Relevance: GS-3: Conservation, environmental pollution and degradation.

Key Phrases: Transition bonds, green bonds, industrial sector, Paris Agreement, Bridging Green and Brown Market, decommissioning coal plants, waste-to-energy, thermal power, GHG emissions, carbon capture storage, renewable technologies, decarbonisation, International Capital Market Association.

Why in News?

• These are more inclusive than green bonds and can be issued by firms that aspire to reduce their GHG emissions.

Context:

• Globally, the industrial sector accounts for nearly 30 per cent of greenhouse gas (GHG) emissions and India is no different. And maintaining the 2°C temperature goal, as envisaged in the 2015 Paris Agreement, requires transitioning this sector.
• If you consider hard-to-abate industries such as shipping and aviation, chemicals, steel, and cement, decarbonisation is a complex process, and transformation happens in a series of phases. Such brown industries require major investments to achieve any significant reduction in emissions.
• To add to this, traditional forms of sustainable finance usually do not classify investments in these business activities as “green.” And this is where transition bonds come in.

Area where Transition Bond can be utilizes:

• Cogeneration plants (gas powered combine heat and power (CHP));
• Carbon capture storage;
• Gas transport infrastructure which can be switched to lower carbon intensity fuels;
• Coal-to-gas fuel switch in defined geographical areas, with defined carbon avoidance performance;
• Waste-to-energy;
• Gas powered ships;
• Aircraft alternative fuels; and
• Cement, metals or glass energy efficiency investments (reduction of clinker ratio, use of recycled raw materials, smelting reduction and higher recycling)

Bridging Green and Brown Market

• Transition bond is a class of debt instruments that maintain the transparency and rigour that characterise green bonds but are designed to be more inclusive in their standards.
• Unlike green bonds that are earmarked to raise money for climate and environmental projects, transition bonds can be issued by firms aspiring to reduce their GHG emissions. In other words, these bonds enable entities that would otherwise not qualify to issue green bonds to obtain sustainability-related financing.
• The money can be used for activities that reduce the environmental impact of the business, such as carbon capture and storage, decommissioning coal plants, waste-to-energy, or exclusively financing new and/or existing eligible transition projects.
• Financing capital equipment costs, particularly in heavy industries, is a good use case. Often, the specialised capital equipment used have long replacement cycles and require a substantial investment for up-gradation. The decommissioning also requires many steps including remediation and restoration of the project site, in addition to construction of a new facility.
• The bonds specify what they hope to achieve with the investment and these precise milestones and objectives provide investors with clarity on the overlap in goals for issuer and investors. For instance, a thermal power utility issuing transition bond seeks to achieve emissions rate of 90 gCO2/kWh, which would be suitable for investors are looking for, say, projects that achieve emissions rate of 100 gCO2/kWh. The bond’s time horizon also has to be aligned with the key performance indicators achieved to avoid mismatch.
• One good example of an industry that can benefit from transition bonds is cement. India’s cement industries contribute about 8 per cent to the country’s total GHG emissions. Carbon intensity in production can be reduced by 48 per cent by investing in a combination of existing technologies such as carbon capture storage (CCS), renewable technologies, and intermediate product substitutes.

Small sliver

• Transition bonds can play a significant role in mobilising capital at scale for accelerated industrial decarbonization. S&P Global estimates transition finance, including issuance, to contribute as much as $1 trillion to the estimated $3 trillion of annual investments needed to limit global warming to 2°C by 2050.
• Despite the potential, transition bonds have so far played only a small role as a financing solution to decarbonise hard-to-abate sectors. According to BloombergNEF, the transition finance market has seen $11.5 billion in the issuance of 24 transition bonds since its inception. This compares to $1.7 trillion and $391 billion for green and social bonds, respectively.
• The slow growth of the transition bond market can be attributed to the non-availability of a clear definition of what transition finance actually means and to what extent such instruments are environmentally sustainable. This has fueled scepticism among investors about this debt instrument becoming yet another tool for “transition washing.”
• That said, there is much room for optimism, as seen in the case of Cadent Gas, the largest distributor of gas in Great Britain. In March 2020, it was the first company in the UK to utilise sustainable debt finance to enable its low-carbon transition. The use of proceeds was outlined for retrofit of gas transmission and distribution networks, renewable energy, clean transportation and energy efficient buildings. The bond was oversubscribed 8.4x indicating investors’ keen appetite.

Way Forward:

• The financial materiality of transition risks arising due to policy, regulation, legal and market changes is going to require brown industries to increase their efforts and allocate more capital to adapting to climate change.
• Though still in early stages, the issuance of transition bonds is following the International Capital Market Association (ICMA) guidelines on climate transition finance. These guidelines provide common expectations to capital markets participants on the practices, actions, and disclosures to be made available when raising funds in debt markets for climate transition-related purposes. However, securities regulators can put statutory regulations in place for the commitments required by companies to be eligible for transition bonds.

Source: The Hindu BL

Mains Question:

Q. What do you understand by Transition Bonds? Discuss the importance of Transition Bonds to move towards carbon neutrality in India. Illustrate.