ESG compliance criteria and categories
The ESG Decree sets out certain criteria which must be complied with to be recognized as ESG project, in particular, to reduce CO2 and NOx emissions, increase energy efficiency, use modern technologies with high green-environment standards, utilize renewable energy sources, and work towards preserving and restoring biodiversity.
Should these criteria be met (subject to verification by authorized entities), such projects may be recognized as ESG project ("Green" or "Adaptational") and be eligible for government subsidies.
"Green" projects
"Green" projects are the highest-grade category of projects. They have to meet internationally recognized environmental standards first outlined in the Paris Climate Agreement and the United Nations' 2030 Agenda and Sustainable Development Goals and reproduced in the ESG Decree. The concept of "green" projects is designed primarily to attract foreign investors seeking sustainable investment options.
Green projects are divided into 8 distinct industry groups, each with a set of criteria corresponding to a certain type of project relevant to that particular industry:
- waste management;
- energy;
- construction;
- manufacturing;
- transportation and industrial machinery;
- water supply and discharge;
- natural landscapes, rivers, water bodies and biodiversity; and
- agriculture.
Adaptational projects
Adaptational projects may not meet the international ESG standards at this time; however, they should meet the Russia-specific environmental standards. Projects meeting these criteria may attract additional investments from Russian institutions and ventures and will also be eligible for government subsidies going forward.
The ESG Decree provides for a narrower range of industries for adaptational projects that may be adapted to comply with ESG principles compared to the green projects category (construction; water supply and discharge; and natural landscapes, rivers, water bodies and biodiversity are excluded from the industries list for adaptational projects), albeit it introduces a new Sustainable Infrastructure group.
The criteria for adaptational projects differ considerably from those in place for green projects. A broad analysis suggests that while the criteria for green projects are designed to perfect the tools and facilities used for sustainable business and production development, criteria for adaptational projects are meant only to point potentially sustainable Russian projects in the right direction for further green renovation. An example of this would be the criteria for use of renewable energy (e.g. solar, geothermal, wind etc.) which is a specific requirement for green projects, while the criteria for adaptational projects in this regard only require that businesses modernize their production facilities so that they could support energy types different from the ones currently used (e.g. natural gas) without specifying the exact energy types to be used going forward.
Sustainable Finance Instruments
The ESG Decree introduces the concept of sustainable finance instruments ("SFI") and criteria for these instruments. The SFIs should meet the following main criteria:
- financing is directed at sustainable development projects and only for the purposes of compensating any costs or expenses.
- any funds raised by the SFI should be utilized no later than 24 months after the SFI has been issued, unless specified otherwise in the SFI. No special procedure establishing grounds for utilization period extension has been adopted so far; therefore, it is unclear whether parties to the SFI are free to set a longer period on their own discretion, or whether approval from supervising authorities is required.
- any idle funds left over from financing a sustainable development project will be utilized and accounted for under the project initiator's idle funds management policies; project initiators will be required to submit a cash flow accounts report in respect of such funds to supervising authorities.
The SFI might be practically issued in the form of "green bonds" or "green facilities". No special procedure for green facilities has been adopted so far; however, green bonds are an increasingly popular financial instrument among Russian companies, and quite a number of green bonds have already been issued by Russian companies.
Should an issuer opt to label as and include "Green bonds" into the bond prospectus, the decision to issue the bonds and the bonds themselves are to meet certain requirements imposed by the Central Bank of Russia, institution/monetary authority acting as financial market regulator and responsible for monetary policy of the Russian Federation. The issuer has to disclose the project description, budget, purpose and project positive environmental or social impact, adapt special ESG and audit policies, and adapt special procedure on supervision of compliance with the project purpose. Non-compliance with the project purpose constitutes an event of default under the SFI.
Verification and Verifying Entities
In order to be eligible for potential government subsidies, the SFI and sustainable development projects must undergo a verification procedure conducted by special verifying entities confirmed in their capacity as such by VEB.RF, the special national economic development institution and the entity acting as intermediary between businesses, financial institutions and public authorities, and major investors in large-scale projects both in Russia and abroad. VEB.RF is appointed by the Russian Government [1] to act as the methodological center for sustainable finance regulations and has published a provisional list of verifying entities on its official website [2], which includes only three agencies so far: "Expert RA" Agency, Acra-Ratings and the National Rating Agency.
Verification is performed in two steps:
- preliminary step: determining project compliance with the ESG criteria set out in the ESG Decree prior to funds utilization (i.e. prior to registering a green bond offer or prior to the entering into a green facility agreement); and
- confirmation step: determining compliance with the ESG criteria set out in the ESG Decree and project description following funds utilization.
Verification is performed based on a number of documents, policies and records provided by project initiators to the verifying entities; moreover, the verifying entities are free to adopt other verification procedures, including interviews with the initiator's employees and using publicly disclosed and available information.
The ESG Decree provides a detailed account of the verification order and the nature of factors to be scrutinized in deciding whether a sustainable development project is in compliance with the criteria set out in the ESG Decree. Verifying entities and project initiators are free to agree on the appropriate verifying period based on the complexity of the project.
Post-verification approval
Subject to successful verification of a project, the verifying entities are required to produce a verification report and deliver a copy to VEB.RF.
VEB.RF seems to be a key player in coordinating and supporting sustainable finance in Russia. VEB.RF is responsible for overseeing the entire verification process and has a significant impact on deciding whether a project is in compliance with the sustainable development criteria. Should it find that not to be the case, the priorly issued report of the verifying entity will be subject to additional review.
Subsidies and benefits for sustainable development projects
The Russian Government gained ground towards introducing subsidies and benefits for companies engaged in sustainable development projects and adopted the Decree of the Russian Government No. 541 dated 30 April 2019 "On approval of rules for granting subsidies from the federal budget to Russian organizations for partial compensation of expenses incurred from payments on bond coupons issued for effecting best available technology investment projects, and (or) for partial compensation of expenses incurred from payments on loan interests obtained from Russian credit institutions, as well as from international financial organizations established under the international treaties to which the Russian Federation is party, for effecting best possible technology investment projects" ("ESG Subsidies Decree").
Under the ESG Subsidies Decree the Ministry of Industry and Trade, the state authority responsible for industry, exports and imports regulations and technical regulation ("Minpromtorg"), grants subsidies for green bond issuers and green loan borrowers provided that the project they invested their money into complied with certain criteria, with the primary ones being:
- an investment project is aimed at reducing the negative effect on the environment by applying the best available technology to production sites and other environmentally adverse activities;
- an investment project advances step-by-step progression towards compliance with technological and environmental regulatory standards and (or) reduction of the use of polluting agents [3]; and
- an investment project involves expenditures for implementing the best available technology.
The ESG Subsidies Decree was adopted before the ESG Decree and it is currently unclear whether the ESG Subsidies Decree will now exist as a direct supplement of the ESG Decree. We assume that to be the case and VEB.RF will be responsible for coordinating with Minpromtorg and other government bodies on the granting of subsidies to initiators of sustainable development projects.
Eligibility for subsidies
The ESG Subsidies Decree states that initiators may be subsidized to reimburse up to 60% of green loan interest payments or up to 60% of green bond coupon payments under the condition that:
- the initiator (and (or) its subsidiaries) is not a foreign entity, as well as entity whose shares are owned by foreign entities registered in offshore jurisdictions, included into the list of the Ministry of Finance [4];
- he initiator (and (or) its subsidiaries) does not receive funds from the federal budget under other legislative acts for the purposes of supporting sustainable development projects;
- the initiator (and (or) its subsidiaries) has no accrued tax arrears;
- the initiator (and (or) its subsidiaries) has no outstanding obligation to return subsidies to the federal budget;
- the initiator (and (or) its subsidiaries) is not undergoing any reorganization (excluding cases of consolidation), liquidation or bankruptcy procedures; and
- the initiator's (and (or) its subsidiaries') directors and (or) high-ranking officials are not included into the register of disqualified persons.
Information disclosure
Under the ESG Subsidies Decree initiators should to provide a wide range of documents and information regarding both sustainable development projects and initiators themselves. To grant subsidies Minpromtorg should enter into an agreement with an initiator (so called "subsidies agreement") which contemplates allocation of subsidies to an eligible company as well as an information exchange mechanism.
Conclusion
The ESG Decree introduces the basis for sustainable development projects in Russia and allows initiators to attract additional investments for their projects. However, currently the exact role played by VEB.RF, and further subsidies and benefits for sustainable development projects remain uncertain , but the Russian government will continue to support the global sustainable finance trends going forward.
References
1 the list includes, among others, BVI, Cayman Islands, Bermuda, the Principality of Liechtenstein, the Republic of Panama, and the Principality of Monaco.
2 The list of polluting agents under governmental control: Directive of the Russian Government dated 8 July 2015 No. 1316-p "On approval of the list of polluting agents in respect of which governmental regulatory measures in the field of environment protection are exercised".
3 Directive of the Russian Government dated 18 November 2020 No. 3024-p "On the coordinating role of the Russian Ministry of Economic Development in matters of developing investments in, and raising extra-budgetary funds for sustainable (including green) projects in the Russian Federation"
4 Rating agencies approved by VEB.RF as independent verifying entities (provisional list): https://veb.ru/ustojchivoe-razvitie/zeljonoe-finansirovanie/
