Transition finance – designed to help polluting companies develop long-term strategies to reduce their carbon footprint – is a relatively recent addition to the range of sustainable finance tools. Sabine Mueller and Nick Robins explain how and why the “just transition” to net zero, an inclusive process that considers the impact on all people and places, needs to be fully integrated.
Sustainable finance will be a priority again in 2022, not least to accelerate action on climate change and clean energy. the Communiqué of the G20 meeting of finance ministers and central bank governors highlighted sustainable finance as “critical for a green, resilient and inclusive global economic recovery” from COVID-19 in February]. A focus area of the G20 Working Group on Sustainable Finance (SFWG) this year is transitional finance, with finance ministers promising to “take action to enable transitional finance to ensure an orderly, just and affordable transition to a low-carbon and low-carbon economy support. resilient economy”.
Supporting the move away from unsustainable activities
Transition finance is a relatively new tool that focuses on helping companies in carbon-heavy and hard-to-reduce sectors to decarbonize, rather than providing capital for activities that already meet green standards. It is typically structured as a bond to use the proceeds, requiring issuers to demonstrate that the proceeds are used for activities that help reduce carbon emissions.
The transition bond market is still in its infancy compared to other forms of sustainable finance. In the first three quarters of 2021, 14 transition bonds were issued with a total volume of US$5 billion Climate Bond Initiative. As of September 2021, the volume of transitional bonds was $9.9 billion from a total of 31 issuances. In comparison, green bond issuance grew to $354.2 billion in the first three quarters of 2021, bringing the total volume to $1.4 trillion.
The skeptical view of transition financing questions whether these instruments really take companies beyond “business-as-usual” or simply do “transition-washing”. Building market trust requires robust frameworks that are both science-based and built on key international standards for environmental, social and governance (ESG) performance. the OECD published an inventory of new approaches and financial tools in 2021, showing a growing number of transitional funding frameworks from collective initiatives and individual institutions that aim to set out what looks “good” and define what ambitious decarbonization targets entail.
Japan established it Taskforce to formulate roadmaps to advance transition finance in business and industry, which produce sector-specific greenhouse gas reduction roadmaps that serve as a basis for developing and evaluating transition strategies. The Japanese government is also collecting examples of best practice on transitional funding and is applying its core climate change funding guidelines, for which it has offered to subsidize up to 90 percent of the cost of external verifications.
the I is currently working to define activities that have a significant environmental impact as well as those that do not have a significant impact to support the transitions of businesses that are currently having a negative impact on the planet. The Commission is examining ways of integrating these activities into the Green taxonomyas well as the possibility to consolidate the ecological and social taxonomies.
As part of this market creation process, the G20’s Working group on sustainable finance has been tasked with developing a high-level transition financing framework in 2022.
consideration of the just transition
As G20 finance ministers stressed last month, successful transitions must be “orderly, equitable and affordable”. This builds on the big shift made at COP26 when the Just Transition has moved into the mainstream climate policy and finance, with at least 10 new initiatives aimed directly or indirectly at making the just transition a reality. In fact, the Glasgow Financial Alliance for Net Zero (GFANZ) has recognized the just transition as a best practice component of transition plans for both the real economy and the financial sector.
High-emission and hard-to-reduce sectors are arguably the areas where the social risks and opportunities associated with climate action are greatest in terms of potential impacts on workers and communities. For example, the Glasgow COP underlined the need to accelerate the phase-out of coal-fired power generation, and a growing number of initiatives are developing mechanisms for “responsible decommissioning” of coal plants, including fair treatment of workers and communities.
Transitional funding seems an obvious tool to drive the environmental and social dimensions of decarbonization forward. However, the increasing recognition of the just transition as a critical success factor is not yet reflected in current transition financing guidelines or practice. Of the eight selected transition finance frameworks presented in Table 1, only two explicitly cover just transition: The ICMA Climate Change Finance Handbook recommends: “Where a transition may have negative impacts on workers and communities, issuers should Explain how they incorporate ‘just transition’ considerations into their climate change strategy, and may also list any ‘social’ expenditures deemed relevant in the context of transition finance.” Japanese government guidelines take a similar approach .
Table 1. Consideration of the social dimension in selected transition financing frameworks
Three frameworks support the integration of social considerations more generally, albeit in a very limited way. AXA’s policies include disclosure of “estimated environmental and social performance and impacts” as part of good practice. The EBRD framework covers the social dimension as a potential additional eligibility criterion but does not provide further details on how this might be applied. In addition, projects are expected to comply with EBRD specifications environmental and social policy. Similarly, Standard Chartered’s guidelines contain a reference to theirs Framework for environmental and social risk management Determination of minimum security.
The remaining three packages of guidelines do not consider the social elements of the net-zero transition. While the DBS definition includes a company that diversifies through the acquisition of a socially positive business as a reason for being classified as a company in transition, it does not mention social factors in its description of an instrument for using proceeds. The Climate Bonds Initiative documents explicitly recognize the importance of just transition and sustainable development, but deliberately limit their scope to climate protection only.
Close the gap
With the growing number of banks and investors committing to support the just transition, we expect transition finance frameworks and practices to evolve rapidly.
One group that could lead the way is the multilateral development banks, which have published theirs Just Transition Principles at the COP26. Since 2019, the EBRD has issued a handful of transitional instruments under its Green Transition Bond Framework. Proceeds will support projects to improve energy and resource efficiency and sustainable infrastructure in sectors that are heavily dependent on fossil fuels. This is particularly relevant in the EBRD regions as they are among the most carbon intensive economies in the world. In early 2021, the EBRD issued one A$280 million Transitional Loan, which was purchased entirely by Japan Post Insurance Co as part of its commitment to supporting environmental sustainability and a just transition. At a strategic level, the EBRD aims to link its previously separate policies to support green and inclusive transitions through theirs Just Transition Initiative. An obvious next step would be to apply this to its bond issuance programs.
Corporate issuers could also make a step forward, not least in the energy sector, where a new Energy Framework for a Just Transition was released in 2021. Italian utility snam For example, is a repeat issuer of transition bonds and has set a goal to increase its proportion of sustainable financing to 60 percent by 2024 to help the company become carbon neutral by 2040. Most of Snam’s transition notes have reached more than three times oversubscription by investors. These and other energy companies could also issue transition bonds that support decarbonization through a just transition and ensure employees and the regions they operate in are not left behind when fossil fuel plants close.
This year, the G20 Working Group on Sustainable Finance has a real opportunity to strengthen transition finance by incorporating the just transition. It could set the standard for other individual and collective initiatives. The inclusion of explicit guidance, targets and reporting for workers, communities and consumers would help ensure that the social opportunities of the transition are realized and the risks mitigated. This targeted approach allows transition finance to fulfill its role as a key contributor to a truly inclusive transition to net zero.