Transition finance completes the picture of greener goals

When we think about climate change and greenhouse gas emissions, the tendency is to blame carbon-intensive companies yet ignore the fact that many of them have already embarked on their green journey. In conversation with Yulanda Chung, head of sustainability, institutional banking group at DBS, The Asset discusses transition finance and how it relates to this becoming-greener business, which allows more issuers from the real economy to fight against climate change.

With ESG gaining more traction in Asia, the financial industry is taking actions to fight climate change and related systemic risks. One of the most urgent missions is greening industrial sectors that are responsible for intensive carbon emissions. As such, green finance is a hot topic among corporates and banks who are determined to foster a more sustainable development model.

There are different labels in the green financing space, and the standards can vary in different markets. Yet, one of the most commonly used classifications defines three shades of green, which reflects issuers’ adherence to a long-term vision for a low carbon, environmentally resilient society, according to the Center for International Climate Research (CICERO).

Dark green marks the highest level which refers to projects that already apply solutions of the future, medium green refers to projects that represent steps to the long-term vision, while light green indicates that the project is predicted to be environmentally friendly but does not contribute to the long-term vision.

“We consider transition finance almost akin to the category of being light green,” says Chung. “Companies in polluting sectors can adopt incremental solutions to become greener,” she explains.

Compared to the more commonly used green finance solutions, the spectrum of industries that transition finance can engage with is much wider, and, as a result, it allows those carbon-intensive companies to finance their journey of shifting away from fossil fuels.

“For us, a key measure of whether an asset or an activity can be considered in transition is about the degree of decarbonization,” Chung says. Instead of a universal definition, Chung looks into the comparison of a company’s performance against the industry norm and evaluated in the context of the stage of economic development of the host country, as well as the requirements for system-wide adaptations. A grid upgrade on its own may not be dark green but is essential in order to accommodate more intermittent renewable energy.

Transition finance can complement the dark green finance market. “In the green bond market, the underlying assets of the green bonds are dominated by the usual categories - it could be renewable energy, mass transit, or green buildings. They are no doubt green and important, but they remain only a niche of the real economy,” Chung notes.

Transition finance in Asia

Yet, transition finance is still in its nascent stage in Asia, and it takes longer for this region to complete its transition journey.

“When we look at climate negotiations decades ago, the debate was about proportional responsibility. Post-industrial revolution, the developed countries were mainly responsible for the high carbon concentration in our atmosphere,” says Chung.

But in the current state of affairs, emerging powers in Asia, such as China and India, will be the biggest emitters, though they are not the biggest emitters on a per-capita basis, according to Chung. She notes that there should be a recognition that developing markets may find that they need more time to make the transition, hampered by unaffordable capital investments or yet-to-mature technological solutions to decarbonize polluting sectors.

In June, with the launch of a Sustainable and Transition Finance Framework and Taxonomy, DBS became a first mover to capture growing demand in the transition finance space in Asia.

“We believe there will be a lot of opportunities for companies who are trying to decarbonize, but who may struggle to adopt the so-called dark green solutions given the pace of economic development of the countries. And as a result, transition finance can be an area for them to make incremental progress,” Chung says.

Chung sees substantial opportunities in the six core Asian markets of the bank, namely, Singapore, India, Indonesia and the Greater China markets. “We have a track record of 100 deals worth S$12 billion (US$8.72 billion) that were closed and mandated over the last two-and-a-half years,” she notes. “China, with it being a manufacturing base for many products, would also present plenty of room for improvement.”

The taxonomy will serve as a reference to guide clients to adapt and build resilience in the face of climate change, resource scarcity, and address critical global issues such as social inequality.

The keys to transition finance

“With transition finance and our taxonomy, we want to be transparent. We adopt a science-based approach to help our clients, advise them what those solutions would be, the benefits of adopting those solutions, and to avoid accusations of greenwashing,” Chung explains.

The taxonomy outlines the way DBS manages transactions that are classified as “Green”, “Transition” and/or contributing to the United Nations Sustainable Development Goals. It also summarizes a broad list of eligible economic activities, such as the use of recycled plastics for apparel making, or adoption of hybrid engines for heavy duty vehicles.

The transparency relies on good quality data. “We need good greenhouse gas profile data from our customers. At DBS, through the offer of sustainability linked loans, we are able to incentivize companies to be more transparent in their greenhouse gas disclosure. We are effectively rewarding companies to start reporting their climate strategy, mitigation and adaption plans,” Chung notes.

Transition finance is also very context driven. Chung suggests banks who want to do transition finance do more research, starting with the client’s overall climate strategy. “When we talk about something that is in transition, we want to also know what they are transitioning into - what is the end goal for that company. Is it Paris-compliant?” she says.

The time-bound nature of the projects is also crucial. “It is important to take that into account because we are talking about achieving net-zero (greenhouse gas emissions) by 2050, and looking to peak emissions by 2030. So that trajectory for us is important to our evaluation,” Chung adds.

The banks also need to understand the market’s economic development. “What would be considered in transition in a developing market may not be in a developed market. And as a result, we really need to look at clients’ pathway to achieve Paris-compliant goals, not just the asset or activity being financed in isolation,” Chung notes.

Investors’ appetite for transition finance

Although the financial industry is still at an early stage regarding transition finance, the new asset class has already caught the eye of institutional investors, especially in the insurance sector.

“There are institutional investors whose mandates confine them to only invest in dark green solutions. But many of them would also welcome transition finance to allow them to expand the scope of the investment they could make while still being able to contribute to the greening of the planet,” Chung predicts.

She expects more peers from the financial community to join this business. “It will start to gain momentum and we hope that what we do at DBS can lead and propel the industry to adopt similar methodologies to promote transition finance.”

Find out more about DBS’ transition finance framework at www.dbs.com/sustainability.

Published by Asset Publishing and Research Limited August 2020