Transition bonds: a new tool for financing the shift towards climate sustainability?

Transition bonds are increasingly being used to finance sustainable solutions
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As companies seek to shift to more environmentally sustainable modes of operation, transition bonds are increasingly seen as a key financing tool for those in the fossil fuel or high-polluting sectors.

Transition bonds are a relatively new class of debt instrument used to finance a company's transition to reduced environmental impact or lower carbon emissions. They are often issued in fields that would not normally qualify for green bonds, such as large carbon-emitting industries like oil and gas, iron and steel, chemicals, aviation and shipping.

Amid heightened awareness of the need to reduce carbon emissions, many expected transition bonds to play a key role in global financial markets in 2021.

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Deals for 2021 include the $300m sale of Castle Peak Power in February, the proceeds of which will go towards the construction of a gas turbine unit at a power plant in Hong Kong, and the Hong Kong branch of Bank of China, the issuance of a $780m transition bond in January for projects aligned with China's goal of achieving carbon neutrality by 2060.

Separately, in January, the European Bank for Reconstruction and Development issued a A$280m ($216.6m) transition bond to finance its portfolio of green transition projects, while in February Italian energy infrastructure company SNAM launched a €750m two-tranche transition bond to help meet its 2040 carbon neutrality target.

Appetite for transition

While the uptake of transition bonds may have been a little slower than expected, there are some signs that they will play a more prominent role in the future.

In February, the London Stock Exchange announced the establishment of a transition bond segment in its sustainable bond market, while there have been calls for Japan's Ministry of Economy, Trade and Industry to introduce a target of selling 30 transition bonds by 2023.

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In another important decision, earlier this month, the Asian Development Bank (ADB) announced that it would no longer finance coal mining or oil and natural gas production and exploration.

While this was a blow to companies involved in fossil fuel production, the announcement was an encouraging sign for the future of transition bonds in emerging markets, as the bank signalled that it would continue to provide financial support for plants transitioning to cleaner solutions.Atalayar_Bonos

"The ADB will support developing member countries to mitigate the environmental and health impacts of existing coal-fired power plants and district heating systems by financing emission control technologies," the bank said in a statement.

Looking ahead, transition bonds are expected to benefit mainly from broader global trends towards sustainable or green finance.
CBI analysis published in April found that, despite the severe economic impact of COVID-19, a record $700bn in green, social and sustainable finance was issued last year, almost double the $358bn recorded in 2019.

In fact, in March, Standard & Poor's Global predicted that transition finance could account for $1 trillion of the estimated $3 trillion in annual funding needed to meet long-term climate goals.

Concerns about "transition washout"

While many are optimistic about the value of transition bonds, others are concerned about the impact they will actually have on achieving positive environmental and sustainable outcomes.

A common criticism revolves around how ambitious many of these transition bonds are, with the absence of clear international standards raising concerns about the potential for 'transition laundering' by companies.

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To help address this concern, in December last year, Swiss-based industry trade group International Capital Market Association published the 'Climate Transition Finance Handbook' to provide a framework for transition strategies.

The guide, which aims to create general rules for transition-themed green bonds and sustainability-linked bonds, stated that bonds with the 'transition' label should clearly stipulate how funding will be used to support the Paris climate agreement.