October 19, 2020

Guest post by Vasundhara Saravade and Jorge Sanz González

In the midst of the ongoing global climate crisis, we must push high carbon intensive growth industries like steel, cement and petrochemicals to shift not only steadily, but also relatively quickly towards low-carbon operations. However, if a transition of the economy is to occur in time, it needs both early adopters (think renewable energy sector) and laggards (think fossil fuel industry) alike to work towards the same goal – low-carbon, climate resilient and socially inclusive economic growth that does not undercut environmental thresholds. A major hurdle to this – when analyzing the green bond market – is that not every market stakeholder is in the position to issue or invest in such bonds, given their carbon-based business model or internal resource constraints. Such factors make it hard to scale up climate finance today in order to match the enormous transition challenge that we face over the next decade.

Transition bonds: A new climate finance tool on the horizon

In order to not leave anyone or any industry behind, the idea of transition bonds has surfaced in global climate finance circles. Transition bonds come into play as we move existing industries to a greener pathway. But what exactly is a transition bond? A transition bond allows actors and industries that are excluded from traditional green finance sectors to access financing for their transition efforts, based on certain criteria and timelines. Given the emphasis on maintaining the integrity (and accountability) of a transition, it is integral that transition bonds are transparent in their climate commitments, especially at the entity or issuer level. Given the sectors they target, such bonds will receive more scrutiny from both investors and stakeholders involved in this societal transformation (ranging from civil society actors to regulators).  

Data will be the new gold for transition bonds

There is a need to create formalized definitions and a universal lexicon of transition bonds, identifying the sectors or entities included in this category and their brown-to-green pathway. Data is emerging as a key competitive advantage in reaching these transition goals. Although investors already have internal taxonomies to help classify their investments, the ultimate ability to verify this with standardized, data-driven measures (i.e. green credit ratings or policies) will serve as reassurance of progress along a coordinated pathway to transition.

Corporate engagement will be crucial for success

In the new low-carbon economy, successful transitions will also rely on engagement and reputation-building. An important distinction for an issuer of transition bonds needs to be the overall level of engagement and strategy change through which they tackle climate impacts and adapt to the new economy. Investors find that issuers that are serious about transitioning not only show this through their engagement at the corporate initiative level, but also at the company strategy or mission level.

A good example of this is Ørsted, the Danish government’s oil and natural gas company. In existence since 1973, over the last decade they transitioned to being fully green by pivoting into the development of offshore windfarms. Using the green bond market, Ørsted was able to raise climate finance and build its new corporate reputation. With their stock market value increasing to approximately US$30 billion, it is now one of the most valuable renewable energy companies in Europe. Although this transition took a decade to achieve, the level of commitment and long-term impact of a brown-to-green issuer of this scale serves as a hopeful energy transition success story in the green bond market.

Accountability and timing

Investors often look at sunset dates as a way to track the progress of a transition. Similarly, governments should be looking at the sunset dates for certain economic activities or sub-sectors that may not be profitable and communicate these to all stakeholders. There is also a need to classify sub-sectors of the economy into a stranded category (cannot be phased out or not in line with global transition targets – e.g. coal-fired power generation) or an interim one (phased out by 2050). However, this can be complex, with sub-classifications changing based on entity-level (e.g. interim company that does waste to energy from municipal solid waste) or activity level (e.g. interim plastics recycling facilities across a region) transitions.

Much like Europe’s 2050 targets and taxonomy efforts, transition in Canada needs a national push towards mapping emission productions pathways per sector. One way to do this is by tracking progress via a centralized data portal called the Canadian Centre for Climate Information and Analytics. Investors are also aware that without a phase-out of public subsidies in transition sectors, these efforts will experience economic and political push-back. Hence, phase outs should not only occur for stranded assets, but also for interim ones that will need major capital, infrastructure and technology upgrades over time.

However, what is certain is that when transition activities start to reduce over time, investors and governments cannot afford to go back to passive engagement. If we are to achieve this transition in the next decade, a proactive approach is critical, especially in Canada where transition risks are high due to our resource economy. No matter which new climate finance tool is on the horizon (transition bonds or otherwise) – it will require sustained climate stewardship and accountability to see this challenge through.

For more on sustainable finance data and advancing the business case for the Canadian Centre for Climate Information and Analytics, read Smart Prosperity’s recent report on Bridging the Transparency Gap in Sustainable Finance

For more of Vasundhara’s work on climate bonds and green transition, check out her insights on: Canadian Financial Sector Stability & Climate Change - Solutions Towards a Low-Carbon & Climate Resilient Transition and Lessons for Canada from Emerging Green Bond Markets