Cadent Gas reignites the “transition bond” debate

The debate over “transition bonds” is alive once again after Cadent Gas published its inaugural Transition Bond Framework in February. Jacob Michaelsen, Nordea’s head of Sustainable Finance Advisory, dives into the framework and revisits one of the most hot-button issues from last year.

By Jacob Michaelsen, head of Sustainable Finance Advisory, Nordea

One of the main talking points for the sustainable debt markets in 2019 was “transition bonds”, a proposed new bond type designed to allow not-so-green companies to finance their gradual shift to a cleaner way of doing business.

The discussion stemmed from three key developments last year: First, Italian energy infrastructure company Snam issued a “climate action bond”, then French asset manager AXA IM established a set of Transition Bond Guidelines and finally Brazilian beef paddy producer Marfrig issued a “sustainable transition bond” to fund sustainable cattle purchases. The “transition” concept quickly drew criticism for potential greenwashing.

Cadent Gas logo

It’s only March, and we’re already well on our way to surpassing these steps in the “transition” journey in 2020. First came the recent announcement of the ICMA Executive Committee to establish a separate Working Group on Climate Transition Finance. And now the UK natural gas distribution network operator Cadent Gas has published its new Transition Bond Framework.

Eligible use of proceeds from the bonds issued include replacing pipelines to reduce methane leakages and allow for the integration of hydrogen and other low-carbon gases as well as projects related to renewable energy, clean transportation and energy efficient buildings.

Full transition or business as usual?

The initial reaction in the market was mixed. Monica Filkova, until recently head of market intelligence at the Climate Bond Initiative, noted that “gas is a fossil fuel so unless they can get methane leakage/emissions to zero, and not net zero, it’s not compatible with full transition”. However, “since their plan is to phase out fossil fuel for something more climate friendly such as hydrogen or biogas, perhaps it makes sense – but then targets and benchmarks would help”, she added.

Although there is certainly room for scepticism, Xuan Sheng Ou Yong, green bonds and ESG analyst at BNP Paribas Asset Management, said he was initially sceptical but, after some digging, less so.

“The ambition is well thought through, with proper due diligence and stakeholder engagement”, he said, but he questions what should represent “business-as-usual” for gas distribution companies. “I still am hesitant about considering methane leakage reduction as a deviation from business-as-usual for the issuer, but retrofitting for hydrogen is a clear step towards a low carbon future”, he said.

Considerations around Cadent Gas’s Transition Bond Framework

If we look at the framework itself, a few observations stand out. First, and most obviously, the framework follows the standard template for a traditional green bond framework. This is not a problem as such. Indeed, it is arguably a positive as Cadent has looked to build on the existing best practices in the market. That said, it is worth noting that Cadent has chosen not to include any references to ICMA or the Green Bond Principles.

As no widely agreed upon standards or principles exist for bonds labelled “transition”, issuers are free to define them as they see fit. However, considering the ICMA Executive Committee’s recent launch of the Climate Transition Finance Working Group, it raises the question of how such bonds should be structured and aligned.

Another notable point is the proceeds themselves. Cadent Gas highlights four categories as eligible for their transition bonds:

  • “Retrofit of gas transmissions and distribution networks”
  • “Renewable Energy”
  • “Clean Transportation”
  • “Energy Efficient Buildings”

The most relevant of these, at least from a transition perspective, is the “Retrofitting of gas transmissions and distribution networks” as that gets closest to Cadent Gas’s underlying business model and is also the source of its biggest climate impact.

The remaining categories and definitions are quite familiar to the green bond market. One such example is “Energy Efficient Buildings” where some of the eligible definitions include “LEED Gold”/”BREEAM Excellent”, on-site renewable energy production and improvements of energy efficiencies by 30% – all thresholds eligible in the green bond market.

Subjectivity rules the day

This then begs the question: Where do we draw the line between green and transition? Is it the assets or the issuer that defines the label? Although it may seem a straightforward choice for many (to focus on assets), Cadent Gas highlights a situation where this is put to the test. A similar question can be posed for airport operators such as Schiphol or Swedavia.

At the end of the day, subjectivity reigns in the green and transition bond discussions. That makes it even more important to carefully consider such cases before bringing more “transition bond” labelled transactions to the market – at least until we see what comes out of the newly established Climate Transition Working Group. Then again, the best way to learn is to do, so maybe we should proceed and tread carefully. Time will tell.

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