It makes sense that green bonds are meant for green companies. But there aren’t that many of them -- not enough to meet the rising demand from investors who want their money to have a positive impact on the environment. So what if some of that money went to finance green activities by less-than-green firms, such as oil companies, coal miners and agricultural businesses? A new concept that’s gaining traction, dubbed for now as transition bonds, could vastly expand the green credit field, and could help cut pollution where it needs to be cut. The risk is that they could provide cover for companies not fully committed to shifting quickly away from their carbon-spewing ways.
1. What would one be like?
A new class of bonds, transition bonds would finance projects aimed at helping the seller switch to a cleaner way of doing business, particularly if they help the climate. For example, an energy company could use them to finance efforts to capture and store its carbon emissions or to move from coal to gas-fired power plants. There’s no consensus yet on what types of commitments companies would need to make, though it’s expected that borrowers would need to sign up to specific targets, as well as broader sustainability goals. Investors would demand transparency, adding further pressure on companies to make public their impact on the environment and detail measurable ways in which they plan to bring their businesses in line with goals set in the Paris Agreement on climate change.
2. How is that different from a green bond?
It’s different because rather than focusing solely on the use of the proceeds or the profile of the issuer, a transition bond is about an issuer’s behavior: are they committing to becoming greener? By contrast, a green bond is restricted to financing for projects that are environmentally friendly. A focus on behavior is an approach that’s already taken off in the loan market. There, a new product called sustainability-linked loans allows borrowers to win a reduction in interest costs by hitting certain targets, such as cutting pollution or reducing food waste. They are one of this year’s fastest-growing debt asset classes.
3. Why aren’t green bonds an option?
The rules don’t prohibit oil producers and coal miners from selling green bonds, but it’s not a great option because some investors doubt those bonds are really green. Investors and banks are increasingly taking a company’s overall profile and commitment to reducing their carbon footprint into account when considering anything labeled “green,” while distancing themselves from non-renewable investments. In 2017, the first green bond sale by a major oil company, Spanish firm Repsol SA, divided the green-bond industry and the securities weren’t included in major green bond indexes. Better, say advocates of transition bonds, for those companies to have their own separate asset class.
4. What’s are the next steps?
There needs to be a wide-ranging discussion between banks, investors, policy makers and companies to decide whether it’s a good idea and how to proceed. In an effort to jump-start the conversation, Axa Investment Managers in June published proposals for transition bonds, arguing that they should be structured similarly to green bonds and be accompanied by a high level of transparency by issuers. French bank BNP Paribas SA has said it supports the the idea. Last year a body representing some Canadian companies also published proposals for transition bonds.
5. What are the challenges?
The suggestion comes at a time when the question of what makes a green bond is still being debated. There is still no single standard for green bonds, although the European Union recently published proposals for a code, potentially superseding the well-followed green bond principles used by trade body ICMA. With skepticism persisting about green bonds, getting people to trust that a transition bond is a solution, not just a marketing trick, may be tough. To avoid accusations of greenwashing -- making misleading claims about how effective at tackling climate change a project is -- there would need to be well-defined criteria for eligible projects and transparent reporting requirements.
6. What’s at stake?
An average of as much as $3.5 trillion worth of investments are needed every year through 2050 to build the necessary clean energy infrastructure to keep global warming in check. This could be the moment when green bonds go mainstream. But currently they only make up a small fraction of the market, with a cumulative $698.5 billion of green bonds sold, according to research by BloombergNEF. If more firms can seek financing based on environmental goals and more big investors swing behind the asset class, transition bonds could see growth similar to that seen in sustainability-linked loans.
--With assistance from Emily Chasan.
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