Bringing you live news and features since 2013
Bringing you news, views and analysis since 2013
Frederic Vonner, PwC
Frederic Vonner, PwC

50774

Recalibrating transition finance and green bonds

RELATED TOPICS​

PwC Luxembourg’s Frederic Vonner writes that the fight against climate change is a generational undertaking which requires global cooperation and the mobilisation of capital on a scale never before seen. 

Living up to the ambitions set by the Paris Agreement will necessitate the full decarbonisation of our global economy. However, pivoting planet-spanning supply chains and replacing carbon intensive assets with ones based on clean technologies will only be possible with tremendous capital commitments.

Transition finance tools such as ‘use of proceeds’ instruments (also known as Green, Social and Sustainability Bonds – GSS Bonds) and sustainability-linked instruments are an important means through which net zero goals can be reached. However, their full potential is far from being achieved, and many corporations have not yet set up credible net zero strategies. What’s worse, some actors are using them to shore up their almost inexistent green credentials.

Despite many challenges – unreliable data, variations in national net zero commitments, lack of sectoral pathways, greenwashing risks etc. – transition finance remains an important tool in the fight against climate change which must be fine-tuned and harnessed.

Transition Finance’s Untapped Potential

In practice, the green transition is the coordinated effort by a multitude of market actors to do the right thing by producing, consuming, and investing responsibly. Many companies have already adopted sustainable business models and have reached net zero territory, but to truly cut down on global GHG emissions, highly polluting companies in hard-to-abate industries must follow suit.

Transition finance is the allocation of capital to enable such transformations, in large part through special financial tools such as GSS Bonds and Sustainability-Linked Instruments. GSS Bonds are known as ‘use of proceeds’ instruments since they are earmarked for use by the issuers in specific projects which have recognised sustainability standards. In contrast, Sustainability-Linked Loans and Bonds (SLLs and SLBs) are simply meant to be broadly used by the issuing/borrowing corporation to fund its transition.

As an enforcement mechanism, the entity must follow certain Sustainability Performance Targets (SPTs) or it risks incurring penalties such as higher interest rates or a coupon step-up, for SLLs or SLBs respectively. Overall, as highlighted by a 2022 OECD survey, financial market participants overwhelmingly prefer transition finance debt instruments over equity investments.

According to the OECD’s Guidance on Transition Finance, the total amount of sustainable debt issuance reached USD 1.6tn in 2021, of which GSS Bonds accounted for 62 per cent, while SLBs and SLLs represented a total of 33 per cent, with the remaining 5 per cent being made up of Green Loans.

Multilateral development banks have a particularly important role to play in funding the green transition. The very first green bonds were issued by the European Investment Bank on the Luxembourg Stock Exchange, which created the market in 2007 and is still contributing to its development, as 45 per cent of the institution’s funding came from GSS Bonds in 2022. Europe is still leading in terms of sustainable debt, with GSS Bonds making up 13.7 per cent of total European new bond issuance in 2021, according to a 2022 PwC report. This number is expected to reach almost 44 per cent by 2026. 

This will only increase as governments are doubling down on the green transition through massive public investment programs. Already in October 2021, the European Commission issued the first green bond to fund the NextGenerationEU plan – in total, the Commission is expected to fund up EUR 250bn of the plan via such bonds. The subsequent REPowerEU Plan and the Green Deal Industrial Plan build on this as they aim to decarbonise the European economy by encouraging investments and cooperation in net zero technologies.

Across the pond, the Biden Administration’s Inflation Reduction Act is the largest climate investment in the United States’ history, and it has earmarked billions of dollars in investments in renewable energy production, green hydrogen, electric vehicles, batteries and carbon capture solutions, to name a few.

The appetite for GSS Bonds is growing fast – investors are mostly limited by the number of worthy projects to fund, to the point that many are willing to pay a ‘greenium.’ For issuing companies, this access to vast capital from an eager and committed investor base is a tremendous advantage, beyond the brand enhancement they get.

However, this has also attracted dishonest practices, causing distrust and potentially stifling market growth.

Challenges to Transition Finance

Ensuring that capital meant to finance the world’s green transition is actually directed where it will have the most impact is a major challenge facing transition finance.

There are serious concerns about the credibility of corporate transition plans, which serve as the basis of companies’ decarbonisation strategies. These often do not rely on science-based metrics or targets, lack ambition and fall short of the objectives laid out in the Paris Agreement. More importantly, regardless of their ambition, these plans are difficult to enforce as most companies offer insufficient disclosure, as per a recent report by the Carbon Disclosure Project (CDP).

In addition, GSS Bonds have been called into question in a recent journal article which showed that many do not represent credible commitments to pursue sustainability objectives and make no specific promises regarding the use of proceeds. In instances where promises are made, the sustainable projects are defined so vaguely that investors can’t prove non-compliance.

Governments, supranational organisations, and corporations must all take an active role in solving such challenges before transition finance can have the impact needed at the pace required to limit climate change in line with the Paris Agreement.

At the EU-level, numerous sustainability disclosure laws have already been passed to combat greenwashing, protect investors and encourage sustainable investments. At the international level, the International Sustainability Standards Board has recently published two sustainability disclosure standards (IFRS S1 & S2) that were endorsed by the IOSCO. These will gradually build trust in companies’ sustainability-related disclosures, favour credible corporate transition plans, and allow investors to allocate capital with confidence.

Europe needs to take a leadership role and ensure that transition finance is fine-tuned and rendered devoid of greenwashing. Luxembourg, as the host of the first and largest green exchange in the world – the Luxembourg Green Exchange (LGX) – is in a particularly unique position to support this. Launched in 2016 and dedicated solely to GSS assets, the LGX carries over 3,400 securities and has already issued over EUR 900bn through sustainable bonds.

The groundwork has been laid, but much more work remains to be done. Confronting these challenges head-on through regulatory and policy actions is essential before GSS Bonds can truly unleash the much-needed green transition and move the needle on a global scale.

Latest News

Bequant has announced that it has launched a new capital introduction platform designed specifically for..
ndosuez Wealth Management has announced the launch of Indosuez Funds - Chronos Green Bonds 2028,..
New global research from industry association Global Digital Finance (GDF) shows most major financial institutions..

Related Articles

graph
The exodus from hedge funds continues with investors questioning unswayed by relatively strong performance from the alternative asset class...
The exodus from hedge funds continues with investors questioning unswayed by relatively strong performance from the alternative asset class...
Waves
A joint statement from BNP Paribas Asset Management, Federated Hermes Limited, Mirova, Robeco and Storebrand Asset Management has been published, entitled The urgent need for better ocean-related data to make informed investment decisions...
A joint statement from BNP Paribas Asset Management, Federated Hermes Limited, Mirova, Robeco and Storebrand Asset Management has been published,..
Frozen soap bubble
From the end of this month, the UK’s Sustainability Disclosure Requirements (SDR) regime comes into force which the Financial Conduct Authority says has a simple aim: “Financial products that are marketed as sustainable should do as they claim and have the evidence to back it up.”..
From the end of this month, the UK’s Sustainability Disclosure Requirements (SDR) regime comes into force which the Financial Conduct..
Global ESG Investing
On May 15 Florida’s Republican Governor Ron DeSantis signed legislation that furthers his ongoing campaign to oppose the role of climate change and ESG factors in state policymaking...
On May 15 Florida’s Republican Governor Ron DeSantis signed legislation that furthers his ongoing campaign to oppose the role of..
Subscribe to the Institutional Asset Manager newsletter

Subscribe for access to our weekly newsletter, newsletter archive, updates on the site and exclusive email content.

Marketing by