Financing the transition is key to tackling climate change

JIN DING/CHINA DAILY

Transition finance, which provides finance to high-carbon industries, should be part of a wide range of innovative financing options to tackle climate change. Confronting climate change and taking action to overcome its impacts and effects remains a pressing concern worldwide. There was consensus that the financial industry should go beyond supporting purely green activities to effectively transform existing carbon emitters.

Achieving financing for the transition is crucial to tackling climate change.

Transition Finance is a concept to provide financial services to high carbon emitting industries – such as coal-fired power generation, steel, cement, chemicals, paper manufacturing, aviation and construction – to finance the transition to decarbonization.

The concept was born from the realization that effective decarbonization of the entire global economy will require much more than green finance. Green finance and sustainable finance – as currently defined – largely focus on supporting activities that involve minimal pollution and carbon emissions. However, a much larger amount of finance is needed in carbon-intensive sectors that need to decarbonize and eventually achieve net zero emissions.

The main challenge in financing the transition is the lack of private sector financing for decarbonization activities due to various obstacles, including the lack of a clear definition of transition activities, which could make investors fear that their participation could be considered as “green laundering” or pretending to invest in an environmentally friendly company that is not; lack of disclosure which may encourage false transition activities; the lack of financial instruments that provide incentives for deeper emission reductions; and the lack of demonstration projects that show that successful decarbonization is achievable in most high-emitting sectors.

To address these issues and effectively mobilize private investment in transition activities, a transition financing framework needs to be established. To make transition financing feasible, this policy framework must consider the following elements: identification of transition activities, disclosure and reporting, financing tools, incentives, and social impact mitigation.

First, there must be a credible approach to identifying and labeling transition activities. Any activity supporting a credible transition to net-zero greenhouse gas emissions should be considered transitional. One way to identify transition activities is to develop a “transition finance taxonomy” in which specific transition activities are presented along with descriptions of technical pathways and emission reduction targets. This is done in the European Union and in some pilot regions in China, focusing on industries such as steel, cement, petrochemicals and agriculture.

The concept of financing the transition was born from the realization that effective decarbonization of the entire global economy will require much more than green finance. Identification approaches should be flexible and dynamic, and serve to reduce the cost of market players and mitigate risk.

Second, good reporting practices are needed to help prevent transition activities that give the wrong impression or support an unsubstantiated assertion of sustainability, where companies may claim to be investing in emissions reduction activities but are in fact involved. in projects that lock in high carbon emissions — a behavior often referred to as “greenwashing”.

Third, a toolkit of financial instruments should be developed to support transition activities. This can include debt instruments such as transition and sustainability related loans and bonds. For example, if a project’s fundraising can provide stronger than expected emissions reduction performance, investors will charge a lower interest rate. The toolkit may also include equity-linked instruments, such as the transition funds launched in Europe.

In addition, existing instruments such as private equity, venture capital funds, buyout funds and mezzanine financing facilities can be adopted to facilitate transition activities. And risk reduction facilities should be developed to help reduce the perceived risks of transition.

Fourth, tax subsidies, tax incentives, and green finance related incentives such as central bank funding facilities should be considered to support transition financing and improve the bankability of transition projects.

Fifth, socio-economic costs, such as unemployment, energy shortages, and inflation, must be considered and disclosed when designing transition activities. To mitigate these costs, careful employment impact assessments and the inclusion of mitigation measures in transition plans, such as employee training and reskilling programs, are essential to achieve a “transition just “. Efforts should also be made to incorporate these social elements (e.g. job performance) into the design of sustainability-related product KPIs.

As for Asia and the Pacific, it should take the following steps to promote financing for the transition: As a start, economies in the region should ensure that regulators and financial institutions clarify eligibility criteria for transition activities, which could take the form of a transition taxonomy. , to reduce costs for banks and investors. This will guide companies to adopt the best technical paths of transition.

In addition, they should develop demonstration projects to highlight the feasibility of financing the transition, which is new to most players in the financial sector, and give concrete examples to counter the perception of high costs and risks. These could include transition projects in coal-fired power generation, steel, cement and petrochemicals.

In addition, the Asia-Pacific region should consider launching its own transition funds. Transition funds can be initiated by governments or international organizations, such as multilateral development banks and other international financial institutions, or through international collaboration between different countries to reduce the costs and risks of finance these transactions and help attract private sector investment.

In fact, a wide range of activities, with innovative financing options, are needed to tackle climate change, and financing the transition is an important part of this equation.

Ma Jun is the Chairman of the Beijing-based Institute of Finance and Sustainability; and Akiko Terada-Hagiwara is the Principal Country Specialist, Resident Mission of the People’s Republic of China, East Asia Department, Asian Development Bank.

The opinions expressed are those of the authors and do not necessarily reflect the views of China Daily or the Asian Development Bank.