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Investors eye 'transition bonds' to decarbonize heavy industry

SNL Image

Investors are hoping to use transition bonds to lower emissions from industrial activities such as this steel mill in Cuba.
Source: Associated Press

France's AXA Investment Managers SA is working with other financial firms to hammer out guidelines for issuing bonds aimed at transitioning heavy industry away from fossil fuels, a spin-off of the green bond movement that is attracting billions for environmental projects.

The idea is not entirely new. In July 2017, Hong Kong-headquartered Castle Peak Power Co. Ltd., a subsidiary of CLP Holdings Ltd., issued a $500 million "energy transition bond" to pay for a natural gas plant that the company said was critical to Hong Kong's efforts to cut carbon emissions. And New Mexico Gov. Michelle Lujan Grisham in March signed legislation allowing utilities to seek regulatory approval to issue transitions bonds to securitize the costs associated with abandoning certain coal-fired power plants.

Such instruments could provide another financing vehicle for large industrial companies and investors to support the transition away from fossil fuels, which can include the costs of bringing low-carbon forms of generation capacity online and of retiring fossil-fuel plants.

Without an agreed-upon definition, though, issuers are self-labeling transition bonds for marketing purposes as they try to tap into the growing pool of investors who are focused on environmental, social and governance, or ESG, issues, said Yo Takatsuki, head of ESG research and engagement at AXA IM.

"Many major financial institutions around the world ... have started to make quite public commitments around their role in mitigating climate change," Takatsuki said, and they are looking for investment opportunities "that would allow us to not only see where the money is going but to be able to have a bit more attribution about the effects and the impacts of the investments that we are making."

'Real-economy companies'

In the green bond market, where companies and governments issued debt at a record pace in the first half of 2019, more issuers are getting bonds certified in order to assure investors that their money is spent on projects or assets that actually benefit the environment. In return for the verification, green bond issuers are being rewarded with "a significant pricing advantage," Séan Wallace McCarthy, CEO of Build America Mutual Assurance Co., said in June.

AXA IM published draft transition bond guidelines in June to begin developing industry-wide standards to help "real-economy companies," such as manufacturing, shipping and mining, decarbonize, Takatsuki said.

"What we've tried to do is to say there is merit in the market moving towards establishing a supplementary asset class alongside green bonds ... which are more aimed specifically for heavy industries and extractives companies, which thus far haven't entered the green bond market," he said.

The firm suggested allowing transition bond proceeds to be spent on carbon capture and storage projects, natural gas transport infrastructure and coal-to-gas fuel switching, among other uses. In addition to input from other industry stakeholders, Takatsuki said, the final guidelines could also draw from the EU Taxonomy, a tool being developed by the European Commission to help capital markets identify investment opportunities that are in line with environmental policy objectives.

Green-seeking capital

Japanese shipper Nippon Yusen Kabushiki Kaisha faces the kinds of challenges that could be helped by the transition bonds AXA wants to create.

In May 2018, Nippon Yusen Kabushiki Kaisha issued $91.5 million in green bonds to finance projects related to liquefied natural gas. The debt was not certified by the Climate Bonds Initiative, or CBI, which said LNG, on its own, "falls short of the steep emission reductions required to meet the Paris Agreement" on climate change. But because the assets being financed "are currently the lowest-emission ... option for long-haul shipping," CBI decided to include the debt in its green bond database.

"We have capital, and it wants green," said CBI CEO Sean Kidney. "Now we have to start looking at the more complicated segments — mining, minerals, manufacturing [and] property, for that matter — and start identifying what are the right investments to make."

Investors are "very anxious" about the issue of climate change and greenhouse gas emissions, Kidney added. "How do we make sure that … the industries and companies we have stakes in transition, move forward, and how do we prioritize the right kind of investments they're making?"

The key, he added, is "How can we tell what's genuine and not genuine?"