A growing number of bankers and investment managers are trying to develop a transition bond market that will allow carbon-intensive companies and industries to finance their gradual shift away from fossil fuels.
Last month, AXA Investment Managers (IM) issued a statement calling for the adoption of transition bonds.
Yo Takatsuki, head of ESG research and engagement at AXA IM, says it is hoped that it will lead to the development of a working group, so that in 12 months’ time a formal set of principles will be in place to support the growth of transition bonds.
AXA IM is one of the largest holders of green, sustainable and social bonds, with €4.5 billion invested at the end of March – €3.9 billion in green bonds.
Takatsuki says the investment manager made the call because green bonds simply aren’t moving the needle on the shift to clean energy fast enough.
|Yo Takatsuki, AXA Investment Managers|
“The green bond market has been helpful in encouraging those companies that wanted to be green to do so, and those that already were to become even more green,” says Takatsuki.
"It helped them get their story out, and promote clean energy. But it has not shifted the mentality of corporate issuers that are far from being green to adjust to a low-carbon world."
He adds: “In autos, shipping, tech, extractive industries and steel I had hoped a step would have been taken. But that just is not the case. We need a different and complementary tack. We need better financing tools available for transition financing.”
Herve Duteil, chief sustainability officer, Americas at BNP Paribas, agrees. He says his bank has been in discussions for several months with investors to promote the development of a transition bond market.
“The reality is we are not going to reach a decarbonized world by solely focusing on wind and solar farm or the green sector," says Duteil. "There are some industries that will remain brown for the foreseeable future until new technologies are developed – like the airline industry.
"But we need to look at these brown sectors and improve their energy efficiency even if we can’t get them to a full green. Transition bonds could help us do that.”
As yet there have been just two bonds similar to the transition bonds suggested. The first was an energy transition bond from Hong Kong’s main electricity generation company, Castle Peak Power Company Limited (CAPCO). The financing was needed to build a gas-fired unit to replace coal.
The second was a climate action bond from Snam earlier this year. The Italian gas company is using the proceeds to fund investments in biomethane and energy efficiency and those aimed at improving the environmental impact of Snam’s activities, as it targets a 25% reduction in its methane emissions by 2025.
Diverse investor demand and potentially favourable financing terms in a new asset class of transition bonds may help to encourage the shift in brown companies and industries Takatsuki mentions. A different class of bonds would also have other benefits – chiefly ensuring green bonds remain green and free from greenwashing.
“While natural gas is less brown than coal, it is still not green; yet, sustainable investors we speak to understand the role gas has to play as a transition fuel,” says Duteil. “Transition bonds would help the green bond market maintain its integrity and quell concerns about greenwashing.”
Sense of urgency
Given the sense of urgency around carbon reduction, any framework for transition bonds needs to be timely. Duteil says new principles are not warranted. “There’s no need to make this complicated. The green bond principles are about a process and worked well to be used for the Snam deal.” (BNP Paribas was a lead manager on the Snam deal).
Crédit Agricole CIB
“The green bond principles are guidelines recommending transparency, disclosure and reporting, and originally were not including any list of eligible assets,” she says. "In the subsequent versions, there has been the inclusion of a list (not considered as being exhaustive) of potential eligible assets.
"For instance, they also apply for energy-efficient assets – financing assets to improve energy efficiency. Therefore, they lend themselves to being adopted for transition bonds.”
That said, there are several nuances that will need to be considered. Geography is one of them, says Duval. She points to the CAPCO bond.
“In this case, gas was the best option for a transition because the opportunity for Hong Kong to develop renewable energy projects is limited," says Duval. "Now, that would not be the case in places like France where renewables and indeed nuclear would be the cleanest energy options for any fossil fuel company looking for a transition.”
With this focus on “the best option”, Duval says the market will have to come to some agreement on what is the best way to proceed so that any deal is transparent and clear. “What we do not want is a confused market,” she says.
Duteil goes one step further. “What we don’t want to see is headlines about Company X going from brown to green. This is not what a transition bond means. It is about going from brown to less brown. We can’t have investors or the media confused about this.”
What is enough?
Other guidelines would need to take into consideration the long-term commitment of any company transitioning to greater energy efficiency. Says Takatsuki: “This isn’t meant to be for one-off projects. We would expect issuance to show long-term climate goals.”
Adds Duteil: “There also need to be clarity around – what is enough? Is 10% more efficient enough for some industries and not others? For example, if engineers determine that a 40% fuel-efficiency can be achieved in the airline industry, can an airline raise a transition bond for 25% fuel-efficiency? It may be up to the investors to set their own standards.”
Investors will also have to determine whether transition bonds should be incorporated or kept separate to green bond funds.
What the now open discussions around transition bonds should lead to, in addition to a new asset class, is greater thought about tackling the large volumes of financing still supporting brown industries. Green bond market issuance was about $180 billion in 2018.
Says Takatsuki: “Solutions to some of these big global challenges are just not being looked at closely enough in terms of how the financial market is structured and shaped. We really need to start coming up with different ways of financing around climate change, and the discussion on transition bonds may encourage that.”