Six ways to fix sustainable finance – 4: Develop transition finance

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By:
Helen Avery
Published on:

Euromoney has drawn up six recommendations for the sustainable finance sector, based on the views of 20 experts in the field. The fourth of our six proposals is to develop transition finance.

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SIX WAYS TO FIX SUSTAINABLE FINANCE
Introduction: Sustainable finance's biggest problems
1. Join the PRB
2. Mandate TCFD
3. Standardize climate risk measurements
4. Develop transition finance
5. Target deforestation reduction
6. Incentivize green finance

Can banks be expected to cut finance to environmentally-damaging companies?

“How do you cut finance to prevent people from burning rainforests so they can afford to buy a car, when Americans have three cars?” asks one sustainable finance head. “It keeps me awake at night – this question of how to steward this transition in a way that won’t cause harm to those who need financial support.”

It is here in this grey area, where finance needs to support the transition of the global economy from brown to green, that sustainable finance heads say greater action is needed.

“Sectors have to transition and they’re going to need financing,” says one head of sustainable finance. “We cannot take the moral high ground and withdraw financing from the biggest polluters, yet none of us seem clear on the tool that will work best to finance that transition.”

Green bonds are failing to change either the direction of finance or corporate clients’ strategic plans. Sustainability-linked loans are considered more impactful and several bankers also point to ENEL’s recent bond as a potential structure others could follow. In September the Italian power producer launched a $1.5 billion SDG-linked bond that had a commitment to increase the coupon by 25 basis points if the company fails to meet its renewables capacity development targets by the end of 2021.

graph4 transition

One banker puts forward that the market needs to start insisting on greater clarity around the purpose of financing – and to ask companies to better explain their transition strategies so any financing for such companies could be seen as ‘transition finance’.

Investors will have to be convinced, however. Several large investors have criticized ENEL’s bond for being described as ‘green’.

Several sustainable finance heads say they are frustrated with investors and asset owners. “We need investors to support bonds and other financial tools that help a transition – be those called transition bonds, or dark green (or brown) bonds, rather than just looking for pure green,” says one.

Discussions around whether definitions or frameworks need to be put in place around ‘transition’ products are increasing. The EU Taxonomy has started to integrate ‘transition’ into its guidelines around ‘green’ and will be expanding its definitions. One banker points out that Canada’s Standards Association (CSA) is defining transition for Canada and Icma has also started a working group on transition finance.

One sustainable finance head blames corporates for slowing down the transition. “Corporates aren’t doing enough. Sustainable finance is a tool to help them and they’re not using it,” he says.

The consensus, however, is that a broader range of products and services is needed for both investors and corporate, which means banks need to start innovating beyond green bonds. Boston Common Asset Management’s study showed 55% of the banks it surveyed have set explicit targets to increase and promote low-carbon products and services, up from 46% last year. Lauren Compere, director of shareholder engagement at the asset management firm says it is not enough.

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Rhian-Mari Thomas, Green Finance Institute

Rhian-Mari Thomas, chief executive of the Green Finance Institute (GFI) agrees. “We need to get institutional investors involved and at present we don’t have enough investable opportunities that meet their return criteria.” She highlights the lack of emerging markets products where arguably much of the investment in climate change mitigation needs to go.

“The perceived risk in emerging markets – FX risk, political risk, a lack of secondary market and liquidity – means the large amounts of capital are not getting to where they need to go. We need more investable channels and tools; possibly aggregating different projects, using warehousing techniques, for example, as well as involving concessional and philanthropic capital to credit enhance or reduce risk.”

One sustainable finance head echoes Thomas in arguing that greater emphasis should be put on developing blended finance solutions.

Thomas also says that for more innovative financings to develop, there needs to be greater collaboration between sustainable finance heads and those with structuring and deal making expertise.

It’s a point made by several on the periphery of sustainable finance – that the backgrounds of those working in sustainable finance is often in public sector and policy-making rather than deal-making. Indeed some point out there is a gap that needs to be bridged if sustainable finance is to stop being seen as a niche business and instead integrated into core bank businesses.

“We need to better connect those that understand the issues and those who are doing the deals,” says one market participant. “Some of that will include making these issues relatable to capital markets teams so they can assess the risks and opportunities to their revenues from brown versus green opportunities.

"On a very practical level, they want to know where they should be allocating resources. And speaking to them in acronyms or about methodologies or these bigger initiatives won’t capture their attention.”