As companies look to shift towards more environmentally sustainable operations, those in fossil fuel or heavy-polluting sectors are increasingly turning to transition bonds – a relatively new class of debt instrument used to fund a company’s s efforts to reduce its environmental impact or lower carbon emissions. They are often issued in large carbon-emitting industries that would not normally qualify for green bonds, such as oil and gas, iron and steel, chemicals, aviation and shipping. In the UAE, for example, Etihad Airways issued a $600m sukuk (Islamic bond) in September 2020 that was linked to its carbon-reduction targets. The airline is committed to net-zero carbon emissions by 2050 and a 50% reduction in net emissions by 2035.
Amid a heightened awareness of the need to reduce carbon emissions, many expected transition bonds to play a larger role in global financial markets after Spanish oil and gas company Repsol issued a €500m, five-year bond in May 2017. However, a total of 11 were issued in 2020 as a whole, according to non-profit organisation Climate Bonds Initiative (CBI). BloombergNEF found that as of June 2023 some $18bn of transition bonds had been launched around the world, with the bulk of the bonds issued by China and Japan.
In May 2021 Ghana’s Securities and Exchange Commission and the World Bank’s International Finance Corporation announced the development of a dedicated green bond exchange in the West African country, which opened in the capital Accra in February 2022. To date the African Development Bank has issued the bulk of the continent’s green finance, at around $1.5bn.
Appetite for Change
Despite the slow uptake, there are signs that transition bonds will play a more prominent role moving forwards. The London Stock Exchange established a transition bond segment in its sustainable bond market in February 2021, raising over $1.2bn as of the end of 2022, while in October 2022 the International Stock Exchange launched a new transition offering within its sustainable finance segment. Significantly, in May 2021 the Asian Development Bank announced that it would no longer fund coal mining, or oil and natural gas exploration and production. While this had a negative impact on companies active in fossil fuels, the announcement was an encouraging sign for the future of transition bonds in emerging markets, as the bank noted that it would continue to provide support for plants transitioning to cleaner solutions.
One example of the successful implementation of transition bonds is Japan. In May 2021 the country’s Ministry of Economy, Trade and Industry established a framework for transition finance to help reach the government’s 2030 and 2050 carbon-reduction targets of a 46% decrease in emissions by the former and carbon neutrality by the latter. After developing a series of net-zero roadmaps to achieve these goals, the country had issued nearly 30 transition bonds as of February 2023, with others on the horizon. In May 2022 Prime Minister Fumio Kishida announced plans to launch approximately $152bn of sovereign transition bonds over the coming decade, setting a precedent for other countries – especially those where a high percentage of GDP comes from hard-to-abate sectors.
Transition Washing
Although many observers are optimistic about the benefits of transition bonds, others are sceptical about whether the vehicles will bring about the expected outcomes. A common criticism revolves around how ambitious the projects that many transition bonds back are, despite the absence of clear international standards.
To help address the latter point, in June 2023 the Switzerland-based industry trade group International Capital Market Association published the “Climate Transition Finance Handbook” to provide a framework for transition strategies. The guide, which aims to create general rules for green bonds and sustainability-linked bonds, stated that bonds with the transition label should clearly stipulate how the funding will be used to support the Paris Agreement.
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