Often dismissed as a ‘lighter’ shade of green or even as grey bonds, transition bonds are critical in the fight against the climate crisis.
But to fulfill their role as instruments that can fund to material improvements in sustainability, issuers and investors both nwed to get iver their reservations about the product.
Transition finance operates on a simple premise: to achieve net zero emissions, it’s not enough to only grow the green sectors of the economy, high polluting sectors need to change too.
But investors can be apprehensive that the pace of transition from brown to green is too slow to satisfy their green investment mandates. Or they fear greenwashing - that the label on the bonds masks activities more destructive to the environment.
These concerns are not unfounded. In the absence of clear and well understood definitions for what constitutes a transition bond for high-emitting sectors, the risk of greenwashing goes up. As a result, transition bonds have not emerged as a widespread sustainable debt product.
Only 2% of the green and sustainability bond market and 20% of the sustainability-linked bond market has come from hard-to-abate sectors, according to data from Icma.
The product is a missed opportunity but guidance is emerging that could give issuers and investors greater comfort, including from the the International Financial Reporting Standards (IFRS) and European Sustainability Reporting Standards (ESRS) and the UK Transition Plan Taskforce.
But even with clearer standards, the real challenge lies in transforming heavily polluting industries such as fossil fuels.
Funding a wind farm is an easy sell to ESG-minded investors. But to simply build more of them is akin to sticking a plaster on a broken leg. We didn’t get into a climate crisis just because we weren’t building clean housing or recycling hubs.
Make no mistake, those things are important but if the sectors that are thought to have driven global warming do not transition, then climate goals won't be achieved.
That sort of structural change will be the hardest part of the sustainability transition: how to phase out fossil fuel power generation, while keeping the lights on.
Many coal plants in Asia Pacific are protected by long-term contracts, and if they run to their expected life, they would eat two-thirds of the global carbon budget, said Alice Carr, executive director for public policy and Just Energy Partnerships at the Glasgow Financial Alliance for Net Zero (Gfanz) on a recent Icma transition finance webinar.
It is a “wicked problem” with “no simple solutions”, said Robert Youngman, who works on green finance and investment at the Organisation for Economic Co-operation and Development (OECD), on the same webinar
But solve that problem the world should and that is why transition bonds, with credible and ambitious targets or projects behind them will be the darkest shade of green investments - they will fund the biggest change towards a sustainable economy.