The International Capital Market Association (ICMA) is wading into the debate about transition finance with a new label to stimulate bond issuance.
The body, which already oversees the principles that underpin the green bond market, has now published guidance to govern ‘transition bonds’.
The guidelines “introduce a standalone Climate Transition Bond label under the principles designed to help [re]finance critical projects for achieving the goals of the Paris Agreement, especially from those in high-emitting sectors and/or with high-emitting activities,” ICMA said in a statement.
Transition bonds differ from green bonds because they allow companies and governments to raise debt to finance projects that contribute to decarbonisation, rather than projects that are already perceived to be green.
For example, the new label would permit proceeds to be allocated to projects that replace one type of fuel with a less polluting one, such as switching coal for gas – as long as they allow for the future integration of truly low-carbon alternatives.
ICMA previously said it wouldn’t develop a label for transition bonds, because they rely on narrative strategies that make it harder to standardise.
But Simone Utermarck, ICMA’s director of sustainable finance, said demand had grown, especially in emerging markets.
“From European investors and issuers, there wasn’t as much demand,” she told IPE, because there is already a well-established green bond market.
Bumpy road for transition finance
Despite increasingly widespread recognition that more needs to be done to channel capital towards the transition – rather than simply refinancing straightforward green projects – the transition bond market has struggled to find its feet.
There was a two-year gap between the first official transition bond in 2017, from power company Castle Peak, and the second, from beef giant Marfrig.
The latter was highly controversial and many investors distanced themselves from the transaction, claiming it wasn’t accompanied by a meaningful issuer-level strategy to become more sustainable.
Nervousness about potential greenwashing risks has continued to plague the market, with limited issuance in recent years, although the format has been popular in Japan.
Credibility safeguards
Sean Kidney, chief executive officer of the Climate Bonds Initiative, said he welcomed ICMA’s foray into the transition bond market.
However, he warned, the new guidelines “need more precision” when it comes to what counts as a credible transition strategy from issuers.
Specifically, he said the framework should not be based on the Paris Agreement’s original objective to stay “well below 2°C”, but instead require alignment with 1.5°C.
“Investors don’t want to be attacked for not being ambitious enough, and they will cop a lot of flak if they’re investing in climate bonds that don’t align with the current science,” he said.
“That could weaken the entire market.”
But Utermarck noted that taxonomies, such as those developed by governments across Europe, Asia and Latin America, could be used as “safeguards” to ensure that transition bonds financed projects and decarbonisation pathways that were appropriate within specific sectors and geographies.
“The issuer should really talk about that [and] put their story and reason for transition forward to the market,” she said, adding that ICMA would provide further clarifications in the future, if it perceived them to be necessary.
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