Transition finance is a nebulous term with no universally accepted definition. It can be applied to public or private funds, as well as fields ranging from financing early coal retirements, natural gas projects and financing or subsidising decarbonisation of hard-to-abate sectors where there is no commercially viable emissions reduction technology available.
While centred around the aim of decarbonisation, this flexibility is the main appeal of transition finance. It can funnel financing to areas where fossil fuels or assets with higher carbon emissions are involved and would otherwise fall outside the scope of other sustainability financing instruments.
More markets are seeking to address the shift to a low-carbon economy in ways that align closely with their broader environmental, social and governance interests. This is particularly so in markets with a heavier reliance on brown assets or where natural gas is expected to play a substantial role as a bridge fuel towards a future low- or no-carbon energy system. Asia, which is home to most of the world’s coal-fired power generation, is a prime example of sustainable finance taxonomies being adapted to meet regional needs and the structure of energy markets(Figure 1).
Figure 1. Coal reliance in Asia Pacific economies remains high in 2023
Source: Sustainable Fitch, Fitch Solutions
In a world first, coal phase-out has been included as a supported activity within the second version of the Association of Southeast Asian Nations taxonomy of sustainable activities. Not only will this act as a blueprint for other markets seeking to adapt taxonomies to suit local conditions, it represents a cornerstone for alignment with transition finance instruments or sustainability-linked financing where key performance indicators chart a decarbonisation pathway.
In most iterations, transition bonds allow for the issuance of debt with the use of proceeds going towards natural gas. With a total of $12bn of transition bonds issued, issuance has been small compared to the rest of the labelled bond space.
Japan’s introduction of a comprehensive transition framework last year to support its emissions reduction goals for 2030 and 2050 saw Japanese companies dominating bond issuances under the transition label (Figure 2). Other markets, such as China and Hong Kong, have also had issuances, largely in local currency.
Figure 2. Issuance of transition bonds low against rest of labelled bond space
Labelled bond issuance from fiscal year 2022 to first quarter 2023
*All issuance in Italy by Italian gas network operator Snam S.p.A
Source: Sustainable Fitch, Environmental Finance Bonds Database
Investor appetite for transition bonds appears mixed (Figure 3). As the majority of issuance has taken place in Asia Pacific in local currency, it suggests take up has been largely from local investors. Investors outside the region may be more hesitant to add transition bonds to their portfolios as it may dilute alignment with major taxonomies, notably the European Union’s green taxonomy. While this taxonomy allows for natural gas projects, these need to meet specific criteria and thresholds.
Figure 3. Transition bonds struggling to catch on
Source: Sustainable Fitch, Environmental Finance Bonds Database
While the transition label may struggle to gain traction outside of Asia for now, issuers might find that sustainability-linked bonds also fit the purpose of financing transition activities. These bonds are still inherently tied to an improvement in environmental performance over time, while also providing quantifiable sustainability targets. This may include stricter decarbonisation targets or more specific and measurable greenhouse gas emission reduction plans.
The pace of issuance of SLBs indicates rising demand from investors for such instruments. The Asean SLB standards that were released in late 2022 help enhance the credibility and standardisation of these bonds that rely on transition activities, which may bolster their appeal further over, or in addition to, transition bonds.
Marina Petroleka is Global Head of Research, Sustainable Fitch.
This article was originally published in the SPI Journal, Summer 2023 edition.
