50 Shades of Green: classification and disclosure requirements for green bonds

As we enter into a post COVID-19 New Zealand, alternative investment options may begin to look more and more appealing as returns on term deposits and other traditional investments continue to fall. Savvy investors and issuers alike should take note of recent comments from the Financial Markets Authority (FMA) on the application of the “same class” disclosure exclusion for offers of financial products described as “green bonds”. Green bonds may not fall within the same class as their “vanilla” counterparts – even where their terms of issue may be identical.

What are green bonds?

While not defined by the FMA or the Financial Markets Conduct Act 2013 (FMCA), green bonds are typically categorised as bonds through which investors’ funds are applied towards the generation of environmental benefits, assisting communities with combating the effects of climate change, or towards other environmentally-friendly projects.

In today’s climate, green bonds can provide for an attractive rate of return over more traditional investments, while also presenting opportunities for eco-conscious investors to take part in positive environmental development. In 2019, the collective worldwide value of issued green bonds soared to USD$185 billion, with further increases anticipated for 2020.

Other than their climate-focused characteristics, green bonds and vanilla bonds operate identically as debt securities. Investors still expect financial returns on their investment, which, like vanilla bonds, are usually paid over time at a fixed interest rate, and upon maturity of the bond.

Position under Financial Markets Law

Despite the growing recognition of green bonds, there are currently no specific mandatory standards applying to issuers of bonds with environmental characteristics. How then are investors to determine if a bond is really “green” – and if so, what shade?

With no specific regulation in place, investors often rely on an issuer’s adherence to voluntary frameworks such as the Green Bonds Principles and the Climate Bonds Initiative.

These frameworks exist to assure investors that associated issuers will apply green bond investments in a manner consistent with achieving environmental benefit.

Additionally, the FMCA imposes a general prohibition on misleading and deceptive conduct. Issuers are required to explain the particular features and expected returns relating to a financial product, and must do so honestly and clearly.

However, there remains concern that issuers may take advantage of the more general and voluntary nature of green bond regulation in order to attract investors through a token push towards corporate and environmental responsibility, with no strict requirement to make tangible and meaningful commitments towards those goals in the long term.

There has been confusion surrounding whether green bonds offered by an issuer on the same issue, return, and maturity terms as previously issued vanilla bonds are eligible for the “same class exclusion” under the FMCA. This exclusion permits financial products which provide for identical rights, privilege, limitations and conditions as a financial product previously issued by an issuer to be issued without the requirement to comply with the full band of disclosure obligations under the FMCA.

The exclusion recognises that requiring issuers to repeat disclosure obligations for identically classed financial products would be unduly onerous and costly, and not provide any material benefit to potential investors.

View of the FMA

The FMA considered the place of green bonds within New Zealand’s financial markets as part of a broad consultation in late 2019, recognising that it maintains a role in facilitating fairness and transparency within emerging financial products.

A view has been effectively formed by the FMA that the “green” qualities attaching to green bonds distinguish the bond from any vanilla counterpart. This recognises that the means and purpose for which funds raised by green bonds is applied form a critical feature of the bond, and is enough to form a class of bond distinct from any vanilla bond which may otherwise have identical financial and technical characteristics.

The FMA highlighted that investors in green bonds have a reasonable expectation that their investment will be used to contribute to environmental improvements. In this sense, investors derive a non-financial personal benefit above and beyond financial returns.

This distinction in classification is relevant to the application of the “same class exclusion”, which the FMA has clarified will only reliably apply where green bonds issued by an issuer are identical in characteristics (including “green” characteristics) to bonds previously issued by that issuer.

Where the previously issued bonds identified by the issuer for the purposes of the exclusion are not consistent with the “green” features of the subsequently issued green bonds, the exclusion will not apply. Instead, and in the absence of any other exclusion, the issuer will be required to comply with the substantive FMCA disclosure requirements as part of that green bond issue.

Alternatively, the FMA has noted that it is willing to explore granting specific individual exemptions to issuers of green bonds. In lieu of complying with the full disclosure requirements under the FMCA, such issuers of green bonds could instead be required to undertake a more limited disclosure to investors – essentially detailing and describing the “green” characteristics of the bond.

The distinction is intended to ensure that green bond investors are not left confused by a promoted green bond being described as being within the same class as a vanilla bond, as well as to limit the extent of “greenwashing” by restricting the application of the “same class exclusion” and requiring issuers to fully disclose exactly what makes their bonds “green”.

The FMA is expected to publish final guidance on green bond regulation this year, after consideration of all submissions made during the consultation process.

The consultation at a glance

  • for the purposes of the FMCA “same class exclusion”, the climate-friendly characteristics of green bonds may form part of the requisite “class” (alongside the financial and technical terms of the bond)
  • green bonds and vanilla bonds which do not share identical “green” characteristics will likely be considered separate classes – even where all other terms of issue are identical
  • the exclusion can be effectively relied upon if the “green” features of a green bond are identical to a previously issued vanilla bond, provided that all other class criteria is met
  • for green bonds and vanilla bonds which do not share identical “green” characteristics, specific exemptions to full FMCA disclosure requirements may be made available by the FMA, likely on the basis that the issuer undertakes short-form disclosure to investors as to what makes the bond “green”

Concluding comments

Whether you are a corporate issuer or environmentally-minded investor, the Business Law team at Lane Neave is well versed in structuring offers of bonds, debt securities, equity, and other financial products, and can assist you in achieving your investment goals and remaining compliant with New Zealand’s regulations.

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