Green bonds have come a long way in the last decade with increasing demand from investors looking to align their investments with the Sustainable Development Goals through financing businesses that are ready to go green. However, there are investors who are keen to diversify their sustainability portfolios beyond the relatively narrow scope of green uses to which the proceeds from green bonds may traditionally be put to, to a wider pool of companies. At the same time, in the transition from the current brown economy towards a greener economy in the long term, it is necessary for some existing highly pollutive, extractive, or greenhouse gas intensive businesses and industries, to become less brown for the foreseeable future, eg by being more resource efficient at an acceptable pace, until the technology exists for them to turn green. Like green businesses, these businesses will also require and deserve financial support for the transition, such as reduced cost of funding and access to ESG investors. Investors and businesses looking for green investments may also find the exclusive focus on green bonds and green loans that require proceeds to be put to wholly green purposes too restrictive for their purposes. This update examines the emerging use of transition bonds to fill this gap.

What is a Transition Bond?

Transition bonds are a class of use-of-proceeds based debt instruments, designed to be more inclusive in its standards while maintaining the transparency and rigour that increasingly characterise green bond standards, such as the Climate Bond Initiative's Climate Bond Standard, International Capital Markets Association's Green Bond Principles, and the EU Green Bond Standard that will soon be introduced.

As of now, the number of transition bonds issued has only been a trickle. One of the first issuances of a transition bond took place in 2017, with Hong Kong's electricity generation company, Castle Peak Company Limited's USD500 million "energy transition bond" to finance the building of a new 550MW combined cycle gas turbine generation unit. In February 2019, Italian gas company, Snam also issued a "climate action bond" that raised a 500 million six-year bond to fund investments in biomethane and energy efficiency and other projects to reduce the environmental impacts of its activities, including the reduction of its methane emissions by 25% by 2025. In August the same year, Brazilian beef producer Marfrig Global Foods issued a USD500 million 10-year "sustainable transition bond", to fund their purchase of cattle only from ranchers in the Amazon region who comply with nondeforestation and other sustainable criteria, such as animal welfare and fair-labour practices. More recently, UK gas distributor, Cadent Gas, in March 2020, issued a 500 million 12-year bond to replace pipelines to facilitate the future carriage of hydrogen and other low-carbon gases and reduce methane leakage.

However, the potential pool of issuers which can make use of transition bonds may dwarf that of green bonds. If the rapid growth rate of total green bond issuance in the past decade is any indication, the market for transition bonds could be considerable.

An Alternative to Sustainability-Linked Bonds

One instrument that serves a similar function of encouraging a commitment to green performance is the sustainability-linked bond, where the interest rate margin is linked to agreed sustainability performance ratings or targets. For example, in September 2019, Italian power generation company Enel raised 2.5 billion through the issuance of a five-year sustainability-linked bond with the coupon rate applicable, subject to a potential onetime 25-basis-point increase from 2.65%, if less than 55% of Enel's total power generation capacity comes from renewable power facilities as of 31 December 2021, the half-way point of the security, from 46% in June 2019.

Sustainability-linked bonds adopt an approach that is different from the use-of-proceeds approach of green bonds in that the proceeds can be put to general purposes. This means that while the proceeds incentivise sustainable behaviour, they do not necessarily go towards funding green activities, and may in fact do just the opposite. Thus, sustainability-linked debt instruments play a complementary role from green bonds by greening finance in a fundamentally different way from transition bonds.

Mitigating the Greenwashing Risk

While transition bond labelling has the potential benefit of signalling to investors the alignment of a borrower's business activities with a smaller environmental footprint; like green bonds, and perhaps even more so, the risk is that in the absence of transparent and clear criteria, labelling bonds as "transition bonds" may add to the confusion for investors who lack the sophistication to look behind the label, if companies get the funds at preferential margins along with the reputational benefit for projects without some environmental benefits to show for it.

In order not to undermine the potential growth and benefit of transition bonds, it is important that transparent and clear criteria are introduced and adopted as soon as possible, so that investors can distinguish between the financing of genuine commitments to climate change mitigation, and those which are mere marketing tools capitalising on the growing green financing appetite. To that end, standards and principles have started to emerge to add credibility to transition bonds.

AXA Transition Bond Guidelines

AXA Investment Managers have started the ball rolling with their proposed Transition Bond Guidelines,1 which follows the same structure as the existing Green Bonds Principles, Social Bonds Principles and Sustainability Bonds Guidelines, framed around the four core components:

(1) use of proceeds;

(2) process for project evaluation and selection;

(3) management of proceeds; and

(4) reporting

To establish clear expectations on the issuer's broader environmental strategy and practices, an additional component is required:

(5) issuer's overall sustainability strategy

Transition bond issuers are expected to communicate what climate transition means in the context of their current business model and their future strategic direction, and commit to align their business with meeting the COP21 Paris Agreement goals.

The proceeds raised in transition bonds must be used to finance projects within pre-defined transition related activities. These include, but are not limited to:

(a) cogeneration plants (gas powered combine heat and power (CHP));

(b) carbon capture storage;

(c) gas transport infrastructure which can be switched to lower carbon intensity fuels;

(d) coal-to-gas fuel switch in defined geographical areas, with defined carbon avoidance performance;

(e) waste-to-energy;

(f) gas powered ships;

(g) aircraft alternative fuels; and

(h) cement, metals or glass energy efficiency investments (reduction of clinker ratio, use of recycled raw materials, smelting reduction and higher recycling)

Issuers are urged to provide clear descriptions of the eligible assets and the asset selection process and criteria. They should also explain how the projects aid transition towards a climate friendly way of doing business, including a consideration of negative externalities, objectives, expected outcomes and impacts.

In relation to reporting, issuers should also externally audit information to be published. AXA also recommends that GHG indicators are considered alongside the International Energy Agency pathway for a CO2 emissions trajectory to limit the average global temperature increase to 2C.

In order to legitimise the use of the term, transition bond issuers must communicate how climate transition fits into their business model and long-term strategic direction. Senior management and board directors should commit to meeting the Paris Agreement goals publicly. Transition bonds should not be a flash in the pan, but should be part of a broader commitment towards measurable, intentional, sustainability.

Emerging Industry Standards

Sustainability standards and accreditation bodies are following suit with industry-wide standards. In September 2019, Climate Bond Initiative, issuer of the gold standard for climate bonds, and Credit Suisse launched a partnership to "develop a framework that will underpin a scalable and robust Transition Bond market". 2 In November 2019, the Executive Committee of the International Capital Markets Association, issuers of the Green Bond Principles, established a Working Group on Climate Transition Finance to focus on "understanding why corporate issuers from carbon intensive industries have been largely absent from the green bond market thus far and considering providing guidance for potential future issuances".3

Proposed EU Regulation

Regulatory developments will also be a significant influence in the evolution of transition bond standards. In the light of developments in the EU, the AXA's Transition Bond Guidelines are likely to be seen as not going far enough to mitigate greenwashing risk. The EU Commission is currently exploring the possibility of a legislative initiative for an EU Green Bond Standard. The Technical Expert Group on Sustainable Finance ("TEG") established by the Commission has recommended that the Standard should require that proceeds from EU Green Bonds go to finance or refinance projects/activities that: (a) contribute substantially to at least one of the six taxonomydefined environmental objectives;4 (b) do not significantly harm any of the other objectives; and (c) comply with the minimum social safeguards. Where technical screening criteria have been developed, financed projects or activities must meet these criteria.

The proposed Taxonomy Regulation is currently pending the adoption by the European Parliament. Article 10(1) of the adopted text of the Regulation published by the Council of the EU in April 2020 sets out some illustrative categories of process and product innovations that contribute substantially, but explicitly exclude processes and innovations that improve energy efficiency for power generation activities that use solid fossil fuels.5

With regard to transitional economic activities in relation to climate change mitigation, Article 10(2) clarifies that an economic activity for which there is no technologically and economically feasible low-carbon alternative, still qualifies as contributing substantially to climate change mitigation, where it supports the transition to a climateneutral economy consistent with a pathway to limit the temperature increase to 1.5 C above pre-industrial levels, and where that activity:

(a) has greenhouse gas emission levels that correspond to the best performance in the sector or industry;

(b) does not hamper the development and deployment of low-carbon alternatives; and

(c) does not lead to a lock-in of carbon-intensive assets, considering the economic lifetime of those assets.

The TEG in their final report6 also expressed the view that this formulation of the Regulation is consistent with the TEG's position in their earlier June 2019 report that transitional economic activities are activities that are critical to the economy, but must significantly enhance their performance beyond the industry average, without lock-in to carbon-intensive assets or processes.

Article 19 of the Regulation sets out the requirements for the establishment of technical screening criteria by the Commission through delegated acts. In line with Article 10(1)(b), Article 19(3) provides that the technical screening criteria must ensure that power generation activities that use solid fossil fuels do not qualify as environmentally sustainable economic activities. The TEG in their final report supplemented this exclusion with the view that energy generation from gaseous or liquid fossil fuels should only be considered to make a substantial contribution to climate change mitigation where it meets the technical screening criteria, which the TEG recommended be set at less than 100g CO2e/kWh in five-year increments to 0g CO2e/kWh by 2050. They also recommended that activities related to the dedicated storage and/or transportation of any fossil fuels, including gaseous or liquid fossil fuels should also not be considered as making a substantial contribution to climate change mitigation.7

The EU Green Bond Standard is voluntary and the Taxonomy Regulation is intended to apply to financial market participants offering financial products in the EU as environmentally sustainable investments, but both regulatory initiatives are indicative of the direction in which globally converging standards for green financing may be headed in the not-too-distant future.8


Transition bonds are poised to adopt their rightful complementary role alongside green bonds and sustainabilitylinked bonds. They will help to address a much wider range of businesses and encourage businesses to mitigate the negative impact of their brown activities on the environment. But the label should not be a free-for-all to cover just about any transition from the brown to the less brown, purely for the sake of accommodating demand. Standards and criteria representing prevailing best practice must be adopted and fine-tuned over time to protect the integrity of transition bonds as representing genuine pathways to a green economy. Emerging standards and regulation such as the AXA Transition Bond Guidelines, EU Green Bond Standard, and EU Taxonomy Regulation point the way forward for prospective issuers and investors of transition bonds and are welcome developments.