In recent years, the number of strategies supporting sustainable causes has continued to grow, encompassing the likes of green or other labelled use-of-proceeds bonds, as well as solutions designed to promote better business production and resource utilisation practices.
Meaningful worldwide climate-change solutions won't be cheap. Hervé Duteil explains the vital role transition financing could play for "brown" industries.
But underwriting only the green initiatives omits a substantial subset of industries that must become more efficient quickly, and yet cannot reach a perfectly green state. These companies have more recently become leading candidates for so-called transition financing, which, based on certain criteria, allows qualifying "brown" businesses easier access to capital to transition away from non-sustainable activities. Such measures could go a long way towards eliminating carbon dependency over the next three decades.
Green rushWhat's fuelling the rush to sustainability? In a word: survival. For one thing, the long-term risks arising from unchecked climate change pose a threat to all industries, as well as investment portfolios. There has also been a willingness among proponents to move beyond a purely philanthropic-based approach, to include products for the capital markets that are capable of making a positive impact while generating competitive returns and achieving scale.
While sustainable finance has tended to focus exclusively on purely green industries and enterprises, in recent years it became apparent that some modifications would be needed in order to bring about bankable change. This, in turn, has led to greater emphasis on transition-labelled financing, as well as outcome-based solutions – where the interest rate moves up or down depending on the achievement level of carefully chosen sustainability performance targets. The goal would be to include companies and industries that green stakeholders may not otherwise accept – for instance, those that are currently carbon-intensive. Creating a transition-based subset for brown firms with green aspirations not only preserves the integrity of bona fide green financing, but also helps broaden the base of sustainable finance candidates, theoretically making emission reduction and other climate-facing goals more reachable.
" Creating a transition-based subset for brown firms with green aspirations helps broaden the base of sustainable finance candidates, making emission reduction more reachable. "
To ensure the effort remains on target, proponents must not only focus on green industries, but also carbon-intensive segments, such as transport, cement, steel and certain heavy industries which, with the right resources, could still become more efficient.
Candidates for sustainable financing are typically grouped into two classes: those fully committed to renewable operations and are therefore eligible for green bonds and similar vehicles; as well as industries that are currently brown but can yet adopt more sustainable practices, making them potential transition-finance recipients.
While carbon-intensive firms generally fall into the latter category, criteria for eligibility may vary based on the specific situation. For example, an airline that is building a wind farm to supply power to its facilities may possibly be classified as green; by comparison, the same company replacing part of its fleet with more fuel-efficient jets would be deemed transitional since the upgrade reduces, but does not fully eliminate, carbon-based reliance. Furthermore, such financing should not allow firms to indefinitely continue brown activity, even in a reduced capacity, if green alternatives exist by then. Such standards are needed in order to realise the goal of complete global de-carbonisation by 2050, as specified under the Paris Agreement.
Unlike the more demanding work of establishing a green bond or green loan framework, outcome-based financiers instead create realistic, yet ambitious, targets for brown industries seeking mission-critical improvements. For example, a bottling enterprise could choose to upgrade its existing plastic-usage/recycling protocols; large tech firms, on the other hand, may focus on reducing greenhouse gas (GHG) emissions from their global data centres.