In this legal update, we present a brief overview of the development and recent key regulatory changes on sustainable development and ESG (Environmental, Social, and Corporate Governance), green finance and green energy in Russia. As Russia has joined the Paris Agreement (and recently announced its intended nationally determined contribution (NDC) to reduce emissions, which calls for a greenhouse gas emissions decrease by 2030 to 70% of the 1990 level), the development of a Russian legislative framework to meet CO2 reduction commitments has been intensified. Investors and companies are highly interested in implementing green policies, in decarbonising and reducing the carbon footprint of their operations, and in using green and transition financing instruments. Furthermore, due to the current situation in international energy markets and growing investor interest in 'green' types of energy, Russia has been taking steps to explore and expand into new energy markets. In particular, Russia is taking increasingly active steps to develop hydrogen energy.
1. Regulation of greenhouse gas emissions
1.1. The development of emissions regulation
1.1.1. Russian regulation on environmental protection and limitations on greenhouse gas (GHG) emissions was developed long before accession to the Paris Agreement. In addition to special regulation to protect certain components of the natural environment (including water, land and forest legislation, legislation on the use of natural resources and subsoil), in 1999 Federal Law No. FZ-96 “On the Protection of Atmospheric Air” (Air Protection Law) was adopted, which was followed in 2001 by Federal Law No. FZ-7 “On Environmental Protection” (Environmental Protection Law). These two laws replaced similar laws and acts of the Russian Soviet Federative Socialist Republic.
1.1.2. Issues concerning climate change and the reduction of GHG emissions were comprehensively addressed in the Climate Doctrine of Russia of 2009 (Order No. 861-rp of the Russian President of 17 December 2009) (Climate Doctrine) and later in the Strategy of Environmental Security of Russia for the period up to 2025 (Decree No. 176 of the Russian President of 19 April 2017). The Climate Doctrine set goals for improving energy efficiency, developing renewable and alternative energy sources (RES), and envisaged an option of using of tax and economic instruments to promote a reduction in GHG emissions.
1.1.3. Upon signing the Paris Agreement, Russia started to improve the state regulation of GHG emissions, as part of the ratification preparations, in accordance with the Government's plan identifying the main steps in this area (Resolution No. 2344-r of the Russian Government of 3 November 2016). In particular, under this initiative, Federal Law No. FZ-296 “On Limiting Greenhouse Gas Emissions” of 02 July 2021 (Emissions Law) was developed and will enter into force on 30 December 2021.
1.2. What issues are regulated by newly adopted and currently existing laws?
1.2.1. The general current regulation of pollutant emissions into the environment (soil, water, atmosphere, etc) is set out in the Environmental Protection Law, which, among other things, provides for:
- various normative standards (limits) for a permissible impact on and emissions into the environment;
- the obligation of legal entities to finance measures preventing and/or reducing any negative impact on the environment;
- payments for having a negative impact on the environment, which may vary depending on a number of factors (type of pollutants, application of ratios and compliance with normative standards (limits), as well as funding for measures preventing and/or reducing the negative impact on the environment).
The Air Protection Law includes a special regulation on emissions into the atmosphere (including providing the requirement to establish normative standards (limits) for emissions and determining harmful activities affecting the atmospheric air). This law is in many ways related to the Environmental Protection Law and contains references to the regulation provided in it.
1.2.2. The new Emissions Law provides for narrow and focused regulation of GHG emissions compared to the Environmental Protection Law and the Air Protection Law and includes several key innovations:
- Introducing “carbon units” (CU) and the option of CU trading. A CU is defined as the result of a climate project (ie a project to reduce emissions or increase GHG absorption). Initially, CUs are calculated and credited for implementation of a climate project to an account of a climate project performer. Then CUs may be transferred to a CU purchaser or set off against the carbon footprint of the climate project performer itself.
- Introducing mandatory (for some emitters, depending on the volume of emissions in a given year) and voluntary reporting of emissions for legal entities;
- Establishing emission reduction targets for various industries at the federal level;
- Establishing three registers: (i) the register of GHG emissions for recording emitters' emissions reports ; (ii) the GHG cadastre for recording anthropogenic emissions from sources and their absorption; and (iii) the register of carbon units for recording climate projects and CUs, as well as transactions with CUs issued into circulation (transfer of CUs by their owner to another person). According to the latest information, the Government plans to appoint the National Settlement Depository as the operator of the СU register.
1.2.3. Lawmakers are also proposing additional tax incentives in connection with the implementation of climate projects and the circulation of СUs, and planning to clarify the procedure of verifying climate project implementation reports, which is necessary to issue СUs into circulation (at the time of this legal update, draft laws on amendments to the Tax Code and the Emissions Law are at the public discussion stage (one of the early stages of the legislation process)). The Emissions Law is still quite general in its nature. For its implementation, some normative acts and technical regulations are still to be adopted in addition to those mentioned above. For example, a procedure for assessing whether an emission reduction target has been achieved should be developed. In addition, the Emissions Law does not provide for a detailed procedure and conditions for trading and offsetting CUs. In particular, the Emissions Law does not explicitly provide an option of a CU transfer by the first purchaser (who received CUs from the original CU owner)1 to subsequent purchasers and the possibility of other transactions with CUs, eg a CU pledge. In addition, the Emissions Law does not establish any connection between the achievement of the emission reduction targets and CU use. These issues may be of key importance for CU trading and the implementation of the Emissions Law's economic idea.
1.2.4. In the period from 2022 to 2025 (inclusive), an experiment to test the Emissions Law system in the Sakhalin Region will take place. For this purpose, a draft law on the experiment has been developed (Experiment Bill). As of the date of this legal update, it mainly provides for similar regulation with some additional details compared to the Emissions Law, which may potentially be reflected in the Emissions Law after the experiment is completed.
1.2.5. In addition to CUs, the Experiment Bill provides for emission quotas (Quota) for legal entities. A legal entity complying with (ie not exceeding) the Quotas will receive quota compliance units (QCU) (QCUs are calculated as the positive difference between the actual emissions and the maximum Quota). According to the Experiment Bill, QCUs can be used (offset) to meet future Quotas. Based on the current provisions of the Experiment Bill, the Quota mechanism may presumably replace the emission reduction targets mechanism in the Emissions Law, and thereby eliminates the corresponding regulatory gap. Furthermore, the Experiment Bill explicitly allows for “civil” transactions with QCUs, registerable in the unified register of carbon units. This expands the opportunities for market players. The legal regime of and the trading terms in respect of QCUs may likely be added to the Emissions Law; the legal regime of QCUs may also be extended to CUs under the Emissions Law, which would eliminate the ambiguities in the regulation noted above.
2. Development of the hydrogen energy industry
2.1. Is hydrogen energy the same as green energy?
2.1.1. Although hydrogen energy is often compared to 'green' initiatives, hydrogen production can be either completely 'green' or accompanied with CO2 emissions, depending on which raw materials and production method used. Water electrolysis, for instance, is seen as one of the 'greenest' ways to produce hydrogen (the EU has selected this very method as part of the European green agenda, even though it is the most expensive and energy demanding method). Producing hydrogen from fossil fuels and natural gas can also be done with or without CO2 emissions (in the latter case, however, with solid carbon formation). The latter also involves the use of capturing and storing CO2 technology, which makes the production process more expensive. In addition, the electric power source used for hydrogen production also matters as it may be generated using traditional source or RES. Therefore, even the 'greenest' hydrogen production method can itself be associated with CO2 emissions, depending on the energy source used for its production. 2
2.2. Previous and new plans of developing the hydrogen energy industry
2.2.1. The first major initiatives for the hydrogen energy industry in Russia were launched relatively recently, at the same time as the global tendency towards environment protection, GHG emission reduction and the use of RES. However, hydrogen technology standardisation and some individual plans for developing hydrogen energy industry and technology have existed in Russia for quite a while. For instance, back in 2008 OJSC INTER RAO UES, in its Technical Policy Concept for the Electric Power Industry in Russia for the period up to 2030, emphasised the need for hydrogen production and developing hydrogen engines. In 2011, the Ministry of Industry and Trade of the Russian Federation (Minpromtorg) was considering the production of hydrogen from water (using the efforts of the nuclear power industry) and from coal (Order of Minpromtorg of Russia No. 206 dated 22 February 2011). In 2013, the Ministry of Economic Development of the Russian Federation (Mineconomdevelopment) named Russia as a leader in hydrogen energy research and developments in its Long-Term Socio-Economic Development in Russia Forecasts for the period up to 2030. In 2014, the Government in its Scientific and Technological Development in Russia Forecast for the period up to 2030 identified as the priority in the medium- and long-term perspective the development of hydrogen technology in the area of hydrogen production, storage, use and transportation ensuring a large-scale transition to hydrogen energy. Since 2003 Russia has been a member of International Partnership for Hydrogen and Fuel Cells in the Economy (IPHE).3 IPHE's partners share information and help facilitate multinational research and other initiatives that advance the introduction of hydrogen technologies on a global scale.
2.2.2. More detailed plans for the hydrogen energy development were drawn up in 2020 as a part of the Energy Strategy for the period up to 2035 (Decree No. 1523-r of the Government of the Russian Federation of 9 June 2020) setting a goal of achieving world leadership in hydrogen production and export, determining plans for hydrogen production4 and export volumes and describing steps to achieve these goals. By the end of 2020, the Government had adopted an action plan for hydrogen energy development in Russia for the period up to 2024 (Decree No. 2634-r of the Government of the Russian Federation of 12 October 2020) (Hydrogen Plan) providing for a comprehensive approach to the development of this sphere, starting with the creation of a scientific, technological and regulatory framework, the establishment of government support measures for domestic hydrogen production, trading and export, and ending with the launch of pilot projects and activities, including ones with the participation of Gazprom (the creation of hydrogen production using methane, the development and testing of methane-hydrogen-based gas turbines) and Rosatom (the creation of hydrogen production using the capacities of nuclear power plants, the creation of hydrogen-powered railway transport). Comparing the first initiative in developing the hydrogen energy industry with the Hydrogen Plan, one may see a continuity and consistency in these plans.
2.2.3. As part of the Hydrogen Plan, the Government published the concept of hydrogen energy development (Decree No. 2162-р of the Government of the Russian Federation dated 05 August 2021) (Concept), providing for development stages for the period up to 2035 and for a long term perspective up to 2050:
- to 2024 - development of the regulatory framework, implementation of government support measures, creation of science and technology infrastructure and implementation of pilot projects;
- to 2035 - creation of major export-oriented hydrogen production from fossil fuels based on nuclear power and from water using electrolysis based on nuclear power plants, hydroelectric power plants and RES; expansion of hydrogen technology on the market;
- to 2050 - establishing major hydrogen production using RES.
2.2.4. Both the Hydrogen Plan and the Concept mainly consider hydrogen production using fossil fuels (with CO2 capture) and water electrolysis using nuclear energy resources (in contrast to the EU sustainable development plans, which consider water electrolysis using RES as the main hydrogen production method). However, the Concept recognises that the cost of hydrogen and its carbon footprint will be the main competitiveness factors for hydrogen energy, therefore Russia needs to aim for low-carbon hydrogen production.
2.2.5. Notably, the Hydrogen Plan and the Concept do not concentrate on hydrogen production for own use, but rather about export possibilities, scientific and technological development opportunities and the application of hydrogen technologies in other areas. It is fair to assume that Russia is entering the hydrogen race5 due to changes in global energy markets and its desire to remain a leading energy supplier, and that Russia intends not only to offer hydrogen on international markets, but also to create demand by introducing technology that uses it. That said, the Hydrogen Plan and the Concept provide for international co-operation development for, among other things, the elaboration of unified hydrogen standards and classifications depending on the carbon footprint of the hydrogen production. In our opinion, the results of such co-operation will be of paramount importance for Russian hydrogen exports.
3. Green finance regulation
3.1. State regulation and support
3.1.1. The rapid development of the hydrogen energy industry and the regulation of GHG emissions facilitates capital flows into these areas to implement energy and climate projects. Continuing the transition to more sustainable production and companies' intention to implement internal decarbonisation policies also creates favourable conditions for the raising of target 'transition' financing.
3.1.2. Up until recently, the state has mainly focused on the regulation of the public relation area (in particular, environmental protection, limiting negative impact on the environment and reducing GHG emissions). At the same time there have been a range of government support measures for implementing and financing green projects, which continue to exist (such as support of the production of high-tech goods and the implementation of best available technology, a mechanism of special investment contracts, Industrial Development Fund financing with a discounted interest rate, state guarantees for projects improving energy efficiency, guarantees for the purchase price for RES facility capacities as well as various subsidies and tax benefits).
3.1.3. The Government has approved goals and directions of sustainable development as the first step of the green finance regulation process (Resolution No. 1912-r of the Russian Government of 14 July 2021) (Sustainable Development Goals). The document is declarative in its nature, but is also comprehensive, establishing overall unifying 'green' goals and areas of sustainable development for any project and production type and also providing for the definitions of “green project” and “adaptation project” (transition projects), their criteria and verification procedure. To be recognised as “green”, the project has to comply simultaneously with a set of principles:
- conformity with one or more directions of sustainable development, provided for by the Sustainable Development Goals (provided that both quantitative and qualitative criteria established by the Government for green projects are fulfilled);
- contribution to the achievement of certain environmental impact and certain goals relating to positive effect on the environment provided for in the Sustainable Development Goals;
- focus on the goals of the Paris Agreement and/or the UN Sustainable Development Goals;
- conformity with technology parameters (goals) of the best available technology;
- absence of any significant side-effect on the environment ('Do No Significant Harm' principle).
The Sustainable Development Goals provide for fewer principles for recognising a project as an adaptation project, and refer to special quantitative and qualitative criteria for such projects. During the development of the Russian taxonomy (please see details below in paragraph 3.1.4), Mineconomdevelopment stated that green project criteria have to comply with global ones to be more attractive to foreign investors, while adaptation projects may be unable to meet global standards (usually such projects relate to oil, gas and other carbon extraction, but are aimed at reducing negative impact on the environment), but will still be supported by the state due to their significant environmental impact.
3.1.4. In order to implement the Sustainable Development Goals, on 21 September 2021 the Order of the Government of the Russian Federation “On the Approval of the Criteria for Sustainable Development (Including Green) Projects in the Russian Federation and Requirements for the Verification System for Sustainable Development (Including Green) Projects in the Russian Federation” (the Russian model of “taxonomy”) (Russian Taxonomy) has been adopted. Russian Taxonomy was developed by VEB.RF and the Government and it is seen to be a key document for green finance. In addition to the Criteria for sustainable development projects (ie the quantitative and qualitative criteria for green and adaptation projects referred to in the Sustainable Development Goals) Russian Taxonomy also provides for conditions for recognising financial instruments (Russian Taxonomy mentions loans and bonds) as financial instruments aimed at financing “sustainable development projects” (green and adaptation projects) and a verification procedure aimed at checking that such financial instruments conform to Russian Taxonomy requirements. To be recognised as “sustainable”, a financial instrument has to comply with a number of requirements, including the following:
- the financing must have a purpose of implementing sustainable development projects (both financing a new project and refinancing an existing project, provided it complies with the criteria for sustainable development projects and provided the financing proceeds have been used as specified in paragraph (ii) below);
- the financing proceeds received using the relevant financial instrument must be used to cover the capital and operating expenditures required to implement the relevant sustainable development project or to finance/refinance the sustainable development project portfolio. The financing proceeds must be directly used for the project implementation, while temporary free funds may be invested in accordance with the policies of the entity implementing the project (information on such investment must be disclosed in publicly available sources or may be provided to VEB.RF, which performs overarching functions to support investments in the sustainable development area).
Given its comprehensive nature, Russian Taxonomy and the opportunities it provides require separate detailed consideration. However, Russian Taxonomy will certainly be of principal importance crucial for the implementation and financing of ESG projects in Russia (including climate projects in the meaning of the Emissions Law, if they comply with Russian Taxonomy criteria).
3.1.5. Furthermore, some additional green project government support measures are being proposed, such as a kind of soft term financing programme for projects improving energy efficiency classified as green (which is being developed by Mineconomdevelopment).
3.1.6. In addition, market players point out the lack and the necessity of implementing ESG factors into banks' corporate activities, which may stimulate directly and significantly bank green finance. However, since banking regulatory issues (such as loan-loss reserves, normative maintenance, etc) are key to the stability of markets, regulators traditionally consider any changes carefully and largely look at the global trends and general regulation (including Basel II and Basel III). Therefore, in our view, one should not expect changes towards 'green transition' in this area to occur soon. Despite this, Russian banks are increasingly adopting and implementing green principles in their own operations and adding them to financing conditions.
3.2. Voluntary regulation
3.2.1. Major regulators and development institutions (the Central Bank of Russia, Mineconomdevelopment (the state coordinator of green investment policy), VEB.RF and the Moscow Stock Exchange) have for several years been actively engaged in the development, adoption and implementation of the voluntary regulation of sustainable and green finance instruments, principles for responsible investment, principles of ESG linked non-financial information disclosure, methodologies and standards for verifying green and transition finance instruments.
3.2.2. To ensure investor attractiveness, major companies (such as, inter alia, Gazprom, Rosneft, SIBUR, Nornikel, Rusal, Polymetal and Aeroflot) have developed and implemented environmental principles and policies. Complying with global green standards and adopting green development strategies strengthens a company's standing in rapidly changing global markets and, among other things, helps preserve sales markets. The adoption of the EU green agenda (including the European Green Deal) and the adoption of the Russian Taxonomy and non-financial reporting law (details are provided below in this legal update) may require these principles and politics to be updated.
4. Plans of Future Development
4.1. Several key laws and regulations that would determine the Russian ESG sphere's future development (both, green energy and green finance) are currently being developed and are expected to be adopted in the foreseeable future:
- a draft non-financial reporting law, developed by Mineconomdevelopment, providing for the disclosure of ESG-linked information and indicators by state and major companies as part of their non-financial reporting. In practice, such reporting may be used by banks and investors to assess companies for financing (including green financing). At the time of this legal update, the draft has been positively assessed at the stage of the regulation effect assessment and is awaiting consideration by the Government.
- a draft law on ensuring owners of industrial infrastructure perform obligations to liquidate harm caused to the environment, developed by the Ministry of Natural Resources and Environment of the Russian Federation, providing for the industrial infrastructure owner's obligation to liquidate harm caused to the environment at different stages of the life circle of the enterprise. From a practical standpoint, the adoption of this law will make companies take into account and integrate the liquidation of harm to the environment into their economic planning of activities. In our view, it may potentially create conditions for 'transition' financing for the implementation of such plans. At the time of this legal update, the draft was negatively assessed at the stage of the regulation effect assessment and needs to be revised and improved before further consideration.
In addition to the above, for several years Mineconomdevelopment has been developing a draft Russian Low Carbon Development Strategy for the period up to 2050. In March 2020, Mineconomdevelopment published a first draft, providing for several options for developing climate regulation. Mineconomdevelopment proposed following the basic scenario, which assumes an increase of energy efficiency and forest fund maintenance. It has recently been reported in the mass media6 that the original version of the strategy has been revised and that a new draft has been developed to set ambitious goals for reducing GHG emissions competing with the EU's sustainable development plans. At the time of this legal update, the updated draft is unavailable.
At the moment the development of ESG and green finance regulation is rapidly moving forward in Russia, the results of which shall determine the future of this sphere. In our view, since Russia intends to maintain its status as a major worldwide energy supplier, a correlation between European and Russian regulations is especially important, particularly from the perspective of opportunities for attracting foreign investments in implementing Russian green projects and from the perspective of gaining access to the European market of goods produced under such projects.
1 The Emissions Law only provides for an option for a CU transfer by the CU owner (climate project performer) to a first purchaser.
2 This is a major political point, from the perspective of the EU green agenda hydrogen produced using such non-'green' or not entirely 'green' (in the EU authorities' opinion) energy may not be allowed onto the EU market or may be subject to a 'carbon tax' (this is justified by, among other things, the necessity to avoid 'carbon leakage', ie the migration of carbon-intensive processes and productions into other less developed countries in connection with the adoption of sustainability policies in developed countries). A response to this call would determine Russian hydrogen export capabilities.
3International Partnership for Hydrogen and Fuel Cells in the Economy
4 These goals provide for the production of 0.2 million tonnes of hydrogen for export by 2024 and 2 million tonnes for export by 2030.
5 Many states have recently adopted hydrogen energy concepts and intend to actively develop hydrogen technology (eg the UK hydrogen strategy published in August 2021, EU hydrogen strategy, published in June 2020 .
6 Минэкономики нашло способ обогнать ЕС по сокращению вредных выбросов Достичь низкоуглеродных целей России должна помочь поглощающая способность лесов