From brown to green: The growing role of transition bonds

Mondrian’s David Cudmore says, although more vulnerable to greenwashing, ‘brown’ sectors must play their part


David Cudmore, portfolio manager, Mondrian Global Green Bond Fund

The green bond market has enjoyed astonishing levels of growth over recent years as it becomes more prominent across all regions. More than $530bn has been issued across 2019 and 2020 alone, greater than the cumulative amount of issuance up to the end of 2018.

This has fuelled an increasing number of issuers and broader range of sectors coming to the market as ambitions toward a greener future have been supported through direct investment. Sovereign issuers have been a part of this growth, adding almost $60bn in the past two years. The future development of the wider market will hinge on how the global sovereign green bond market takes shape and how it spurs action across regions.

Another crucial development, which will play a significant role in the makeup of green finance, are transition bonds. Transition bonds are environmentally beneficial bonds issued out of ‘brown’ sectors: those that traditionally have a high reliance on fossil fuels or other environmentally harmful materials and likely possess a heavy carbon footprint. 

Transition bonds are both a challenge and opportunity in green finance. The challenge to ensure the funding is creating a significant positive environmental impact and the opportunity to truly transition away from carbon-intensive activities to create the type of game-changing environmental benefits that are desperately needed.

Brown sectors

Examples include oil and gas, mining and construction materials. Green investment opportunities in these sectors are naturally limited but they will be pivotal in supporting the global reduction of greenhouse gas emissions and other pollutants, and will help plot a path to a more sustainable future. To date, only a handful of securities that could be classified as transition bonds have been issued.

If the global economy is to make the broad sustainable changes needed to protect our futures, where most look to compliance with the Paris agreement and aim to keep temperature increases below 1.5 degrees, all industries will have to adapt. This is not the exclusive realm of sectors that are already highly green.  

By excluding ‘brown’ sectors, we would be depriving these areas of the capital needed to transition their business and support the overall move to a greener future. Arguably, it would be investment in these sectors that could yield the most significant positive impact for the environment. However, the transition of these sectors is not straightforward.

While all eyes are on what the global economy should look like in the future, it is undeniable that these sectors are highly integrated in today’s economy. They support jobs, create investment and contribute to economic growth. 

Although these companies play significant roles in the global economy, the greatest barrier to change may be the impact initiatives have on certain domestic economies and regions. There are significant vested interests and reliance in maintaining the status quo in these industries, which creates a substantial hurdle to green development on the global scale that is required.  This is an issue across both developed and emerging economies and as such is a truly global barrier.

These sectors need to be welcomed into the green financing community and supported to make the changes that could potentially yield the most significant environmental effect. All sectors and issuers will be encouraged to seek more sources of green finance, but a green revolution of scale will fail to ignite without a realistic and supported transition across brown sectors.

Transition bonds are naturally well placed to face this issue, where the issuer would be able to clearly demonstrate the environmental benefits of their projects and investors would be comforted with a structured framework and increasing transparency of the impact of their investment. These types of industries are naturally more vulnerable to greenwashing given the pressure to ‘green’ their businesses and difficulty in moving away from their traditional and financially successful business models. This should be at the forefront of investors’ minds when it comes to transition bonds, but certainly not a block to investment.

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