The addition of transition finance to the portfolio of sustainable finance instruments is a new instrument. It is designed to assist polluting companies in implementing long-term strategies to reduce carbon footprint. Sabrina Muller And Nick RobinsExplain how and why the just Transition to Net-zero, an inclusive process which takes into consideration the impacts on all peoples and places, is necessary.
In 2022, sustainable finance will be a prominent topic again, not least because it helps accelerate action on climate change. The Communiqu of the G20 Finance Ministers Meeting and Central Bank Governors MeetingIn February, sustainable finance was highlighted as a key component of a green, resilient, and inclusive global economic recovery. Transition finance is the focus of the G20’s Sustainable Finance Working group (SFWG). Finance ministers pledged to take steps to facilitate transition finance in order to support an orderly, just, and affordable transition to a low-greenhouse gases emissions and climate-resilient economic recovery.
Supporting the transition away from unsustainable activities
Transition finance is a relatively new tool. It focuses on supporting firms in difficult-to-abate and emissions-intensive sectors to decarbonise rather than allocating capital for activities that meet green standards. It is often structured as a “use-of-proceeds” bond. Therefore, issuers need proof that proceeds are being used for activities that reduce carbon emissions.
The market for transition bonds is still relatively new compared to other forms of sustainable finance. According to the, 14 transition bonds were issued in the first three quarters of 2021. They accumulated to US$5 Billion. Climate Bonds Initiative. The total volume of US$9.9 Billion in transition bonds was 31 issuances as of September 2021. Green bond issuances, however, increased to US$354.2 million in the first three quarters of 2021, bringing their total to US$1.4 trillion.
The skeptical view on transition finance raises questions about whether these instruments are actually moving companies beyond the status quo or just transition-washing. Strong frameworks that are science-based and based on international standards for environmental, governance, and governance (ESG), performance are essential to build market trust. The OECDPublished a inventory of emerging approaches and financial tools in 2021. This showed a growing number and variety of transition finance structures from both collective initiatives and individual institutions. These frameworks aim to define what good looks and what ambitious targets for decarbonisation.
Japan has established the Taskforce for the formulation of Roadmaps to Promote Transition Finance in the Economy and Industry areaThe resulting sector-specific roadmaps will be used to reduce greenhouse gases. The Japanese government is also gathering good practice examples of transition financing, using its Basic Guidelines for Climate Transition Finance. It offered to subsist 90 per cent of external review expenses.
The EUThe Commission is currently defining harmful activities for the environment and supporting companies that have a negative impact on the planet. These activities could be integrated into the Commission’s existing programs. green taxonomyAs well as the possibility to consolidate the environmental and socio-economic taxonomies.
The G20s are part of this market creation process. Sustainable Finance Working GroupA high-level framework was developed for transition financing in 2022.
The just transition
G20 Finance Ministers last month pointed out that successful transitions have to be orderly and just. This builds on the significant shift made at COP26, when the Only transition has moved into mainstreamThere were at least 10 new initiatives in finance and climate policy that had a direct or indirectly focused on making the just transition possible. The fact is that the Glasgow Financial Alliance for Net ZeroThe just transition has been recognized as a best-practice component of the transition plans for both the real economy, and the finance sector.
The social risks and opportunities associated with climate action are most severe in the hard-to-abate and emissions-intensive sectors. These sectors have the potential to have the greatest impact on workers and communities. Glasgow COP, for example, highlighted the need for faster coal power phase-down and a growing number initiatives are developing mechanisms to ensure the responsible retirement of coal assets with fair treatment of workers, communities, and communities.
It seems that transition finance is a useful tool to help decarbonize the environment and society. However, current transition finance guidance and practice do not reflect the recognition of the just-transition as a crucial success factor. Table 1 contains eight selected transition finance models. Only two of these frameworks explicitly cover the just-transition. The ICMAs Climate Transition Finance Handbook suggests that where a transition could have negative effects for workers or communities, issuers should outline the way they have incorporated considerations about a just transition in their climate transition strategy. It may also include any social expenditures relevant to transition finance. Similar approaches are taken by the Japanese Government guidelines.
Table 1. Table 1.
Three frameworks are available to help you integrate social considerations more broadly, but in a very limited way. AXA guidelines require disclosure of the estimated impact and environmental performance as part of good practice. Although the EBRD framework includes the social dimension as a possible additional criterion of eligibility, it does not provide any further details on how this could be applied. Projects must also comply with EBRDs Environmental and Social Policy. Standard Chartereds guidance also includes a reference at its Framework for Environmental and Social Risk Management defining minimum safeguards.
The other three sets of guidelines do NOT consider social elements of net-zero transformation. The DBS definition allows companies to diversify through the acquisition of socially beneficial businesses as one reason to be classified as companies in transition. However, it doesn’t mention social factors when describing a use of proceeds instrument. Climate Bonds Initiative documents acknowledge the importance and necessity of delivering just transition and sustainable development, but they limit their scope to climate mitigation.
Closing the Gap
We expect that transition finance frameworks will evolve quickly as more investors and banks commit to supporting the just transition.
Multilateral development banks (MDBs) are one group that could prove to be early movers. They published their Just Transition PrinciplesCOP26. The EBRD issued a few transition instruments under its Green Transition Bond Framework since 2019. The proceeds go to projects that improve energy efficiency and resource efficiency as well as infrastructure projects in highly dependent sectors. This is especially relevant for the EBRD regions as they are among the most carbon-intensive countries in the world. The EBRD issued a statement in early 2021. AU$ 280 millions transition bondJapan Post Insurance Co purchased the entire inventory of, as part its commitment to support environmental sustainability and a just transformation. Strategically, the EBRD aims to connect its previously separate policies to support green transitions through its Just Transition Initiative. This could be applied to bond issuance programs.
Corporate issuers could make a significant step forward in the energy sector, where there is a need for a new standard. Just Transition Energy FrameworkPublication date: 2021 Italian utility SnamIt is a regular transition bond issuer and has a goal of increasing its share to sustainable finance to 60% by 2024 to help the business become carbon-neutral by 2040. Snams’ transition bonds have been more than three times as popular with investors. These and other energy companies could also issue Transition Bonds to Support Decarbonisation Through a Just Transition, which would ensure that employees and the region where they operate do not suffer as fossil fuel assets are lost.
The G20’s Sustainable Finance Working Group has an opportunity to improve transition finance by incorporating just transition. It could be a model for other collective and individual initiatives. Clear guidance, targets and reporting to workers, communities, and consumers would help ensure that the transition is successful and that risks are minimized. This purposeful approach to transition finance will allow it to fulfill its role as an important contributor in a truly inclusive shift towards net-zero.
Notes:
- This blog post These views are those of the author(s) and not necessarily those of Grantham Research Institute.LSE Business Review and the London School of Economics and Political Science
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