Governments and businesses increasingly recognize that the transition from a carbon-intensive economy to a green economy must be fair and take into account the social dimensions of the process. However, investments in activities that address both the climate and human dimensions of net zero are still not sufficient. Lily Burge, Magali Van Coppenolle, Brendan Curran And Nick Robins consider the role bonds could play in the financing solution.
The transition to net zero will cost $4.5 trillion per year globally by 2030, according to estimates from the International Energy Agency. For this investment to be effective, it must be fair and take into account the social implications of the transition to low-carbon economies.
European farmers’ protests are a recent reminder of the challenges that can arise when people are not put at the center of climate policies. And anger over job losses from the closure of the Port Talbot steelworks in south Wales can be attributed to a transition plan that did not adequately consider the impacts on workers. workers and communities.
Although policy makers, investors and real economy actors increasingly recognize the need for a just transition, this has not been accompanied by sufficient levels of investment in activities that address both to the climatic and human dimensions of carbon neutrality.
Over the past decade, fixed income instruments have been an effective source of financing to achieve environmental and social goals, but they have not yet been explicitly leveraged for a just transition. Could bonds, in a global market of considerable size and liquidity, be a way to attract more funding for a just transition?
Space for financial innovation
Innovative approaches to structuring debt instruments include earmarking funds for specific projects in the case of green or social bonds and adjusting coupon rates based on the company’s achievement of impact goals. issuer in the case of sustainability-linked bonds (SLB). These approaches attach specific environmental and social outcomes to the sale of green, social, sustainable and sustainability-linked (GSS+) bonds. The GSS+ bond market has grown significantly as investors sought to deploy their capital sustainably: cumulative issuance through the end of 2023 totaled US$4.5 trillion in labeled bonds (see Figure 1).
Figure 1. Annual issuance of green, social, sustainable and sustainability-linked (GSS+) bonds, 2014-2023 (in billions of US dollars)
Source: Climate Bonds Initiative
Innovation can also take the form of what is to be financed by issuing bonds. Sovereign issuers, for example, have started issuing debt to finance the achievement of emissions reduction targets set out in their nationally determined contributions (NDCs).
In 2022, Chile became the first government to link its NDC to a sovereign bond framework in the form of a sustainability-linked bond. This allowed the country to raise $2 billion in its first issue. The bond structure offers Chile a financial incentive to meet the social and climate commitments of its CDN: if it fails, it will face an increase in the interest rate on its loans. The voucher price is linked to sustainability performance targets of reducing emissions and increasing renewable electricity production. An additional gender equality target has been added to Chile’s sustainability bond framework in 2023. Failure to achieve a target within the specified time frame will result in a coupon surcharge of 12.5 basis points for the remainder of the bond’s life, bringing the coupon up to 4.465 percent from a starting point of 4.34 percent.
Earlier this year, Japan issued its first labeled bond, the first-ever sovereign transition bond, to finance decarbonization subsidies and R&D spending as part of its green transformation plan. As climate-related sovereign emissions multiply, there is significant room for innovation to jointly address the environmental and social aspects of the transition.
Across all sectors and geographies
The wide range of potential issuers of GSS+ bonds is promising for a just transition because it encompasses many actors who need to be involved in this systemic change, including national and subnational entities, development banks, supranational institutions, authorities educational and health, and non-governmental organizations.
In addition, labeled bonds allow issuers from emerging markets and developing economies (EMDE) to access international capital while guaranteeing investors the ecological and social character of their investments. These bonds are also well suited to risk-sharing mechanisms such as guarantees and blending that can improve risk-return profiles to investment grade profiles, thereby reducing the cost of capital for issuers.
Annual net zero investment must increase four to eight times from current levels by 2030, with investment needs greater in EMDEs. While it is crucial that capital flows from the North to the South, this is not happening at sufficient speed or scale. GSS+ bond issuances can play a critical role in channeling international climate finance where it is most needed and helping these countries invest in their own transitions.
Just transition bonds could help emerging markets advance their dual climate and social goals, including the Sustainable Development Goals, thereby linking investments in the transition to a low-carbon economy to those that ensure positive social outcomes. Such bonds could also ensure affordable, long-term access to capital for sovereign, sub-sovereign and private issuers. Indeed, data suggests that more emerging market players are issuing such bonds.
Are the deposits already in place?
Initial research results from the Climate Bonds Initiative and the Just Transition Finance Lab show that a small but significant portion of existing GSS+ bonds already show the potential to support a just energy transition in the energy sector.
Using the Climate Bonds Social and Sustainable Bond database, we identified emissions that finance both energy spending and employment, education or equality. This subset of just energy transition obligations was used in the analysis as an indicator of emissions with potential just energy transition characteristics. Most of these bonds were issued by development banks, reflecting their social, climate and development policy objectives (see Figure 2). However, despite funding just transition-related spending, none of the identified broadcasts explicitly referenced just transition in the use of funds.
Figure 2. Share of bond issuers in the Just Energy Transition dataset, by total volume (in billions of US dollars)
Source: Climate Bonds Initiative
GSS+ issuance can help demonstrate the issuer’s commitment to a just transition – even in the absence of (just) transition plans – through the information provided in the bond frameworks and associated documentation. As robust transition plans will play a key role in safeguarding a just transition and as the number of transition plans increases, bond issuers have the opportunity to design bonds linked to financing plans for results aligned with a just transition.
Just transition remains an emerging theme for both issuers and investors in the GSS+ bond market. Given the potential for these bonds to increase financing for low-carbon investments that support social outcomes, it is essential to address the barriers to their issuance and help market leaders integrate sustainability factors. just transition in their sustainable financing frameworks.
*The authors would like to thank Antonina Scheer for her review of this blog post.
