Trends to watch before 2023 ends: Transition finance within responsible investment in Asia

IN THE Asian context, transition finance can take the centre stage within the responsible investment market.

According to the Organisation for Economic Cooperation and Development (OECD), transition finance is defined as finance “intended to decarbonise entities or economic activities that are emissions-intensive, may not currently have a low- or zero-emission substitute that is economically available or credible in all relevant contexts, but are important for future socioeconomic development” [1].

Transition finance is a new approach to the decarbonisation of high-emitting industries that is spearheaded in Asia; particular attention is given to those sectors that might be negatively impacted by transition to sustainability such as aviation, oil and gas, and coal.

For instance, the Asia Transition Finance Study Group [2] was created by Japan to provide a comprehensive support measure to South-East Asian Nations (Asean) countries to promote transition finance: the aim is to create practical recommendations to supplement existing frameworks, such as the International Capital Market Association (ICMA) guidelines.

Responsible finance’s objective is to finance the transition of our economy towards a more sustainable model while aiming at delivering financial returns. To reach that goal, it needs to be deployed at scale to reach all geographies, all sectors and all types of clients.

To achieve the objective of the Paris Agreement and limit global warming to well below 2°C, all sectors of the global economy, and in particular high emitting industries, must rapidly decarbonise.

Transition finance is predicted to grow in popularity in the field of responsible investment in specific geographies and sectors, as it is needed for a whole-of-economy decarbonisation to achieve the objectives of the Paris Agreement.

At the same time, inclusive transition is about decarbonising without compromising social and economic development — the energy supply must be reliable and affordable.

In this context, transition finance can ensure that the energy transition is just, as it can help to avoid sizeable economic inefficiencies in emerging markets where there are countries in which greenhouse gas emitting sectors represent a large share of economic activity.

The energy mix needs to shift progressively, first to relatively less emissions-intensive fuels like natural gas, and then to renewables.

For example, should the energy transition not be successful in these sectors, the loss in economic value for Asia would be around 15 to 20% of GDP3 [1] by mid-century.

While investments in environmental, social and governance (ESG) activities will contribute to the decarbonisation of Asian economies, investments in transition activities are also necessary.

Only a combination of both will enable a just transition, one that reduces greenhouse gas emissions but also ensures the reliability and affordability of energy supply.

That said, certain challenges need to be overcome for transition finance to be successful in achieving the transformation of the real economy and gain credibility.

There is still little consensus on how to support the transition to an inclusive low-carbon economy, as there are no set of technical criteria, or qualifying sectors, or technologies that are commonly used.

Transition finance is still a nascent approach and needs to gain credibility by setting tangible key performance indicators (KPIs) and by taking a dynamic view. Better transparency, consistency and real success stories need to be developed.

If transition finance addresses its challenge to gain credibility, asset firms like Amundi believe its ambition will increase.

In order to do so, financial market participants have to identify high-emitting companies and analyse their climate strategies (which is a prerequisite for transition finance), support the implementation of companies’ climate strategies, thoroughly assess companies’ transition plans when deciding to provide financing to a company, and only finance companies with credible plans.

Also, financial market participants should make use of existing frameworks: set interim nett zero targets, use metrics and KPIs, use carbon credits (once plans have been made to “avoid” and “reduce” carbon emissions), be coherent internally with a company’s business plan, among others.

Amundi anticipates several factors that can support a credible transition finance trend in Asia.

“As the real change needs to happen at the company level, we do not believe that specific financial instruments will be needed, and that existing ones should suffice,” it said.

“Issuers can typically finance decarbonisation projects by issuing Sustainability-Linked Bonds, whose proceeds are used to fund projects with environmental or social benefits projects.

“Another driver of success and credibility will be increased data transparency and consistency, dissemination of real success stories.

“Lastly, active ownership and shareholder continued engagement on climate strategies will greatly influence companies.”

As ESG regulations and investors’ demand increases across Asia, asset owners and asset managers should pay attention to fast growth of responsible investing in the region.

ESG integration has boomed in the three years between 2019 and 2021, and will continue to do so in the long term despite the challenging year due to the Russia-Ukraine war in 2022 and consequent energy and food crises.

“We expect that climate-related funds will continue to dominate product development in the medium to long-term as governments contribute to the achievement of the global net zero goal,” it said.

At the same time, Asia has to face the specific double challenge of economic development and decarbonisation, to which a broad and accelerated deployment of responsible investments could be an answer.

Because transition finance addresses these challenges specifically, in the sense that it focuses on enabling a socially acceptable energy transition, and provided it demonstrates its credibility and ambition, it is set to become the centre stage in the field of responsible investment in Asia. – Article courtesy of Amundi Malaysia Sdn Bhd

References:

1. OECD 2022 Guidance on Transition Finance https://www.oecd-ilibrary.org/environment/oecd-guidance-on-transition-finance_7c68a1ee-en

2. The Asia Transition Finance (ATF) Study Group published the ATF Activity Report and the ATF Guidelines in September 2022.

3. Amundi Research Center 2021 ESG Thema #8: Financing the energy transition in Asia https://research-center.amundi.com/article/esg-thema-8-financing-energy-transition-asia