Climate finance continues to be a critical issue in climate change negotiations. Building climate resilient economies will require significant investments in most sectors. As per the Organisation for Economic Cooperation and Development (OECD), investment of around USD 6 trillion per year by 2030 will be required in the infrastructure sector alone to make it aligned with Paris Agreement. Since these figures are only expected to rise in future, it will be critical to see if the intense discussions and commitments by nations towards financial support for developing countries to help them transition into low-carbon economies will bear satisfactory results in limiting the global average temperature rise below 1.5 °C from pre-industrial levels.
Governments and public finance alone cannot support the transition towards Paris Agreement goals. The measures like sovereign green bonds, blended finance and production linked incentive schemes as announced in the Union Budget 2022-23, also may not be sufficient to support such transition. Private capital will have a crucial role to play in this regard. The issuance of green, blue, social and sustainability-linked bonds focussed on Environment, Social and Governance (“ESG”) parameters have become an important source for such finance over the last few years. Globally, green bonds worth USD 700 billion were issued in 2020 which were almost double than those issued in 2019. The Indian private sector has also tapped into these bonds by issuing green bonds worth USD 15.6 billion in international bond markets since 2014 to finance green projects in renewable energy, mass transportation, climate adaptation, etc.
As per estimates, India requires an average annual spending of USD 28 billion aggregating to USD 1.4 trillion to achieve its net-zero target by 2070. Green bonds or blended finance cannot satisfy this huge requirement, particularly for transition of high carbon emitting sectors like cement, iron and steel, construction, metals and mining, aviation, shipping, etc. These sectors currently emit over 30% of the global greenhouse gas emissions, which will further rise in the business-as-usual scenario. Their decarbonisation and transition to low-carbon pathways is thus very critical for a net zero world but it will require significant investments. However, due to rising social pressure against these sectors and ESG-driven investment decisions, the investments flowing in ‘brown’ sectors do not seem promising. These sectors also cannot issue traditional forms of ESG bonds to finance their transition, as they do not satisfy the existing criteria for such bonds.
The issuance of transition bonds to finance the decarbonisation process of these sectors can help fill this gap. These bonds provide capital for facilitating transition of these industries into low carbon pathways in line with the objectives of Paris Agreement. The global focus on transition finance is increasing with the European Union, Japan and Canada framing guidelines on transition finance. There are also multiple independent organisations like Climate Bonds Initiative and International Capital Market Association providing guidance on issuance of transition bonds. Many industries have also issued transition bonds for their decarbonisation objectives. The UK gas distribution company Cadent issued transition bonds to retrofit its gas distribution network and to replace its pipelines to carry hydrogen and other low-carbon gases and reduce methane leakage.
In India, these sectors will need substantial investments for decarbonisation. Public finance and bank/NBFC loans cannot solely provide such finance. For instance, India has mandated thermal power plants to comply with stricter emission standards that require installation or retrofitting of technologies like flue-gas desulphurization, electrostatic precipitators, etc. This is likely to cost between INR 73,176 crore (USD 10.2 billion) and INR 86,135 crore (USD 12 billion) for all plants. The issuance of transition bonds can help power plants to install supercritical technologies for clean energy. It can also help them shift to gas-based power generation or install carbon capture technology.
Steel companies in India have announced new technologies to manufacture climate friendly steel. In case of shipping, Tata Steel has deployed India’s first biofuel-powered ship to replace diesel run engines. The issuance and efficient utilisation of transition bonds can make such transitional measures easier for Indian industry without essentially locking-in a larger share of public finance in these sectors.
Similarly, other high carbon-emitting industries could also utilise transition bonds for decarbonisation strategies that might involve energy efficiency measures, replacement of coal boilers with gas-based boilers, use of gas-based generator sets instead of diesel, use of hydrogen, further research and development in decarbonisation technologies, or for any other projects which can deliver a significant and/or long-term reduction in carbon emissions. The high cost and technological advancement involved in transition of high carbon-emitting sectors makes the case for issuance of transition bonds for their decarbonisation even stronger.
The earlier issuances of transition bonds have been criticised for ‘transition washing’, as issuers focussed more on reputation management rather than decarbonisation. It will therefore be important to add credibility and transparency in transition financing through clear standards and framework. There is a need for disclosure of objectives for issuance of transition bonds and their alignment with Paris Agreement goals; science-based measures for transition; uniform definition for ‘transition’ and measures for addressing potential concerns regarding transition washing. This will enhance investors’ confidence in these bonds and mobilise capital flow to help carbon-intensive industries finance their transition pathways in a just and equitable manner.
This article was originally published in The Times of India on 21 April 2022 Written by: Nawneet Vibhaw, Partner. Click here for original article
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