Transition to a Decarbonized Economy: A New Market

Green bonds have emerged to revolutionize the way sustainable finance is perceived today. Their risk and return are similar to those of vanilla bonds so there is no need to sacrifice return for a higher positive environmental impact. On the contrary, green bonds have attracted a larger book cover than vanilla bonds on average, and have exhibited greater spread according to the latest Climate Bonds report Green Bond Pricing in the Primary Market.

Currently in countries like Mexico, the green bond market is dominated by issuers in the renewable energy, construction and transport sectors. Issuers in other sectors such as cement, steel, copper and chemicals — characterized by high emissions — have not entered the green financial market. This may be due in part to the reputational risk of greenwashing.

Although green bonds have been a positive start to attract funds for climate-aligned assets, activities and projects in the country, the climate problem’s urgency calls for additional financial instruments and clearer corporate and governmental strategies to achieve net-zero greenhouse gas emissions, and the faster the better. Once a strategy has been defined, transition finance can be part of it, not the other way around. The strategy needs to be detailed and investors should be more inquisitive, not only about the projects to finance but also about the zero-emissions strategy.

The former also applies to the sustainability-linked bonds (SLBs) that Mexican issuers have started to explore. Having key performance indicators (KPIs) and different interest rates for each one is not enough. How are those KPIs really linked to a zero-emissions strategy? And what is the company/country financing in order to achieve those KPIs? This is what we want to see: metrics, timescales and transparency.

Since every economic sector has a role to play in addressing climate change in the country, transition finance can be part of this game. But how to play it correctly is under development. So far, there are no specific local rules or criteria in Mexico to evaluate a green transition bond. Globally, the Climate Bonds Initiative and the International Capital Markets Association (ICMA), have opened this discussion.

ICMA published a general handbook on credible transitions with four high-level recommendations for an entity looking at transition:

• Climate transition strategy and governance

• Business model environmental materiality, important to identify their greenhouse gas emissions (GHG)

• Climate transition strategies need to be “science-based,” including targets and pathways

• Implementation transparency

ICMA is proposing these four elements listed above for issuers that want to go to the debt market with a use of proceeds or sustainability-linked bond, especially from a high-emitting industry.

The Climate Bonds Initiative is aligned with this approach and complements it with a more specific strategy framework at the entity level and/or activity level: green transition strategies need to be inclusive (all sectors), ambitious (zero carbon by 2050, among other environmental goals) and flexible (different financial instruments channeled towards entities, activities and projects). These features are present in the paper, Financing Credible Transitions, published jointly by the Climate Bonds Initiative and Credit Suisse in September 2020.

In order to be inclusive, all sectors should be able to transition including high-emissions sectors. One question that entities can start with is, will my product/service be needed post 2050? If so, is it part of the pathway to the Paris Agreement?  Economic sectors and activities can be grouped by their role in a low-carbon economy as follows:

To be ambitious, the entity needs to set up a target aligned to international climate goals, aiming at reducing half of its emissions by 2030 and reaching zero emissions by 2050.

The transition strategy needs to be flexible enough to apply to a wide range of market instruments, and to be implemented by whole entities in all their activities:

Additionally, the paper proposes five guiding transition principles. By meeting these principles, the entity, activity or project will be on a pathway toward a credible transition, and to meeting the Paris Agreement goals:

1. In line with 1.5-degree trajectory and the Paris Agreement
2. Established by science
3. Offsets do not count
4. Technological viability trumps economic competitiveness
5. Action not pledges

To achieve the real shift necessary to deliver net-zero emissions, many sectors will need to completely reimagine how they operate to deliver confidence to investors, clarity to bankers and credibility to issuers.

There are examples happening in Mexico but a deep analysis is required to confirm alignment with the Climate Bonds Transition Framework. If you are an issuer in Mexico and are interested in aligning your corporate strategy, we invite you to follow Climate Bonds’ transition work. We are starting a three-year program on transition that will include the expansion of our Standard and Certification Scheme to enable the certification of transition plans. The program will track markets to provide tools for investors and will provide advice and guidance to governments to develop the right supportive policies.