The case against ‘transition bonds’

Head of Nordea Sustainable Finance Advisory Jacob Michaelsen argues that the sustainable finance market does not need a "transition bond" label, which he says carries more potential downside risk than benefits.

One of the hottest topics in the sustainable debt markets in recent years has been 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. In a head-to-head debate article in Environmental Finance, Head of Nordea’s Sustainable Finance Advisory Jacob Michaelsen argues that the “transition bond” label is not needed now that the Sustainability-Linked Bond Principles have been published.

By Jacob Michaelsen, Head of Sustainable Finance Advisory, Nordea

Note: For the purposes of this article, the term “transition bond” refers to “use of proceeds” bonds only.

Let me be clear to begin with – “Climate Transition Finance” is arguably the most important topic for the sustainable finance market to deal with in the coming 12-36 months. And rightfully so.

We have already spent considerable time on accepting “Green” into the mainstream, and have even gone to great lengths in codifying this in a Taxonomy as part of the EU’s Sustainable Finance Action Plan. This inevitably leaves the topic of “Brown” or “Transition” (recognising that these terms are not synonymous) as the next, but not final, frontier.

Indeed, this was recognised by the EU-appointed Technical Expert Group on Sustainable Finance in their final report on the Taxonomy, where they highlighted that a fully realised Taxonomy should incorporate also “technical screening criteria for significant levels of harm to environmental objectives. (…) So-called ‘brown’ Taxonomy criteria.”

Jacob Michaelsen, Head of Nordea Sustainable Finance Advisory

"'Transition Bonds' carry more potential downside risk than we can hope to gain from them," argues Jacob Michaelsen, Head of Nordea's Sustainable Finance Advisory.

The case against ‘Transition Bonds’

With that said, let me also be clear and state that I do not believe the market currently needs a new transition bond label. The key reasons for this are:

  1. “Transition” is already baked into the green bond market. This is eloquently formulated in the Shades of Green1 methodology, where, in essence, anything that is not “dark green” represents transitioning.
  2. Green bonds are/should be for everyone. To this point, it is somewhat hollow to say that an oil company can’t issue a green bond if you would buy a green bond from any of the major banks, most of whom have significant oil-related exposure on their balance sheet. In any case, isn’t a green bond from, say, an oil company seeking to invest into renewable energy not the purest form of transition there is?2
  3. In the absence of clear and well-agreed-upon definitions for what constitutes a relevant transition (such that an updated Taxonomy would provide3) the risk of “greenwashing” goes up. To this extent, it seems to me that, from a broad market perspective, “transition bonds” carry more potential downside risk than we can hope to gain from them.

We are better off, as a market, to give sustainability-linked bonds our full attention instead of diverting it to a label that is not fully understood and which may call into question the validity of the overall labelled bond market.

Jacob Michaelsen, Head of Sustainable Finance Advisory, Nordea

Sustainability-linked structures are better suited to address transitioning anyway

More specifically to the point of this article, I maintain that sustainability-linked bonds (SLBs) are better suited to deal with transitioning than transition bonds, for the simple point that sustainability-linked structures are forward-looking in nature, and use-of-proceeds are not (necessarily). That is, SLBs require improvements on a KPI – or the transitioning from something to something better.

That is in contrast to transition bonds, where we cannot guarantee overall improvement of the issuer, but simply that the underlying projects are “not as dirty as they could be”.

Obviously the market for SLBs is still in its infancy and one could certainly highlight that we need better definitions of what “material” and “ambitious” means – especially in the context of transitioning. That said, I maintain that, for the time being, we are better off, as a market, to give SLBs our full attention instead of diverting it to a label that is not fully understood and which may call into question the validity of the overall labelled bond market. That hardly seems a sensible move to me.

1- As popularised by CICERO Shades of Green, the second party opinion provider

2- I recognise that many would argue that this would require a credible transitioning story away from fossil-based energy production. A valid point, but one that deserves more nuance than can be afforded here.

3- There are already a number of credible and relevant initiatives providing guidance on this, such as the Transition Pathway Initiative.

Read the full head-to-head debate in Environmental Finance.

And find out more about the infant sustainability-linked bond market.

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