The People’s Bank of China (PBC), the central bank, recently held a video conference on its research tasks in 2022, indicating continuous strong support for China’s green and low-carbon growth. Efforts would be made to conduct more in-depth research on transition finance, connect it with green finance and issue more policy recommendations with practical guidance.

Transition finance refers to financial services with diverse instruments that are provided to market entities, economic activities and asset projects. It is an essential supplement to the green financial system and can help the decarbonization of large emitters, especially those with a record of high carbon intensity and environmental risks.

In many occasions, PBC has repeatedly emphasized the significance of transition finance. Liu Guiping, the deputy governor, advocated more research on transition finance to “stabilize” high-carbon industries, while the Research Bureau also planned to speed up the framework development of green financial system and transition financial system.

With financial markets’ burgeoning interest in transition finance, the types of transition finance tools as well as challenges for financial institutions will multiply. According to experts, the key lies in clearly-defined standards and transparent information disclosure requirements, based on which financial institutions should take one step further by introducing and scaling up innovative use of transition finance products.

Support the adoption of transition finance with clearly-defined standards

It is an urgent task to develop transition finance, considering China’s natural resource endowment is characterized by abundant coal reserves, a shortage of oil as well as a limited supply of natural gas, and traditional high-carbon industries still maintain a dominant position in the national economy. Wang Yao, president of the International Institute of Green Finance (IIGF) of Central University of Finance and Economics (CUFE), said that China has a large industrial system with many high-emitters greatly affecting the environment. These industries or companies need financial support to their technology upgrade and business transformation, in a bid to cut emissions and achieve carbon neutrality step by step.

Transition finance can cover those high-carbon areas beyond green finance. Wang Yao noted, “It offers more options for potential issuers and investors, allowing greater flexibility in terms of returns and investment goals. Transition finance providers expand their focus from green projects to carbon-intensive projects in traditional energy-intensive industries and those aimed at improving carbon capture efficiency.”

In fact, China has already made some progress on transition finance. International organizations such as the International Capital Market Association (ICMA) and economic entities like the European Union (EU) have issued normative documents on transition finance. China’s local governments have also been active. The city of Huzhou in Zhejiang Province, for instance, also issued guidelines on developing a pilot zone for green finance reform and constructing low-carbon transition financial system.

As early as September 2021, the Climate Bonds Initiative (CBI) released a discussion paper - Transition Finance for Transforming Companies: Avoiding Greenwashing when Financing Company Decarbonization - suggesting five hallmarks of a credibly transitioning company, namely goals that are aligned with the Paris Agreement, robust transition plans, implementation actions, internal monitoring, and external reporting.

However, the existing green or sustainable financial system lacks clear classification standards and disclosure requirements for suitable projects. Therefore, financial institutions may have difficulties in identifying “transition” activities as well as emissions-intensive or “brown” activities. This explains why some financial institutions are hesitant to provide financial services for transition activities, said Ma Jun, Chairman of the Green Finance Committee (GFC), China Society for Finance and Banking, and President of the Institute of Finance and Sustainability (IFS).

Defining standards is the top priority. “It is necessary to clarify the concept, standards, and classification of transition finance as soon as possible.” Wang Yao suggested, relevant parties, including academic institutes, financial institutions, and high-emitters should conduct research jointly while taking into consideration the existing international concepts of transition finance and the actual needs of green transition in China. On this basis, PBC will lead relevant departments to develop and publish a widely accepted catalogue of transition finance for eligible projects, which align with industrial and financial regulatory policies.

Ma Jun pointed out five major factors of the transition finance framework, including the definition of transition activities, disclosure methods for transition activities, supporting financial tools, incentive mechanisms, and a fair transition.

Transparent information disclosure to avoid greenwashing

It should be emphasized that “transition” should not be lumped with “light green”. The China Transition Finance Research Report (hereinafter referred to as the Report) released by CBI and the CECEP Hundred Technical Service (Beijing) Co., Ltd. emphasizes that activities “with marginal environmental benefits” should not be labelled as “transitional activities”.

Experts believes this can avoid greenwashing by properly defining the scope of transition finance and give full play to its functions.

Ma Jun argued that the disclosure requirements for transition finance are more complex than those for green finance, so as to ensure that the entities and projects supported align with the goal of carbon neutrality, thus preventing greenwashing or false green transition.

He suggested that based on domestic and international experience, companies seeking transition financing should be required to disclose multiple aspects of their plans. For instance, companies should describe their transition strategies or plans over short, medium, and long term, including their technologies, financing and investment plans, etc., among which their long-term transition strategies and pathways should align with the goal of carbon neutrality. 

In addition, companies should disclose their predicted carbon emission levels and intensity under future transition plans, the methodology for calculating carbon emissions and carbon reduction effects, the implementation and actual effects at each stage, and the use of funds raised from transition finance.

“Compared with green finance, the effect of transition finance is difficult to measure, which highlighting the necessity of a more flexible evaluation system.” Wang Yao said, to truly support corporate transition with transition finance, it is essential to ensure the disclosure of all kinds of information, including environmental related.

Innovate transition finance tools for steady corporate green transition

What kind of financial instruments can help to promote the implementation of transition finance without greenwashing? 

Wang Yao said the sustainability-linked bond (SLB) is a feasible tool and a positive attempt. In April 2021, based on ICMA’s experience, the National Association of Financial Market Institutional Investors (NAFMII) launched SLB and guided market players to complete the issuances of the first batch, which effectively supported the sustainable transition development of those carbon-intensive companies, covering industries as coal power, steel and cement making.

SLBs are a type of debt financing tool linking bond terms to issuers’ sustainable development goals, and the key is to set quantitative goals. The financing costs of a company are linked to the extent to which quantitative targets have been achieved periodically. Transition financing refers to corporate financing activities aimed at achieving carbon neutrality, in which companies are required to provide a roadmap for annual carbon emission reductions and disclose their progress towards transition every year.

However, Wang Yao also emphasized that the transition of high-emitters and the energy system requires a significant amount of funding, which needs more than one single or a few types of financial products. She called for regulators should introduce a package of policy incentives to support innovative transition finance products. Meanwhile, financial institutions should also come up with products such as transition insurance, funds, and trusts based on the actual needs of high-emitters to provide comprehensive financial support to carbon-intensive companies in transition.

According to Ma Jun, uncertainties associated with the transition mean insurance products are required to offset the technical, operational and market risks. He said, government-backed guarantee funds should actively develop products for eligible companies and projects, to lower their financing costs of transition under the risk-sharing mechanism. As for the investment portfolio, financial institutions can also consider to develop diversified products, such as asset-backed securities (ABS), real estate investment trusts (REITs), transition stock and bond funds. 

Source: Financial News, Financial Times