Additional disclosures by green bond issuers will often be needed under the regulations, writes Kristell Herbault
"Checking the compliance with PAB exclusions at issuer level can be deemed rather straightforward based on data providers' input, but it may be less simple at the green bond activity stage"
Last year, the European Securities and Markets Authority (ESMA) published its Guidelines on funds' names using ESG or sustainability-related terms with the aim to "ensure that investors are protected against unsubstantiated or exaggerated sustainability claims in fund names"1.
To achieve this, the Guidelines "provide asset managers with clear and measurable criteria to assess their ability to use ESG or sustainability-related terms in fund names".
However, for fund managers to comply with some of these criteria, they may need more detailed information about the underlying instruments than is currently disclosed by some issuers.
The Guidelines and related Q&As refer to several pieces of the EU Sustainable Finance framework. More specifically, fund managers should apply exclusion criteria to allow the use of different ESG or sustainability-related terms in funds' names, and in consistency with those applicable to EU Climate Transition Benchmarks (CTB) and EU Paris-aligned Benchmarks (PAB).
It concretely means excluding companies:
a) involved in any activities related to controversial weapons
b) in the cultivation and production of tobacco, and
c) those in violation of the United Nations Global Compact (UNGC) principles or the Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises.
In the case of funds using environmental-, impact- or sustainability-related terms in their names, it also means excluding companies that derive a certain percentage of their revenues:
d) from exploration, mining, extraction, distribution or refining of hard coal and lignite,
e) from the exploration, extraction, distribution or refining of oil fuels,
f) from the exploration, extraction, manufacturing or distribution of gaseous fuels, and
g) from electricity generation with a GHG intensity of more than 100 g CO2 e/kWh2.
In terms of the green bond market in particular, the Guidelines initially did not distinguish between a green bond and other securities issued by a given company.
For example, if a company was excluded due to its fossil fuel exposure, its green bonds would also have been barred from funds with environmental-, impact- or sustainability-related terms in their names.
ESMA further detailed specific aspects of the practical application of the Guidelines last December, with the publication of a Q&A . It explained that investments in European Green Bonds (i.e., issued under the European Green Bonds Regulation) do not need to be assessed under the PAB exclusions as listed above, and that for other green bonds, fund managers should look at the activities financed by the green bond to check the PAB exclusions.
However, this "look-through" approach would not be applicable to investments in a company in breach of the UNGC principles or OECD Guidelines for Multinational Enterprises.
Checking the compliance with PAB exclusions at issuer level can be deemed rather straightforward based on data providers' input, but it may be less simple at the green bond activity stage. For example, the 100g CO2e/kWh greenhouse gas (GHG) intensity threshold for electricity generation projects may not always explicitly be part of the eligibility criteria for such projects.
There are, however, certain pieces of information such as the EU Taxonomy Substantial Contribution Criteria which could be a beneficial part of the "look-through" analysis. This is because the exemption granted by ESMA to European Green Bonds suggests a plausible consistency of activities aligned with the EU Taxonomy, with the PAB criteria – although both criteria differ.
If the EU Taxonomy-related information is not available, another useful practice could be to look at the nature of projects financed: as per the Climate Bond Initiative, certain technologies, such as wind and solar, clearly operate below the 100g CO2e/kWh threshold. However, "other technologies such as geothermal, hydropower and bioenergy have a wider range of emissions intensities".
In practice, additional disclosures by green bond issuers are often needed for a thorough assessment, that must in any case be complemented by additional review process for fund managers to ensure the full scope of ESMA Guidelines – which, there is no doubt, will bolster the credibility and transparency of the green bond market.
Kristell Herbault is head of sustainability for global markets at Societe Generale.
The views expressed in this article are those of the author and do not necessarily reflect the official stance of Societe Generale. This article is not intended as investment or regulatory advice and may contain inaccuracies. Readers are encouraged to conduct their own research and consult with a qualified financial advisor before making any investment decisions.