Green bonds but also "transition bonds"

The Climate Bonds Initiative, a non-profit organisation seeking to “mobilise the largest capital market of all, the $100 trillion bond market, for climate change solutions,” and Credit Suisse, have published a white paper Financing Credible Transitions: How to Ensure the Transition Label has Impact.

According to the paper, as companies and investors seek to scale up climate action to meet the targets of the 2015 Paris Agreement, there has been a parallel rise in the use of green bonds and sustainability bonds to finance investments in climate mitigation solutions. “As the market has grown, so too has the breadth of assets and activities that is being financed to cover a more diversified cross-section of the global economy. Large GHG emitters, however, are still largely absent and present an opportunity for the markets to aid their sustainable transition. But while such actors have not played a significant role in the green finance market to date, they have a vital role to play in reducing global emissions – and are often key constituents in mainstream investment portfolios.”

In response to this challenge, the Climate Bonds Initiative and Credit Suisse put forth a new framework for ‘transition bonds’ to fill market gaps where traditional green bonds have excluded these market actors. The framework was developed “to support the rapid growth of a transition bond market as part of larger and liquid climate-related market.” To avoid the potential for “greenwashing” climate targets (such as an overreliance on offsetting emissions rather than reducing them), the framework aims to “deliver confidence for investors, clarity for bankers and credibility for issuers.” The framework was developed based on interviews with key stakeholders such as loans issuers, banks and policymakers.

In short:

• The traditional green bond label focuses more narrowly on how funds are being used, via the “Use of Proceeds” model “where, for example, a green label is appropriate at an activity-level for an oil company building a wind farm but not appropriate for the entire entity.” The authors propose that “the green label continue to be used for eligible investments (i.e. that meet the Principles) in activities or entities that have a long-term role to play and are either already near zero or are following decarbonisation pathways in line with halving global emissions by 2030 and reaching net zero by 2050.”
• In contrast, the proposed transition concept applies to entities if the entire company is on a transition pathway. The proposed transition label would be used for investments that “are making a substantial contribution to halving global emissions levels by 2030 and reaching net zero by 2050 but will not have a long term role to play; OR will have a long term role to play, but at present the long term pathway to net zero goals is not certain.”

Some of the key takeaways highlighted in the paper are below:

Takeaway 1: Financing for climate investments is growing

To meet the goals of the Paris Agreement, there is a diverse emerging ecosystem of bond “labels” that seek to direct financing towards sustainable climate investments:

Source: Climate Bonds Initiative, Financing Credible Transitions: How to Ensure the Transition Label has Impact (September 2020)

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‍Takeaway 2: The transition bonds framework is underpinned by five principles to protect from greenwashing

The authors note that greenwashing of investments in climate solutions is a threat to driving real progress on climate change. The transition bonds framework is therefore underpinned by five core principles to ensure transition investments are credible and robust:

1. “Credible transition goals and pathways align with 1.5°C global warming limits” as defined by the Paris Agreement. Per the 2019 Special Report on Global Warming of the Intergovernmental Panel on Climate Change (IPCC), “global emissions need to drop by 45% from 2010 levels by 2030 and down to net zero globally by 2050.”
2. “Credible transition goals and pathways are established by the climate science community and are not entity specific.” Given the immense complexity of determining the contribution of different sectors, activities, and geographies to climate change and attempting to create mitigation pathways specific to unique circumstances, “pathways should be harmonised globally, e.g. through regulatory approaches such as the roll out of regulated taxonomies like the EU’s.”
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3. “Credible transition goals and pathways don’t count offsets but should count upstream scope 3 emissions as much as is possible.” According to the paper, “offsetting reduces transparency and diverts attention away from reducing inherent emissions.”
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4. “Credible transition pathways take into account technological viability, but not economic competitiveness.” This means that more expensive technologies should not be ruled out as a matter of cost. “Economic barriers to technology up-take could be addressed with appropriate incentives and support, as has been demonstrated for various renewable energy forms.”
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5. “Credible transition means actually following the transition pathway – pledges and policies are not sufficient.” In the face of an increasingly urgent imperative to reduce GHG emissions, the paper states that “[t]ransition to transition is not acceptable.” Rather, “[t]he focus needs to be on impact that is actually being delivered today (and over the term of the investment), as determined by alignment with a credible transition pathway (that meets principles 1-4).”

Source: Climate Bonds Initiative, Financing Credible Transitions: How to Ensure the Transition Label has Impact (September 2020)

‍Takeaway 3: Different economic activities require different approaches to transition

The framework accounts for five categories of economic activities in recognition that not all business entities and activities will be able to transition at the same rate or to the same extent. This ensures that any transition framework is inclusive of entities across the entire economy. The five categories are outlined below:

Source: Climate Bonds Initiative, Financing Credible Transitions: How to Ensure the Transition Label has Impact (September 2020)

‍Takeaway 4: While it is important to distinguish between green bonds and transition bonds, there is a role for both to meet global climate goals

The means of determining when a green bond label is applicable and when a transition bond label is applicable are laid out in two decision trees detailed in the report —one for whole entities, and one for specific activities. In short, whether the green label or transition label can be used depends on a range of factors, including whether the entity is currently near zero, whether the activity can be aligned with the Paris Agreement global warming target, and whether the product or service produced is needed up to 2050 because no viable substitute exists.

“The UN’s 17 Sustainable Development Goals (SDGs) frame a future where it is possible to imagine air that is cleaner than what we breathe today, where everyone can access clean water and where climate change is restrained to avoid threats to peace and our survival. To achieve that from where we are today, we urgently need to reverse rising greenhouse gas (GHG) levels and help communities and economies to adapt. This will require entities with some of the highest emissions levels to reimagine themselves, planning and implementing transition pathways in a world that has renewed priorities for GHG management and climate resilience.”                        

Climate Bonds Initiative and Credit Suisse, Financing Credible Transitions: How to Ensure the Transition Label has Impact (September 2020)