World’s first sovereign climate transition bond a ‘significant milestone’

Is 2024 the year that transition finance finally takes off? Analysts say it could be the strongest year on record following the world’s first sovereign climate transition bond issuance on February 14 by the Japanese government.

Japan’s groundbreaking and sizeable Y1.6tn ($11bn) climate transition bond will use proceeds to fund the country’s Green Transformation programme. It is broken up into different tranches.

The first tranche — some Y800bn of 10-year bonds — was auctioned on February 14. It will be followed on February 27 by a second five-year tranche for a similar amount. Another Y1.4tn-worth of transition bonds will be issued in the next fiscal year, according to Nikkei Asia. 

Transition bonds can be either sustainability-linked or use-of-proceeds bonds issued specifically to support climate transition goals. 

Japan’s transition bond has been in the pipeline for more than two years and complies with the International Capital Market Association’s green bond principles and climate transition finance guidelines.

The bond’s use of proceeds has been verified by the Japan Credit Rating Agency to be 95 per cent aligned with the standards of the Climate Bonds Initiative, a non-profit.

More than 55 per cent of the proceeds of the bond is allocated to support for research and development initiatives aligned with Japan’s efforts to limit temperature increases to 1.5C, in areas ranging from renewable energy to hydrogen utilisation in steelmaking. Some 44.5 per cent is for subsidies for activities ranging from the manufacturing of electricity storage batteries to energy efficiency measures in buildings. 

According to the CBI, the bond excludes any allocation of proceeds towards “gas-fired power generation or operational activities involving ammonia co-firing in coal-fired plants”.

“The bond is a prime example of private public partnership at scale,” says Jarek Olszowka, head of sustainable finance at Nomura. “The government is looking to make sure the economy stays competitive.”

Market milestone

Olszowka says Japan has created sector-specific technology roadmaps for the decarbonisation of electric power production, oil and gas, aviation, paper and pulp, iron and steel, shipping, cement, auto production, the chemical sector and a few others.

“It is about decarbonising their economy,” he says, adding that more than 80 per cent of Japan’s energy comes from fossil fuels. Its terrain is also mountainous, which leaves very little space for renewable energy infrastructure.  

Sean Kidney, chief executive of the CBI, says transition is the theme for the year because corporates, cities and countries need to put in place transition plans in line with global emission reduction targets.

“This bond shows clearly how governments, and others, can raise funds to invest in [the] transition. It marks a significant milestone in transition finance,” says Kidney.

The Japanese government is expected to issue close to Y20tn of transition bonds in the coming decade.

S&P Global Ratings estimates that transition finance, including issuance, could contribute up to $1tn annually (or around 30 per cent of the estimated $3tn per year required to meet net zero emissions by 2050) over the next 30 years.

Olszowka says just financing green technologies is not enough: “We need to also look at the highest-emitting sectors.” There are no readily available green technologies for a number of hard-to-abate sectors such as shipping or coal-fired power plants, so without some form of transition finance, the alternative is just continuing as normal. However, Olszowka says investors in transition bonds do not want to be locked in to a particular solution or technology because there might be some new technology that comes along that is better.

Despite the need for transition financing, instruments such as transition bonds have not captured the market’s imagination as much as green bonds, which accounted for around 60 per cent of total issuance in the green, social, sustainability, and sustainability-linked bonds market last year. Since the first transition bond was issued in 2019, total issuance has been less than $15bn and accounts for less than 1 per cent of the overall GSSSB market, according to S&P. 

Green bonds are much more established with industry bodies like ICMA as well as the EU having created standards governing them. But transition finance is still lacking a universally agreed definition, nor are there widely recognised transition bond principles, says S&P, with which issuers can align their framework.

However, Olszowka says the Japanese government hopes to export its approach to transition finance to drive adoption in other Asia-Pacific markets. 

MAS transition taxonomy

In December, the Monetary Authority of Singapore issued its Singapore-Asia Taxonomy for Sustainable Finance, which defines what activities should be considered green or contributing to the transition across eight focus sectors.

“Defining transition is particularly salient in Asia, where the progressive shift towards a net zero economy is taking place alongside economic development, population growth, and rising energy demands,” the MAS stated following the launch of the taxonomy. “Providing clarity on what constitutes sustainable and transition financing will also help to reduce the risk of green or transition washing, as financial institutions will be able to identify and disclose how their financed activities and labelled products are aligned with the taxonomy.”

The MAS taxonomy features a traffic light system — green, amber and red — for defining green, transition and ineligible activities across its eight focus sectors. Amber is reserved for activities that are not green, but are considered sufficiently helpful in the transition to deserve backing.

For example, in the maritime sector, where zero or low-carbon fuels are still in the early stages of technological evolution, MAS says the introduction of amber thresholds caters to vessels that are aligned with industry targets under the 2023 International Maritime Organization’s greenhouse gas strategy to reach net zero emissions by or around 2050, which sets intermediate targets of reducing emissions by at least 20 per cent and striving for 30 per cent by 2030 compared with 2008 levels.

Olszowka says policymakers should either have transition pathways clearly set out like Japan, or take the approach of Singapore’s transition taxonomy, which sets out what projects are eligible. 

Patrice Cochelin, managing director and head of analytical governance for sustainable finance at S&P Global Ratings, says the MAS taxonomy could lead to more transition bond issuance coming out of the Asia-Pacific region this year. 

He also points to Europe where he says the Corporate Sustainability Due Diligence Directive could also help drive the transition finance market because it may help shed light on sustainability considerations along the value chain.

However, as reported by Sustainable Views, a number of EU countries continue to oppose the CSDDD, with a vote on the regulation now expected on February 28.