When speaking of leaders in the transition to net zero, Japan — or Asia, for that matter — doesn’t spring to mind.
After all, Asia’s emission intensity (how much a given pollutant is emitted relative to a specific activity or industrial process) is more than 40% higher than the rest of the world’s, according to the Asian Development Bank. And the region is home to economies with a high level of fossil fuel dependency.
Banks in the region are also some of the biggest financiers of fossil fuels. According to the 2023 Banking on Climate Chaos report, Japanese bank MUFG funnelled the most money to the hard-to-abate sector in Asia in 2022, providing some $29.5bn in financing.
But by using transition finance, which targets sectors (shipping, aviation, oil and gas, steel, cement) where going ‘green’ is challenging in the short-term due to a lack of economically or technically feasible green alternatives, Asian economies, including Japan, hope to transform their highly fossil-fuel dependent economies in line with Paris agreement climate targets.
Yet, while green activities have clearly defined thresholds for specific climate or environmental objectives, transition goals can vary, says Sustainable Fitch, which may yield a higher risk of greenwashing.
According to the Organisation for Economic Cooperation and Development, the two main factors that contribute to transition finance greenwashing risks are asset stranding and risks of carbon lock-in.
While progress has been made to define green and sustainable financing, transition finance is still without a universally accepted definition. Clearer understanding and stronger guidance about transition activities is needed if it is to become an effective tool in building greener economies.
Despite these challenges, Asia-Pacific (Apac) has embraced transition finance, so much so that it has become the largest region in terms of transition bonds issuance (where the proceeds are used for transition activities), accounting for almost half of the world’s cumulative total, according to the Climate Bonds Initiative’s 2022 Sustainable Debt report.
While transition bonds that have dedicated use-of-proceeds for transition activities are still only a very small proportion of the overall labelled bond market, the global transition bond market reached $3.5bn last year, making it the only area of green, social, and sustainability financing to demonstrate growth last year. The number of global transition finance deals grew from 12 in 2020 and 2021 to 35 in 2022, while the number of issuers more than doubled to 25.
Japan leads the way for transition bonds
The Japanese market was the largest source of transition finance volumes in 2022, according to the Climate Bonds Initiative’s report, encouraged by the Ministry of Economy, Trade, and Industry’s (METI) Basic Guidelines on Climate Transition Finance, published in May 2021.
The METI looks to use transition finance as a key tool for decarbonisation, especially in sectors where emissions reduction is challenging.
Japan’s transition finance market reached approximately ¥1tn ($6.7bn) at the end of FY2022, according to the Japanese Financial Services Agency.
While global issuance volumes of transition bonds grew by a modest 5% to reach $3.5bn in 2022, deal and issuer count surged, according to the Climate Bonds Initiative’s report. This was driven by a diverse range of Chinese and Japanese heavy industry issuers entering the market to raise funds under their respective national transition finance programmes.
Transition bond deals arose predominantly from heavy industry players in China and Japan, with the utility, oil and gas, and steel sectors dominating issuance volumes.
Japan’s largest deals came from Kyushu Electric Power and Tokyo Gas, which raised $429m and $323.3m, respectively, while utility company Huadian Power International issued China’s largest transition bond deal, raising $214m in September 2022.
A new type of ‘sovereign debt’ was announced by the Japanese government in May 2023. Named the Green Transformation, or GX, bond, the government plans to raise $144bn through sovereign bonds to support domestic decarbonisation efforts. Opting for transition pathways, it marks the world’s first issuance of sovereign transition bonds.
Alongside this, more transition finance and transition bond issuance is on the cards for the wider Apac region, says Nneka Chike-Obi, senior director and head of Apac ESG ratings and research at Sustainable Fitch. “I'm interested to see the effects of Japan’s sovereign transition bond, and whether or not other Asian countries look at that as a potential option,” she adds.
Outside of Japan and China, the only other transition bond issuers were the European Bank for Reconstruction and Development and Italian energy infrastructure company, Snam. However, both were repeat transition bond issuers.
European green taxonomy has limited applicability across Apac
The EU is the leading jurisdiction on establishing the green taxonomy and various supporting regulations to reach 2050 net zero targets, says Ms Chike-Obi. But the applicability of European approaches elsewhere is limited by contextual circumstances, she adds, including across Apac and in east Asia specifically.
“For example, the EU taxonomy doesn’t really address commercial agriculture, because commercial agriculture is not the driver of the European economy. But in south-east Asia, not only is commercial agriculture extremely important to the economy, it also has a direct relationship to deforestation and the release of carbon from tropical rainforests. Using the EU taxonomy alone wouldn't even address some of the core climate change-related issues that are happening in Asia,” Ms Chike-Obi says.
Given the limited applicability of the EU’s green taxonomy, the Asean taxonomy has been an important tool to better enable investors to compare and benchmark across potential projects and investments.
A departure from EU standards, the Asean taxonomy adopts a traffic light system where economic activities are classified, according to environmental impact, as ‘red’, ‘amber’, and ‘green’.
According to Sustainable Fitch, widespread adoption of the Asean taxonomy will form an important basis for policy-making and could serve as a roadmap for other emerging markets, such as Latin America and Africa.
“It’s not as ambitious perhaps as the typical European screening criteria, but it’s a start,” says Ms Chike-Obi. And while critics say the standards are not as stringent, the potential impact is enormous, she adds, because of the population and the level of industrial activity in Apac.
“From conversations that I’ve had in south-east Asia, people seem happy with the approach and investors find it easier to understand ‘red, amber, green’ than the EU taxonomy. When Singapore finalises theirs, it’s going to be aligned to the Asean one, and we'll see how the global market reacts to that,” she adds.
Banks are reporting upwards — using their own targets — and that’s where this drive is coming from.
With growing awareness that transition activities require significant financing, a thriving transition bond market could be a useful tool to mobilise capital. But lacking frameworks and definitions leaves issuers and investors reluctant to use transition labels, according to Sustainable Fitch.
With more banks operating in different Asian markets, questions about transitioning, decarbonisation, and reaching net zero have increasingly come to the fore.
Some commercial banks operating in south-east Asia are educating local companies about the purpose of efficiency and decarbonisation, which may otherwise be viewed as a burden, rather than a necessity, Ms Chike-Obi says.
“The banking sector is in the driving seat in Asia, because that's how most companies raise money. Most companies are not issuing bonds or having an initial public offering, they're just having a lender, or a number of banks in a syndicate. Banks are reporting upwards — using their own targets — and that’s where this drive is coming from.”
But the challenge is striking a balance between financing companies that are not yet as far down the decarbonisation path as their European peers, says Ms Chike-Obi, while maintaining pressure to transition activities in line with net zero targets.
