IFR brought together a panel of experts at the Asian Development Bank’s annual meeting in Incheon, South Korea on May 2 to discuss how Asia can fund its ESG transition.
IFR Asia: How would the panel define transition finance?
Kavita Sinha, Green Climate Fund: Transition finance, from a private sector perspective, means financing local private sector organisations and financial institutions in developing countries to move to a lower-emission, climate-resilient pathway to meet the Paris Agreement goals. From financing policy de-risking; supporting the emergence of new technology, business models and policy innovations to scaling up and adoption for low emissions, climate resilient development — all of them together compose transition finance for GCF.
Robbie Singh, Adani Group: From investment and on-the-ground changes, the reality in India is that on a per capita consumption basis, we are about a third of the global average. So, by default, there is an access to energy issue. To us, transition finance is a social necessity. We have to figure out a mechanism by which we keep the costs at a level that allows for access. And that needs to be resolved first.
Aurélia Britsch, Sustainable Fitch: The term ‘transition finance’ has not been truly defined yet, meaning that investors have been a bit cautious so far. Given the structure of the economies in Asia Pacific, which are heavily reliant on manufacturing, shipping and carbon-intensive power generation, transition finance is absolutely key.
Fumitaka “Hama” Nakahama, MUFG Group: To me, transition finance is the financing of activities, which will reduce greenhouse gas emissions by using the eligible or qualified technologies that are cost-effective and available.
IFR Asia: Aurelia, without a clear definition how do you analyse a transition finance product? Is there something in the market that guides us towards what that would be?
Aurélia Britsch, Sustainable Fitch: There have been a lot of initiatives in recent years, with Asia actually a leader in this space. Japan published a transition guideline in 2021 and just a few weeks ago the ASEAN Taxonomy published its second draft — a very significant milestone. It's a work in progress with many products being developed as we speak.
Financial service providers are developing transition-related tools. In the case of Sustainable Fitch, our ESG ratings for sustainability-linked bonds (SLBs) assess whether the instrument is aligned with our transition label. We’re also working on transition assessments for sector-by-sector transition assessments.
IFR Asia: Kavita, as you’re looking at this on a slightly more global scale, how are you seeing the conversations around this transition finance definition?
Kavita Sinha, Green Climate Fund: A lot of the issues that Robbie touched on with regards to access to energy or infrastructure services in developing countries are coming up. I think a lot of definitions on mitigation and adaptation have emerged. But I think to leapfrog to the next stage, we need more convergence on definitions. For example, some partners have brought products to the GCF that are labelled as transition finance products, but very often when we put them through our matrix of measurements and assessment, they fall short.
IFR Asia: Hama, working as a partner with institutions like the GCF, how are you defining transition projects?
Hama Nakahama, MUFG Group: Asia accounts for 50% of greenhouse gas emissions and so we thought strongly that we had to do something. We led discussions called the Asian Transition Finance Group Study, alongside the private sector and the Japanese government. They follow the ICMA handbook — the de facto global standard. However, it’s very much a conceptual document so we thought it was important to help the banks deem which projects are transition finance.
Since then we have issued two documents. One is the Asian Transition Finance Guideline for banks and the other is to help the government deem which technologies should be eligible for us in transition finance.
Robbie Singh, Adani Group: Sorry to be contrarian, but one of the issues of taking a top-down approach is that you run the risk of building barriers. Definitional structures often take some time to resolve, which is something we don’t have. For India, where there is no scope for government subsidies because of socioeconomic issues of education; health and basic access, a lot of companies have to actually make this investment profitable in and of itself. Today, our renewable investments with Adani Green or Adani Transmission, which build distribution systems, are profitable without government subsidies of any type.
Hama Nakahama, MUFG Group: Rather than providing subsidies, it’s important for multilateral institutions and governments to provide credit enhancement. This could be through a first-loss piece while banks play a role in structuring and arranging these projects. Credit enhancement provides leverage to scale up — the same US$10m or US$100m would then mobilise US$1bn.
Aurélia Britsch, Sustainable Fitch: I agree that maybe subsidies won't stay forever, but at the same time it is widely accepted that government climate policy is the main driver of actual change and investment going into these projects, either green or transition. Good policy momentum and increasingly strict requirements on a sector-by-sector basis is a big driver of investment. After that, I agree that private capital needs to be the major part of the investment to fund a transition via blended finance and capital markets as well.
Kavita Sinha, Green Climate Fund: Finance is no replacement for good policy. No amount of financial de-risking, no amount of first-loss capital, no amount of credit enhancement will replace the need for good, solid policies and good regulations, backed by good institutions. That has to come first. Encouraging a paradigm shift is one of our investment criteria — we do not lend to projects as a one-off. Very often, if there is a barrier on the policy side and it requires policy de-risking, we will tailor-make our financing product to be able to do that.
When it comes to private capital for climate initiatives, what we have realised is that 80% of private capital is still flowing only to renewable energy, and transition is more than just renewable energy. Climate change impacts food, water, health and economic security. Where we have put in capital, we have seen multipliers of seven to eight. India, China and Indonesia are in a very unique position of being able to have the depth of markets themselves to raise capital. But most other countries will have to depend on cross-border flows. And right now, 90% of climate finance capital is within borders. So we have to enable greater flows of capital where they are needed most.
Hama Nakahama, MUFG Group: I think when we talk about transition finance from the private sector’s perspective the most important thing is to have proper engagement with our clients to understand their plans and sustainable goals. That's the number one step. In fact, we have engaged discussions with more than 1,000 companies. Then, the second step is to understand whether their sustainable plans are feasible and in line with the guidelines so that the companies are not seen as greenwashing. Third is to come up with bankable finance solutions, which is blended finance. In order for the private sector to make an investment or make a loan available, these projects should be bankable and should be reasonably well paid in terms of the yield.
Through securitisation mechanisms, external credit agencies can give better ratings for these structures, which will massively expand the number of investors. Even if money is available unless a project is bankable, nobody wants to make an investment.
Aurélia Britsch, Sustainable Fitch: Being able to define a credible transition plan is also key. Methodology is the most important factor — whether a plan is aligned with the Paris Agreement. The second is around coverage of the transition plan. For example, when looking at a conglomerate, does it integrate the businesses that have the most negative environmental impact? The third one is around timelines, not just being net-zero by 2050 but having short and medium term goals too using KPIs that are quantifiable and verifiable. For certain sectors, some specific sectorial pathways are also very important.
Kavita Sinha, Green Climate Fund: One point I want to make about bankability is that current financial business models have grossly underestimated climate risks. That’s the reason why a lot of capital reallocation has not happened. The financial sector needs to take a real hard look to make sure that the climate is embedded into business models. Transition finance need not be a niche product. In order to scale, all finance should be transition finance.
Robbie Singh, Adani Group: We had this discussion at the January conference in Davos. Imagine this scenario. We were able to halve the coal in our fleets by injecting solar and wind power behind the meters and using digitised distribution systems. But not a single Japanese or European bank had the courage to fund this transition simply because it has an element of coal in it. Sometimes, it’s easy to make up a policy statement.
I think we need to seriously consider. If we fundamentally believe that this is a massively important issue then a mechanism to transition to low fossil fuels usage in our energy systems should be the first step we take. That will resolve the issue of bankability in and of itself.
IFR Asia: What do you see as necessary in that area, as far as an understanding of the risks and climate-change risks when we’re looking at these financings?
Kavita Sinha, Green Climate Fund: We don’t have exclusion lists but when we're looking at investment criteria in terms of where we allocate capital, there is no proposal on the table from our partners that has coal in it. But I would assume that in terms of meeting efficiency and effective use of capital coal projects would not come close.
From our perspective, if we had to look at capital allocation of either repricing of coal assets or recycling of coal assets versus investing in new capital and new opportunities, our effectiveness and efficiency metrics put us more on the side of pricing the new opportunity.
IFR Asia: Aurelia, how do you see this as affecting ratings at this point? Is something like coal factoring in more when you're looking at risks and ratings?
Aurélia Britsch, Sustainable Fitch: Here I'd like to divide between the way Fitch Ratings covers coal and the way Sustainable Fitch, which I'm part of, covers coal. Fitch Ratings is in the process of integrating ESG and climate risk via the ‘corporate climate vulnerability scores’. This is a scenario-based analysis that measures the vulnerability of a sector, or an entity, to transition risk. At Sustainable Fitch we take more of a sustainability approach through the ESG rating. The ESG ratings assess, at an entity, at a framework and at an instrument level, the impact of a company on the environment and on society. Assessing them against globally established benchmarks such as the EU taxonomy, ICMA green bond principles and others.
Question from audience: Mr Nakahama, could you shed some light on how securitisation creates a more efficient financing option to borrowers?
Hama Nakahama, MUFG Group: Under Basel III, banks are obliged to live with the so-called “standardisation approach” which means if your borrowers have external ratings, the risk-weighting of the asset is reduced. But without a credit rating, the risk weighting jumps. That’s one of the reasons that we believe securitisation mechanisms would work. If a multilateral institution provided a grant or very low cost of capital, it would be key for a diversified project.
Through tranching and creating a first-loss; second-loss; senior and super-senior pieces different investors come in at different risk appetites. So even though the whole project may be rated a Triple B, different liens would have different ratings. But the issue here is pricing. Unless borrowers find the pricing attractive, nobody is going to use it.
Robbie Singh, Adani Group: For us, we can to some extent accept the pricing risk, what we cannot accept is the duration risk. When we sign a power purchasing agreement for a renewable asset, the challenge becomes matching that duration. If you look at the average duration profile (of bonds) out of Asia, ex-Japan, it's like five years, so we are sitting on a disaster on our hands if we fund 35-year assets with five-year capital. Any enhancement should allow us to lift the duration from five to 25–30-year paper.
That needs institutional development in Asia ex-Japan, which is why we need insurers, and other companies to start participating and giving the longer-term capital.
That duration risk is clear in this environment now. In 2015/16, if you issued a five-year paper against a renewable asset and bid that rate into your PPA and now when it’s time to refinance, it’s 400 basis points over. Your equity is finished. You're done. That is what we want to avoid in the emerging markets because we fundamentally have scarcity of risk capital.
Question from audience: Do you think that RLNG, gas and methane projects should still be financed? Shouldn’t those finances be diverted instead towards solar and wind?
Hama Nakahama, MUFG Group: Of course if everyone could adopt renewable energy that would be ideal. However, there is not one solution for everyone. Some countries still rely on gas and coal. So it depends on the needs and the realities of these countries. We also have to think about a just transition for those who will be impacted by the introduction of renewable energy.
Robbie Singh, Adani Group: Just taking on from Hama, we have to find a mechanism to raise the income of our people. We cannot expect them to take the burden of the climate, which is already happening. That privilege is available to Europe. It's not available to us. We have to solve this transition journey.
In 2014, nearly 75% of our capital was going into mining and thermal. Just eight years later today, it's completely reversed. About 81% of our new capital is going to renewables and renewable systems, and only 3% into mining and thermal. I think it will happen, but I don’t think it will be a zero-sum game, though.
Question from audience: What role can multilateral development banks like ADB play to make this transition?
Aurélia Britsch, Sustainable Fitch: Our research team has been covering the Just Energy Transition Partnerships, which is about early coal decommissioning. Transition financing today is not about funding renewables — it’s about funding hard-to-abate sectors. It’s about phasing out coal in the quickest way possible. It's not only about just decarbonising. It’s about making it fair and inclusive, containing the inflation from decarbonisation, making sure we have a steady energy supply and at the same time helping workers transition to the new economy. We need to find a good balance between helping them decarbonise and develop themselves, and at the same time not leaving them with stranded assets in a few decades.
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