Transition bonds allow firms in ‘brown’ industries — ones that generate significant emissions — to raise funds to finance transition to sustainable models
A comprehensive climate strategy requires transitioning carbon-intensive industries to sustainable practices. Investors may fawn over green bonds but transition bonds are what will save the planet.
One piece of the financial asset puzzle that has attracted much innovation in recent years is the market for fixed-income securities or bonds. And if we want to save the world, we need investors to push for a particular class of these securities: transition bonds.
The global market for corporate bonds – debts issued by companies to raise cash for business operations – is worth around $41 trillion. These markets are today facing a reckoning: We face an impending climate crisis, and a new generation of asset owners – millennials, increasingly diverse and, yes, woke – are deciding where capital gets to flow. So, the fixed income capital markets have had to adapt. Much attention is focused specifically on green bonds, a class of securities designed for issuers (usually corporations) toborrow sums of money specifically to facilitate ‘green’ projects such as the development of environment-friendly technologies, investments in sustainable resource management, and so on. In 2021, overall global bond issuances declined by three per cent. Meanwhile, green bond issuances grew to a record high.
On the face of it, this seems promising. Can green bonds transform the debt capital markets? Can they turn the tide of corporate borrowing towards sustainability?
Unfortunately, no. Even at their record last year, these bonds constituted about one to two per cent of all issuances.It is not difficult to see why: Most companies cannot undertake ‘green’ projects; it simply does not make sense for their line of business. Companies in traditionally carbon-intensive industries such as oil and gas, manufacturing, and heavy industry, will struggle to create projects that meet the ‘green’ bond standard. We cancancel Exxon Mobil (deservedly) for hiding climate science from the world. We can blame it for fuelling both climate change and climate denial. We cannot, however, make it disappear. We cannot cancel its 75,000 employees. And importantly, we cannot simply remove itfrom the debt capital markets.
This is where transition bonds come in. Transition bonds allow companies in ‘brown’ industries – ones that typically generate significant emissions – to raise funds to finance their transition to more sustainable business models. For manufacturing firms, for instance, this could look like a bond issuance tied to improved recycling, longer product lifestyles, or general investments in energy efficiency. For both industry and fossil fuel companies, transition issuance could help raise proceeds for investments in promising new technologies such as carbon capture and storage. While rewarding ‘green’ companies is certainly important, progress must also be encouraged in high-carbon sectors.
Unfortunately, ‘brown’ companies increasingly face a dearth of capital raising opportunities and muted investor interest. We need to provide all companies, even the historical polluters, means to evolve. This is especially true in emerging markets like India. Over a quarter of all economic activity in the country arises from manufacturing and heavy industry and if it is not made, cleaner, greener, and more efficient, it can threaten the realisation not just of domestic, but also global environmental goals.
A scorched-earth approach to ‘brown’ industries is likely to lead to, well, scorched earth. Starving companies of capital will slow down, and not hasten, the green transition. Of course, this theory of change is not without its challenges. Green bonds today are certified according to a standard developed by the Climate Bonds Initiative (CBI), a non-profit. No equivalent framework exists for transition bonds; without one, these bonds can easily turn into another platform for meaningless corporate sustainability advertising. When does security make the leap from being a regular bond to one that is tangibly facilitating transition? What can we do to ensure that transition bonds are not simply swindling investors to continue business-as-usual? Those are the 40-trillion-dollar questions.
Hope, however, is on the horizon. The CBI recently published a white paper on transition bonds with Credit Suisse, and the EU’s taxonomy, a key aspect of the European Green Deal, outlines the stages of transition and applicable activities. These new frameworks must inform a new era of sustainable capital markets, and investors must support this sea change with a robust appetite for transition bonds.
(The writer graduated from Brown University, US, and apprenticed at EY-Parthenon and Goldman Sachs. The views expressed are personal.)