While green bonds have become a popular way for companies to fund their sustainability projects, carbon-intensive operations have largely been excluded from these opportunities. But a new form of financing could help heavy emitters decarbonize their operations.
Transition finance is a form of financing that helps companies in “hard-to-abate” sectors like transportation, energy production, and heavy industry raise capital to fund the clean energy transition.
Unlike green bonds, which reward companies that are green already, transition finance allows so-called ‘brown companies’ to issue bonds and use the proceeds to fund projects that contribute to decarbonization. For example, a utility could use them to develop renewable energy projects. Or, a cement company might use them to invest in carbon capture, use, and storage (CCUS) technology.
Closing the gap
Globally, 40% of CO2 emissions come from hard-to-abate sectors like oil and gas, cement, steel, and chemicals. Experts agree that reducing emissions from these sectors will play a critical role in the global transition to a low-carbon economy.
However, turning traditionally brown industries green comes at a huge premium. For example, the cost of capturing CO2 ranges from $600-$800 per metric ton. The United Nation estimates that the transition to a low-carbon economy will require an investment of at least $60 trillion between now and 2050. While some of this funding will come from world governments, achieving long-term climate goals will be virtually impossible without support from financial institutions and investors. Transition finance can help close that gap.
A booming market
Already, sustainable and ESG investing is on track for historic growth. Moody’s predicts that sustainability bond issuance will hit a record $650 billion in 2021.
Even so, the demand for green bonds has far outpaced availability. Companies issuing sustainability bonds — including Google, H&M, and Adidas — have been met with overwhelming interest and are vastly oversubscribed. As the green bond market grows, transition bonds add another product to satisfy the growing appetite for impact investing.
Transition finance offers an exciting new opportunity for both investors and issuers. According to S&P Global Ratings, transition finance (including issuance) could contribute up to $1 trillion per year to the economy as heavy polluters seek out ways to fund the clean energy transition. In addition to providing the necessary capital to fund climate initiatives, issuing transition bonds can unlock access to a broader pool of investors who are interested in ESG issues. And if green bonds are any indication, transition bonds may also offer a pricing advantage compared to traditional non-green bonds.
While critics of transition bonds have voiced concerns about greenwashing, investor response has been overwhelmingly positive. Cadent, the UK's largest gas distribution network, issued the UK's first transition bond in March 2020. The bond, which will be used to replace pipelines to carry hydrogen and other low-carbon gases and reduce methane leakage, were 8.5 times oversubscribed. The initial offering was so popular that Cadent issued a second transition bond in March 2021.
Italian energy infrastructure company SNAM saw a similar response to its $750m transition bond offering in February 2021. The bonds were more than three times oversubscribed "by a high quality and geographically diversified set of institutional investors".l
As with green bonds, the issue of how and what to report is a complicated one for transition bond issuers. Investors generally expect issuers to provide disclosures that help them evaluate the environmental impact of their investments. These disclosures may be part of an annual report, or an investor presentation.
Currently, no universal standard exists for the issuance of transition bonds. However, several institutions including Sustainalytics and AXA Investment Managers have developed their own transition bond frameworks. The International Capital Markets Association (ICMA), which is responsible for the well-known Green & Social Bond Principles, has also launched new guidelines on transition finance. The guidelines clarify the information that should be made available to investors when issuing transition finance. These include four key elements: issuer’s climate transition strategy and governance; business model environmental materiality; climate transition strategy to be ‘science-based’ including targets and pathways; and implementation transparency.
Regardless of which transition bond framework they choose to follow, issuers will need to ensure they are utilizing best practice tools including ESG software to support their reporting efforts. Robust, accurate reporting will build trust and credibility with investors, which in turn directly impacts the bottom line.
Perillon offers simple, affordable ESG software that allows you to capture a broad range of sustainability information and manage performance at the asset level. To learn more, request a free demo with our solutions team.