Integrating Sustainable Finance into the Prospectus Regulation

Sustainable finance is attracting significant investment market share and it is inevitable that issuers in capital markets are keen to leverage upon its attraction to fund their transition and innovative activities. In particular, so called ‘use-of-proceeds’ green bonds (green bonds, in short) are proving to be popular instruments with issuers and investors. However, with growing interest have inevitably come questions about how best to regulate the green bond market, including how best to prevent so-called ‘greenwashing’ and ensure that investors are meaningfully protected. In the EU, the prospectus framework currently caters for what we call ‘generic’ business purposes. However, ‘specialist’ securities such as green bonds may require different mechanisms to ensure the credibility of such market-based instruments. Our paper, which is forthcoming in The Cambridge Handbook of EU Sustainable Finance: Regulation, Supervision and Governance edited by Kern Alexander, Michele Siri and Matteo Gargantini, considers the role that EU prospectus disclosure regulation should play in relation to such instruments.

‘Green’ bonds are debt securities issued on the promise that proceeds of fund-raising are dedicated to ‘green’ projects. Green bonds are structured like traditional debt securities, offering investors a fixed income return. What differentiates green bonds from generalist debt securities is that the purpose for proceeds is specially defined, and for investors, the achievement of ‘green’ outcomes is also important. Otherwise, many features of such debt securities are not different from generalist debt. The rise of specialist securities in the primary market can be attributed to the growth in investor allocations to sustainable finance. Not only can prosocial motivations be at work, but some empirical findings show that sustainable investments can financially deliver. The EU Regulation on Sustainable Disclosure 2019 also introduces a mandatory baseline obligation for all institutional investors to integrate sustainability risks in portfolio management, incentivising investment management entities towards making sustainable allocations.

Helping to address investors’ expectations in the green bond market are several market-based mechanisms. For example, many green bond issuers adhere voluntarily to the green bond principles (GBP) hosted by the International Capital Market Association (ICMA) although these standards are not especially prescriptive. The EU too has taken interest in the green bond market. Among initiatives is the European Commission’s proposal for a regulation on a new voluntary EU Green Bond (EuGB) Standard, which is currently in the legislative pipeline. As far as the Prospectus Regulation is concerned, concerns about green bonds have not (yet) led to major legislative revisions. In our paper, we reflect on this state of affairs and assess current market practice. There are good reasons to be critical of current market practice—ie to rely on existing generic prospectus disclosure requirements together with information disclosure that is made outside the prospectus framework in the so-called ‘bond framework’. The latter typically offers (substance or process-based) ‘green bond’ disclosure on the use of proceeds, the issuer’s approach to the evaluation and selection of eligible projects, as well as the management of proceeds and reporting. Our paper argues that such an approach fails to adequately address the risk of firms providing inconsistent or potentially misleading information about the green bonds to prospective investors. Given (i) the principled support that mandatory disclosure has received by scholarship; (ii) the relevance of substance- and process-based ‘green bond’ disclosure for green bond investors; and (iii) the possibility of rowing back on aspects such as the use of proceeds in prospectuses under current regulation, we argue in favour of transitioning to mandatory ‘green bond’ prospectus requirements, based on common definitions to support the prospectus disclosure framework. Accordingly (where a prospectus needs to be published), we also support mandatory ‘green bond’ disclosure requirements under a mandatory EuGB framework. A voluntary approach is unlikely to offer a long-term solution for credible investor protection, the building up of sustainable finance markets, or the achievement of real issuer behavioural change and substantive outcomes.

However, the elephant in the room are arguably not the prospectus disclosure duties as such. It is the question of investor redress in cases where investors’ ‘green’ expectations are not met. Accordingly, much of the resistance among issuers to make ‘hard’ green commitments in prospectuses stems from the risk of facing the ‘hard’ consequences of failing to meet these commitments—say, for example, in terms of facing a bond default or in terms of facing prospectus liability. To be sure, we acknowledge that depending on the nature or extent of any future green bond prospectus disclosure duties, issuers might have legitimate concerns about liability risk; concerns which are likely to be exacerbated in the absence of a significant ‘green bond’ pricing advantage. At the same time, a prospectus liability regime could prove to be an essential element in the toolkit for preventing greenwashing, as long as it can be properly calibrated to the particularities of ‘use of proceeds’ green bonds. Hence, what is ultimately required as part of a discussion on a green bond prospectus framework, is a proper conversation on the importance and relevance of prospectus liability under a green bond framework; whether concerns about liability risk are justified under (differing) national liability regimes and, if necessary, how best to respond to such concerns in a targeted way without undermining the objective of greenwashing. We urge EU policymakers to engage in these discussions.

Iris H-Y Chiu is a Professor of Corporate Law and Financial Regulation at UCL.

Pierre Schammo is a Professor of Law at the University of Durham.