How Transition Finance Will Make or Break Our Net Zero Future

Growing awareness of climate change has turned green technologies and renewable energy projects into popular investments, particularly for financial institutions that have made their own environmental commitments. But to really reduce emissions, steel makers, airlines, power companies and other heavy emitters will have to make big, expensive changes. Enter “transition finance,” a fast-growing asset class with the potential to dwarf green investments and support cleaner economic growth in developing countries. For now, there’s no consistent standard for what qualifies as transition finance; skeptics say it’s especially susceptible to greenwashing, or misleading consumers or investors about a company’s environmental impact.

1. What is transition finance?

Transition finance refers to investments — typically bonds or loans — designed to help companies in heavy-emitting industries become more energy efficient and reduce their greenhouse gas emissions. So far, there’s no common definition or rules around what kinds of projects qualify — or don’t. Some early transition finance has raised money for natural gas power plants with potential for hydrogen co-firing, or for fuel-efficient aircraft.

2. How is that different from green bonds (or loans)?

For one, the “green” label for bonds and loans is comparatively well-regulated. Many issuers hew to the Green Bond Principles, endorsed by the International Capital Market Association nearly a decade ago. Money raised through specifically green instruments is only supposed to be used for low-carbon projects like developing renewable power or energy-efficient buildings, although that’s not always the case.

3. Why is transition finance important?

4. Who is pushing hardest for transition finance?

Asia is leading the charge. The Association of Southeast Asian Nations has developed guidance for the region that includes investments in carbon capture and the early retirement of coal power plants. China, the world’s worst polluter, is creating a transition taxonomy to cover sectors including steel and agriculture. Corporate transition bonds are booming in Japan, and the country plans to issue 20 trillion yen ($154 billion) in sovereign transition bonds over the next decade. The benefits wouldn’t be limited to Asian countries, though: Canada, whose largest source of emissions is oil and gas, is considering a transition-financing label for investments in those sectors.

5. How big is the market now?

Since 2019, about $18 billion of transition bonds have been issued worldwide, largely driven by China and Japan. Overall issuance from Asia more than doubled last year compared with 2021. Still, the total amount is tiny compared with the $2.2 trillion green bond market, and it’s a minuscule fraction of overall bond issuance.

6. What’s holding investors back?

The absence of clear standards is one big obstacle, along with general skepticism about the sincerity of the issuers. Some companies have issued transition bonds to fund technologies like carbon capture and storage, which seek to address the damage done by emissions but don’t reduce them. These worries are part of the objection to transition finance in Europe, which has led the world in developing green finance standards.

7. Does transition finance have a chance?

There are a lot of stakeholders who want it to succeed. The Just Energy Transition Partnerships, the big multilateral climate finance deals worth $43 billion and counting, are relying on transition finance to cut emissions in the developing world. More broadly, Asia’s push for transition finance will depend on well-defined criteria for eligible projects, the appetite of foreign investors, reliable data collection and transparent reporting.

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Source from: bloomberg