Despite MAS optimism, transition bonds struggling to take off

THE MONETARY Authority of Singapore (MAS) may be optimistic about the prospects for transition bonds, but industry players said there are critical taxonomy gaps and more flexible alternatives keeping the financing instrument from taking off.

MAS managing director Ravi Menon said in July that “the transition bond market has good potential to grow”, as part of remarks that highlighted the need to “to provide the funding support for companies that are not so green, to become greener”.

But transition bonds, a variant of the more common green and sustainable labeled versions, have struggled to become a meaningful source of funding for such activities. Menon himself noted that there were only 12 transition bonds issued globally in 2021, amounting to just US$4.4 billion, a fraction of the US$800 billion in total for green and sustainable bonds.

Data from market intelligence firm Refinitiv showed that no transition bonds were issued in 2021 by issuers from the 10 member states of the Association of Southeast Asian Nations (Asean).

Bankers told The Business Times that one of the main reasons for the low issuance levels of transition bonds is that nobody has managed to establish a commonly accepted taxonomy to define acceptable transition.

To safeguard against greenwashing, transition projects should ideally be aligned with pathways towards credible and ambitious environmental goals. But issuers have different starting points, and transition pathways must be tailored to issuers’ operating geographies and sectors. The complexity is such that the International Capital Market Association’s (ICMA) handbook on transition finance refrains from providing definitions or taxonomies of transition projects.

Kelvin Tan, managing director and head of sustainable finance and investments for Asean at HSBC, said the risk of greenwashing was higher given the lack of widely accepted transition taxonomies and given the use-of-proceeds structure of transition bonds.

“Banks and investors are more cautious at the moment,” he said.

ICMA’s handbook had tried to provide a starting point for determining the credibility of a transition label by stating that an issuer’s strategy had to “effectively addresses climate-related risks and contributes to alignment with the goals of the Paris Agreement.”

However, Clifford Lee, head of fixed income at DBS, said that this first step in and of itself is already proving to be challenging for many corporates as well as sovereigns.

The bankers noted that transition bonds are typically for companies with carbon-intensive operations, otherwise known as “brown” companies, that typically cannot issue green bonds but need capital to reduce their carbon emissions.

These challenges mean that the level of transition bonds only make up less than 1 per cent of the combined total of sustainable debt issuances currently.

In addition, Rahul Sheth, global head of sustainable bonds, debt capital markets of Standard Chartered Bank, said that there is some opacity in terms of the kind of assets that can be financed through transition bonds. (see *Amendment note)

He cited how companies in hard-to-abate sectors typically bundle assets that are a mix of “brown” and “green”. For example, a steel manufacturer that is transitioning from coal to natural gas may have to include renewable energy sources in its mix because simply switching to a less brown fossil fuel will not be enough to reduce its carbon intensity.

However, a bank assessing the issuer on an asset-by-asset basis might classify its renewable energy sources under the green label, instead of including it in the issuer’s overall transition strategy.

Bankers said that the industry needs to come up with an acceptable and practical set of standards and taxonomies for the volume of transition bonds to grow.

This includes being able to monitor and measure transition objectives, which increasingly have social implications, said Tan.

However, Sheth believes that the relative simplicity of sustainability-linked bonds provides a better window for companies trying to reach their net-zero targets. Compared with transition bonds, sustainability-linked bonds now account for about 10 per cent of the total mix of sustainable bonds.

Unlike use-of-proceeds bonds, sustainability-linked bonds do not compel issuers to direct all proceeds to pre-defined sustainability projects. Instead, issuers can use the funds for any purpose, but with the end goal of meeting pre-defined sustainability targets within a timeframe.

“Both sustainability-linked bonds and transition bonds have had similar shelf life in terms of its existence,” Sheth said. “You’ve seen the way one is going versus the other.”

“(Combining all of these factors), I think the transition label has pretty much, I would say, faded away... I don’t think you’re going to see much growth,” he said.

*Amendment note: The article earlier incorrectly stated that Rahul Sheth was the global head of sustainable bonds and debt capital markets at Standard Chartered Bank.