other four environmental objectives are yet to be established. Because of this incomplete scope, the provisional agreement reached on March 1, 2023, in practice, only requires that at least 85 percent of the funds be disposed of in conformity with the Sustainable Requirements, and the remaining 15 percent can be invested in economic activities for which TSC have yet been established (flexibility spot).
In sum, it is clear that the use of proceeds under the EU GBS must be in compliance with the EU Taxonomy Regulation. In this regard, the EU GBS differs greatly from the ICMA GBP.
②Process for Project Evaluation and Selection
a) Pre-issuance review
Issuers must complete the fact sheet included in Annex 1 attached to the EU GBS, which must be then reviewed by external reviewers prior to issuing EuGB (Article 8).
b) Post-issuance review
In addition, issuers must obtain external reviews using the template included in Annex 2 attached to the EU GBS to clarify the use of proceeds and must publish the reports within 90 days of receipt (Article 9).
c) Impact report
After the proceeds have been fully allocated, issuers must prepare impact reports on the environmental impact brought by the appropriation, using the template attached as Annex 3 to the EU GBS, at least once prior to redemption (Article 10).
As shown above, the EU GBS’s requirements for project assessment processes and corresponding reports are more detailed and rigorous than those of the ICMA GBS.
③Management of Proceeds
Prior to the maturity of green bonds under the EU GBS, the proceeds can only be used for the following purposes (Articles 4 and 5): Proceeds must be used for the following purposes before the EU GBS redemption deadline (Articles 4 and 5):
a) Fixed assets
b) Capital expenditures (CapEx)
c) Operating expenses incurred in the three years prior to the date of issuance (OpEx)
d) Financial assets (such as shares and loans) allocated to items a) through c) above. Except for financial assets allocated to items a) through c), proceeds cannot be used on financial assets allocated to financial assets other than items a) through c).
According to the delegated act from the EU Taxonomy Regulation, larger companies and investors are required to disclose the percentages in conformity with the taxonomy of the above-mentioned items [20].
Rules specifically for regulating the management of proceeds exist, and the EU GBS is certainly more rigorous in this regard than the ICMA GBP.
④Reporting
In addition to the requirements of fact sheet, pre-issuance review, post-issuance review, and impact report mentioned above, issuers are required to publish annual allocation reports (Article 13(1)(c) and Article 9) within three months from the end of a fiscal year.
iii. Obtaining External Reviews
External reviewers must be registered with and supervised by the European Securities and Markets Authority (ESMA) (Article 14 et seq.).
In order to remain independent, external reviewers should avoid conflicts of interest (Article 27).
Since the manner in which external reviewers are supervised and whose actions are regulated is clearly and specifically stipulated in the EU GBS, it seems considerably stricter than the ICMA GBP.
(3) Summary
As shown above, the EU GBS, to which the European Union has provisionally agreed, is clearer and stricter than both the J-GBG and the ICMA GBP and is legally binding.
5. Impact on Japanese Companies
(1) Impact on green bonds issued by Japanese companies
As mentioned above, most of the green bonds issued by Japanese companies were structured according to either the J-GBG or the ICMA GBP, or both. However, the EU GBS provisionally agreed upon in March 2023 is more stringent than both the J-GBG and the ICMA GBP and is legally binding.
At present, it is unclear whether the EU GBS, if finalized and comes into force, will lead the ICMA or the Japanese Ministry of the Environment to revise their respective guidelines accordingly. In any case, the EU GBS seems superior in its capability to prevent greenwashing and ensure process transparency to the J-GBG and the ICMA GBP. When boosted investor confidence is demonstrated under the EU GBS, eventually Japanese companies will likely begin to adopt the EU GBS rules.
(2) Impact on other areas of sustainable finance
Green bonds are the basic form of ESG bonds, and the appropriate standard used to regulate the market has long been debated for longer than any other type of sustainable finance. If a large number of green bond issuers around the world come to follow the EU GBS, we cannot deny the possibility that the standard can similarly affect other areas of sustainable finance, such as social bonds, sustainability bonds, sustainability-linked bonds, transition bonds, and green loans.
Given these circumstances, Japanese companies that have long been involved in, or are considering engaging in, sustainable finance should pay special attention to the EU GBS so that they can readily respond should it becomes the norm.
Reference
[1] ICMA "Green Bond Principles, Voluntary Process Guidelines for Issuing Green Bonds", June 2021 (with June 2022 Appendix 1) ,
https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Green-Bond-Principles_June-2022-280622.pdf
[2] Ministry of the Environment's Green Bond and Sustainability Link Bond Guidelines/Green Loans and Sustainability Link Loan Guidelines (2022 edition)
https://www.env.go.jp/content/000062495.pdf
[3] See page 4 of the ICMA GBP
[4] See page 5 of the ICMA GBP
[5] ICMA "Guidelines for Green, Social, Sustainability and Sustainability-Linked Bonds External Reviews, June 2022,
https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/External-Review-Guidelines_June-2022-280622.pdf
[6] ICMA "Pre-issuance Checklist for Social Bonds/Social Bond Programmes", June 2021,
https://www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/Pre-issuance-Checklist-for-Social-Bonds-and-Social-Bond-Programmes-June-2021-100621.pdf(Link)
[7] See page 24 on J-GBG.
[8] See page 23 of J-GBG.
[9] See page 37 of J-GBG.
[10] See page 43 of J-GBG.
[11] See page 44 of J-GBG.
[12] See page 47 of J-GBG.
[13] See page 50 of J-GBG.
[14] EU Commission "Commission proposal for a European green bond standard"
https://finance.ec.europa.eu/publications/commission-proposal-european-green-bond-standard_en
[15] Council of the EU, Press release, 28 February 2023,
https://www.consilium.europa.eu/en/press/press-releases/2023/02/28/sustainable-finance-provisional-agreement-reached-on-european-green-bonds/(Link)
[16] REGULATION (EU) 2020/852 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 18 June 2020,
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32020R0852&from=EN
[17] Article 9 of EU Taxonomy Regulations
[18] Article 3 of EU Taxonomy Regulations
[19] Abbreviation for Do No Significant Harm.
[20] COMMISSION DELEGATED REGULATION (EU) 2021/2178 of 6 July 2021,
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32021R2178
