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Why Japan embraces transition bonds

The shift towards net zero has seen Japan shake off a lack of international regulation and accelerate transition bond finance. Its pragmatism may trigger more global issuance this year.

By Adrian Murdoch

A new start for Japan’s energy transition? Why transition bonds are popular in the Far East. (photo by jira photo via Shutterstock.)
  • In May 2021, Japan’s Ministry of Economy, Trade and Industry established a framework for transition finance to help reach the government’s 2030 and 2050 carbon-reduction targets.
  • The country has made transition an industrial policy rather than a sustainability policy.
  • By the end of the third quarter last year, only $3.4bn transition bonds had emerged in 2022 – all of them from Japan.

Transition bonds are the misunderstood child of sustainability financing. Used to fund a firm’s transition towards either a reduced environmental impact or to reduce their carbon emissions, they have never caught on.

They currently make up a marginal percentage of sustainable issuance. By the end of the third quarter last year, only $3.4bn transition bonds had emerged and it had made up only 0.4% of sustainable bond issuance, according to London-based Climate Bonds Initiative (CBI), a non-profit organisation.

The main reason for the ambivalence is regulatory confusion.

“Some will say that transition is for sectors that are hard to abate; some will say that it is just about decarbonisation; I’ve seen some say that transition is just any kind of pathway towards improved environmental sustainability,” says Nneka Chike-Obi, head of APAC ESG ratings and research in Hong Kong for Sustainable Fitch.

A lack of support for transition bonds from the influential International Capital Market Association (Icma) is also a significant stumbling block.

Transition isn’t a product, “it’s a process, a trajectory, a theme”, Nicholas Pfaff, who is also head of sustainable finance and secretary of the Green Bond Principles and the Social Bond Principles, told Capital Monitor last year. “Accordingly, we decided it didn’t make sense to [develop] transition bond principles but rather to provide guidance on transition strategies and disclosures for issuers of all types of sustainable bonds.”

A lack of international definition has meant that they have never really taken off. The first transition bond emerged from Spanish oil and gas company Repsol in 2017 – a €500m (US$530m) 0.5% five-year bond. Heavy public criticism about the way that proceeds were used, and that their use did not represent a fundamental change in the oil company’s business model, spooked further issuance.

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“When I talk to China-based underwriters, they’re hesitant to do transition bonds. The reason is the debate and controversy around the issues,” says Wenhong Xie, head of the China programme at Climate Bonds Initiative in Beijing.

Big in Japan

“What Japan has done which is a bit different, is that it has put transition as an industrial policy, as opposed to necessarily a sustainability policy,” says Chike-Obi.

In May 2021, the country’s Ministry of Economy, Trade and Industry established a framework for transition finance to help reach the government’s 2030 and 2050 carbon-reduction targets of a 46% reduction in emissions by the former and carbon neutrality by the latter.

“There’s a real cognizance in Japan that they do need to start funding some of these projects and the shift towards net zero,” explains Melissa Cheok, associate director of ESG research at Sustainable Fitch in Singapore and co-author with Chike-Obi of a recent report looking at transition bonds.

Japan is one of the most fossil-fuel-dependent developed economies, with coal and natural gas accounting for 68% of electricity generation. The government wants to address this by promoting transition finance to help companies become less carbon intensive.

The guidelines focus on nine high-emitting sectors with difficult pathways to net zero: aviation, cement, chemicals, electricity, gas, iron and steel, oil, paper and pulp, and shipping.

It is working. No transition bonds had been issued in Japan before the government’s framework. Since then, 23 transition bonds were sold by Japanese companies. Indeed, every transition bond in 2022 was Japanese and denominated in yen.

Although transition bonds made up less than 1% of global ESG issuance in 2021, they were 9% of the market in Japan for the first three quarters of last year.

The reason that the country was able to ignore a lack of international standards is that the bonds are targeted domestically.

The first issuer was JERA, a joint venture between Tokyo Electric Power and Chubu Electric Power, which in May 2021 sold a two tranche ¥12bn (US$92m) 0.420% five-year and ¥8bn 0.664% 10-year transition bond with funds used to decommission thermal power plants.

Other issuers since then include shipping company NYK Line which, in July 2021, sold a two tranche ¥10bn five-year at 0.26% and a ¥10bn seven-year transition bond at 0.38% to finance vessels using lower-carbon fuels and improve energy efficiency; and Mitsubishi Heavy Industries, which in September last year sold a ¥10bn five-year transition bond at 0.31% to decarbonise existing infrastructure and to invest in hydrogen solutions.

Transition bonds could pick up

“Transition bonds really are just Japanese for now,” confirms an ESG analyst for one of the large European banks in Singapore.

But there are signs that it might be picked up elsewhere – certainly, the financing is needed.

In 2021, Asia-Pacific accounted for 52% of global carbon emissions, according to BP’s ‘Statistical Review of World Energy‘, while coal accounted for 55% and 57% of the energy mix in China and India, respectively, according to

Ravi Menon, the Monetary Authority of Singapore’s (MAS) managing director has long been banging the drum for transition funding. “Where industry needs to do better is in transition finance – to provide the funding support for companies that are not so green, to become greener,” he said in July last year.

It is well known that an estimated $200bn a year of green investment until 2030 will be needed if Asean is to have any chance at all of achieving the UN Sustainable Development Goals.

What is different this time, explains Chike-Obi, is that there has been a shift in tone from investors. Although many are still nervous about the international lack of regulations about transition funding and will keep to their wait-and-see approach, there is a growing recognition that this is an answer, even if transition funding isn’t perfect.

“The sentiment from some investors is that they really want to be more involved in transition financing,” says Chike-Obi.

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