FMA consults on Sustainable Bonds Class Exemption

The Financial Markets Authority (FMA) – Te Mana Tātai Hokohoko is consulting on a proposed class exemption for green, social, sustainable and sustainability-linked (GSSS) bonds. This would allow listed issuers to offer GSSS bonds in the "same class" as their existing quoted vanilla bonds without the need for a product disclosure statement. We expect strong support from submitters.

Importantly, the consultation document signals the FMA's interest in ensuring that GSSS bonds have the regulatory framework needed in order to play their important role in financing the transition to a low carbon future. We explore these implications below.

Submissions close at 17:00 on Tuesday 30 April 2024.

Background

Under the Financial Markets Conduct Act 2013 (FMCA), a listed issuer can offer new financial products in the "same class" as existing quoted financial products without the need to comply with the FMCA's product disclosure and registration requirements.¹ Certain conditions apply including the need to give notice to the market and, in the case of listed debt securities, provide prescribed short-form disclosure to investors.²

For financial products to be in the "same class", they must have identical rights, privileges, limitations, and conditions (but, in the case of debt securities, they may have a different redemption date or interest rate or both).³ In its Information sheet: Green bonds – same class exclusion,⁴ the FMA gave its view that green bonds are not in the "same class" as vanilla bonds of the same listed issuer because their green features are rights power, privileges or limitations that attach specifically to the green bond.

The result is that the "same class" exclusion is not currently available to green bonds off the back of an existing quoted vanilla bond. Instead, full compliance with the FMCA's product disclosure and registration provisions would most likely be required. The FMA is worried this is a barrier to GSSS bond issuances.

Proposed exemption

In recognition that the current position may disincentivise issuing green bonds (and incentivise the issuance of plain vanilla bonds or sourcing green capital from offshore), the FMA is now proposing a class exemption that would effectively extend the "same class" exclusion so that green bonds could be issued off the back of an existing quoted vanilla bond issue.

In addition to the conditions and limitations attaching to current the "same class" exemption, the FMA is proposing that the exemption be subject to conditions requiring issuers to disclose the basis of the bonds' "green, social, sustainable and sustainability-linked" label, in line with its Guidance note: Disclosure framework for integrated financial products.⁵ This aligns with the two individual exemptions granted to date allowing issuers to offer sustainable bonds on a similar basis.⁶

Specific issues

The FMA is asking why GSSS bonds are sufficiently similar to vanilla bonds to justify granting the exemption, including pricing impacts, and for insights into the drivers of supply and demand for bonds. The FMA has also specifically called for comment extending the exemption to "sustainability-linked" bonds containing terms that could be triggered over the lifetime of the bond affecting their yield and therefore complicating pricing.

Our observations

Our key takeaways from the consultation are:

• FMA is seeking insights into the GSSS market: The FMA is taking the opportunity to seek wide-ranging feedback on the current regulatory framework for GSSS bonds. This will explore whether the existing rules are effective and examine the factors influencing the market for these bonds, including interest rates, brokerage fees, compliance costs, and the overall regulatory environment. Important questions being asked by the FMA include:
  
  
  • How does the pricing for GSSS bonds differ from that of traditional bonds, and what are the repercussions if issuers fail to meet their commitments?
  • What drives the supply and demand for GSSS bonds among both issuers and investors, and how might proposed exemptions address these drivers?
    
    
• A Growing Interest in GSSS Bonds: The green finance sector is witnessing significant growth, with GSSS bonds continuing to be the largest contributor in impact investing in New Zealand by volume. According to the Responsible Investment Association Australasia's (RIAA) 2023 Benchmark Report, these bonds attracted over AUD10 billion in investments in 2022 alone, highlighting strong growth but noting they still represent a tiny proportion of the market.
  
  
• The Role of Green Finance and SLBs: Green finance plays a pivotal role in the transition towards a more sustainable future. The proposed exemption aims to broaden the accessibility of GSSS bonds, particularly for entities without pre-existing green assets, facilitating the decarbonization of major industrial emitters. In our view, this is why the focus should be on Sustainability-Linked Bonds (SLBs) and whether the exemption will work for them. They are the products most likely to effect change with intensive emitters and also the products most likely to have new terms triggered, potentially impacting yield. So the disclosure needs to be right.
  
  
• Getting disclosure right: Greenwashing is a regulatory focus both here in New Zealand and globally (including regarding allegedly misleading claims about banks' sustainable finance activities). The FMA has therefore signalled exemption conditions requiring disclosure of the basis on which the bonds have a GSSS label and linked this to their earlier IFP Guidance. This is likely to include disclosure on the following topics:
  
  
  • What the GSSS bond purports to offer beyond a vanilla bond.
  • How non-financial performance will be measured and reported on.
  • Oversight and governance of GSSS claims, and controls and processes implemented by management.
  • Whether an external review, certification, assurance, second-party opinion, etc. has been provided, and the nature and scope.
  • Risks or costs associated with the GSSS features of the bond.
  • Consequences of failure, e.g. if the bond does not achieve the desired non-financial outcomes.
    
    
• Targets: In our view, the effectiveness of SLBs hinges on setting ambitious targets that genuinely drive change, and that have strong enough pricing incentives to drive that change. I nteresting, the FMA has said that it plans to assess GSSS bonds against issuers' climate statements and transition plans, and that if the GSSS terms are not ambitious enough then that "would prompt regulatory interest and potential risk being misleading" (by overstating the role of those bonds, or the company's activities, in facilitating the transition to a low carbon future).

If you have any questions about the consultation, sustainable finance, greenwashing, or would like assistance with a submission, please contact us.