Mechanisms to Prevent Carbon Lock-in in Transition Finance

4. Carbon lock-in considerations in transition financial instruments

Abstract

This chapter reviews financial instruments relevant to transition finance, and related frameworks developed by governments and market actors. It analyses associated greenwashing risks, and specifically risk of carbon lock-in. The chapter provides an analysis of green, transition and sustainability-linked bonds issued to date by companies in high-emitting sectors, to understand potential risks of greenwashing and lock-in of such instruments. The chapter finds that existing issuances have a risk of carbon lock-in and that frameworks for transition financial instruments can be strengthened in this regard. It sets out key findings and good practices to this end.

A wide range of financial instruments are relevant to transition finance, namely (i) green bonds and loans to raise financing for activities that are already low-emission, (ii) transition bonds and loans for activities on a credible pathway to become low-emission in the future and (iii) sustainability-linked bonds and loans to finance general purpose activities of an entity planning to transition to a low-emission and sustainable future. The sections below analyse each of these three types of instruments, highlighting their promising features, risks of carbon lock-in and greenwashing, as well as potential ways to address them.

It is worth noting that while each of three labels above are applicable both to bonds and loans, the sections below focus on bonds, even though lending instruments are as important as capital markets to raise finance for the transition. The focus on bonds is mainly due to the fact that their loan counterparts are typically arranged through private operations and are not traded, therefore publicly available information and disclosure on loans is much more limited than bonds (CBI, 2022[1]; World Bank, 2021[2]). Lessons on the use of mechanisms to prevent lock-in as part of transition finance can also be relevant to green, transition and sustainability-linked lending operations, as well as to mainstream financing of fossil fuel assets, where risk of lock-in is arguably highest and existing safeguards are rarely used.

4.1. Green bonds

In the green debt space, which is the largest and most mature thematic debt segment (CBI, 2022[1]; Refinitiv, 2022[3]), greenwashing risks are generally lower than in other market segments, as proceeds from green bonds and loans are exclusively used to (re)finance new or existing green projects (see the Glossary in Annex A for definitions of those instruments). Box 4.1 below provides details on latest trends and existing standards and principles on green bonds.

Different issuers and institutions apply existing green bond standards and principles in various ways. Most green bond issuances align with the International Capital Market Association (ICMA)’s Green Bond Principles (BIS, 2020[4]). Multilateral development banks (MDBs), which contributed to the creation of the green bond market and still play a key role as issuers, investors, and advisors, generally apply ICMA Green Bond Principles and the MDB Common Principles for Climate Mitigation and Adaptation. However, they apply existing guidance on green bonds in different ways. This has resulted in comparable but slightly different green bond frameworks among MDBs, which sometimes closely follow ICMA guidance and other times reflect MDBs’ specific needs and strategic priorities (OECD, forthcoming[5]).

It is also worth noting that ICMA Green Bond Principles do not define what technologies or activities can be classified as “green” and encourage issuers to “provide information on the alignment of projects with official or market-based taxonomies, if relevant, and disclose any green standards or certifications referenced in project selection” (ICMA, 2021[6]). This means that eligibility of activities that can be financed through green bond proceeds depends on the eligibility list or taxonomy used to classify projects (if any). For example, in the European Union (EU), there is both a sustainable finance taxonomy and a green bond standard. If using the (voluntary) European Green Bond Standard (EUGBS) label, issuers will need to ensure that at least 85% of the funds raised by the green bond are allocated to economic activities that align with the EU Taxonomy Regulation (European Commission, 2023[7]).1 See Box 3.3 in (OECD, 2023[8]) for further details on the links between the EU Taxonomy and the EUGBS. Moreover, green bond certifications, such as the one developed by CBI, provide assurance on eligible green activities as they verify that proceeds are used for activities aligned with CBI’s sector-specific eligibility criteria.

Box 4.1. Green bonds: latest trends, principles, and standards

According to the Luxembourg Green Exchange (LGX) DataHub, in 2022 green bond issuances amounted to almost USD 407 billion and the cumulative issued amount over the 2019-2022 period was almost USD 1.4 trillion, with a yearly average of USD 349 billion.1 While green bond issuances were on an upward trend until 2021, it is worth noting that they still represent a relatively small fraction (approximately 5%) of the overall bond market, which is worth USD 8.3 trillion in 2022 (Refinitiv, 2023[9]).

Green bonds are mainly issued in Europe and over half of the bonds recorded globally2 were issued by either utility companies, banks, or real estate companies (ICMA and LGX, 2023[10]). Empirical evidence on the presence of a general “greenium”3 for green bonds is mixed. While some studies find the presence of a greenium, though with substantial variance depending on the type of issuer, credibility of green credentials and presence of external certification (Fatica, Panzica and Rancan, 2021[11]; Kapraun et al., 2019[12]; Pietsch and Salakhova, 2022[13]), others find no greenium (Flammer, 2021[14]; Larcker and Watts, 2020[15]).4

Green bond proceeds have so far mostly financed activities in renewable energy and energy efficiency (IRENA, 2020[16]). A variety of principles and standards5 for green bonds have been developed by different stakeholders, e.g., by market actors (ICMA’s Green Bond Principles and Climate Bonds Initiative (CBI) Standard and Certification Scheme), by relevant actors at regional level (e.g., those of the Association of Southeast Asian Nations (ASEAN) and EU Green Bond Standard), and by jurisdictions at national level (e.g., in China, India, and Japan). In most jurisdictions, except for China, such standards are for voluntary use, so issuers have flexibility on which framework or standard they choose and apply.

1. The issuance amounts include matured bonds.

2. The Luxembourg Green Exchange (LGX) DataHub has global coverage of listed sustainable debt instruments (Luxembourg Stock Exchange, 2023[96]). Issuances in China’s domestic market and those of certain US municipalities are not covered in the database. Issuers located in Russia are not included (ICMA and LGX, 2023[10]).

3. The “greenium” refers to the premium that bondholders are willing to pay to invest in green securities rather than their vanilla counterparts, thus making green bonds a relatively cheaper cost of funding for issuers.

4. A recent ECB Working Paper finds that only green bonds with external review and issued by credible companies trade at both a statistically and economically significant greenium, which seems to evolve over time and be mainly driven by retail investor demand (Pietsch and Salakhova, 2022[13]). Kapraun et al (2019[12]) find that the existence and significance of the greenium varies substantially across currencies and issuer types, with the greenium being high and significant for bonds issued by governments or MDBs or by corporates with strong green credentials. Other studies find no greenium in corporate bonds (Flammer, 2021[14]) and in municipal green bonds (Larcker and Watts, 2020[15]). Fatica, Panzica and Rancan (2021[11]) find presence of greenium for green bonds issued by MDBs and non-financial corporates but not for issuances by financial institutions. They also find that green bonds with external review benefit from a larger greenium compared to self-labeled green securities.

5. It is worth noting that the terms “principles”, “standards”, “frameworks”, and “taxonomies” are commonly used interchangeably though they refer to different concepts. See Box 3.2 in (OECD, 2023[8]) for further details on this.

While green bond standards and green taxonomies broadly converge on the definition of green eligible activities, some differences persist, which can create greenwashing lock-in risk. For example, lock-in risk can arise if green bond proceeds are used to make incremental efficiency improvements of refineries processing fossil fuels, thereby extending plant operating lifetimes (CBI, 2017[17]; I4CE, 2018[18]). The International Finance Corporation (IFC)’s updated Green Bond Framework excludes “projects where the core source of energy is based on fossil fuels and other projects that support carbon intensive activities” (amongst others) from its eligible activities (IFC, 2022[19]). However, CICERO’s second party opinion of IFC’s Framework highlights that IFC could further define and tighten the exclusion criteria of “core energy” fossil fuel as the absence of a specific threshold leaves room for interpretation. In addition, CICERO notes that while direct investments in fossil fuels are excluded, some projects could indirectly be exposed to fossil fuels (e.g., new buildings with fossil fuel heating, energy efficiency in industry processes), which could lead to carbon lock-in (CICERO, 2022[20]).

One notable development and step towards harmonisation of green bond frameworks is China’s 2021 revision of the Green Bond Endorsed Project Catalogue, which removed carbon-intensive projects related to fossil fuels such as clean coal technology from its list of eligible green activities (CBI, 2021[21]). However, some coal mining-related activities are still included in the project catalogue, such as “land remediation, ecological restoration and environmental remediation in coal-mining subsidence areas, relocation of residents within the influenced areas and restoration and upgrading of infrastructure and public service facilities” (People's Bank of China, 2021[22]).

Uncertainty remains around the eligibility of some activities that concern gas investments, given the potential carbon lock-in risk they could create. For example, China’s Green Bond Endorsed Project Catalogue includes some activities related to the construction and operation of natural gas transmission, storage, and peak load regulation facilities as part of the “efficient operation of clean energy” category.2 There have been instances of issuances of green bonds by gas companies that used the issuance proceeds for retrofits of existing gas distribution networks to enable integration of hydrogen, which is recognised by the EU Taxonomy as a “low-carbon economic activity” (European Commission, 2021[23]; GasNet, 2022[24]). Moreover, in the EU, blending gas with hydrogen and other renewable or low-carbon gases can be in line with the EU Taxonomy, provided that the eligibility criteria are met. In particular, the EU Taxonomy Complementary Climate Delegated Act includes some gas-related energy production activities3 as “transition economic activities” as long as they meet one of the following criteria: “(i) lifecycle emissions are below 100gCO₂e/kWh, or (ii) until 2030, and where renewables are not available at sufficient scale, direct emissions are below 270gCO₂e/kWh or, for the activity of electricity generation, their annual direct GHG emissions must not exceed an average of 550kgCO₂e/kW of the facility's capacity over 20 years. While criterion (i) implies almost exclusive use of low-carbon or renewable gases, criterion (ii) and (iii) indicate blending of fossil gas with low-carbon or renewable gases4, or fuel switching at a certain point during the operation of the plant. In this case, the activity must meet a set of cumulative conditions: e.g. it replaces a facility using solid or liquid fossil fuels, it ensures a full switch to renewable or low-carbon gases by 2035, and a regular independent verification of compliance with the criteria is carried out” (European Commission, 2022[25]). Similarly, China’s Green Bond Endorsed Project Catalogue includes “hydrogen-incorporated natural gas pipelines” as eligible green activities, without specifying further details or thresholds (People's Bank of China, 2021[22]).

However, it is recognised that gas blending for electricity generation (notably, for use in buildings and transport) could hinder the transition of other activities for which hydrogen is currently the only viable decarbonisation technology (e.g. steel and cement production), by absorbing much of the available hydrogen production (CBI, 2022[26]; E3G, 2023[27]). Moreover, blending has limited emissions reduction potential, is less efficient than using hydrogen in its pure form,5 and creates stranded asset risk and cost because incremental retrofits and technology replacements are required to increase blending volumes (CBI, 2022[26]). Similarly, blending hydrogen into gas grids can create additional costs to gas consumers, as low-emission hydrogen production costs are likely to remain higher than natural gas prices (IEA, 2019[28]; E3G, 2023[27]). CBI does not assess gas blending to be aligned with the Climate Bonds Principles for a Credible Transition, as blending is not considered a viable decarbonisation strategy and the only valid retrofit pathway is repurposing infrastructure for 100% hydrogen distribution (CBI, 2022[26]).

Assessments regarding the limited environmental benefits of blending natural gas with hydrogen for power generation stand in contrast with their categorisation as transition activities under some approaches. In particular, in power generation, which fundamentally affects consumers, political and social considerations may override technological feasibility factors. Similarly, without projecting costs over the long-term and considering costs of reinvestment to switch to a lower-emission alternative (like renewables) in the future, as part of a detailed economic feasibility assessment, natural gas investments may appear less costly.

It can be expected that there will soon be increased attention to carbon lock-in risk in green bond issuances, particularly given the increasing focus on greenwashing risks in sustainable finance more generally. According to the International Monetary Fund (IMF), as demand for green products is growing fast, especially from green or sustainable investors, there is a risk that issuers may greenwash projects that produce few real climate benefits. There will be a growing need for third-party verification of alignment with standards and taxonomies (IMF, 2022[29]).

In jurisdictions where taxonomies have not been developed, an alternative is additional disclosure requirements on eligible projects and impact reporting. For example, in 2023, the Securities and Exchange Board of India (SEBI) revised its existing framework for green debt securities and provided additional disclosure requirements for green bond issuers. To address risks of greenwashing, according to the new requirements, any green bond issuer shall: (i) avoid using misleading labels, hide trade-offs or cherry pick data to highlight green practices while obscuring unfavorable ones; and (ii) quantify the negative externalities associated with the use of proceeds, amongst other requirements related to maintaining high integrity standards (SEBI, 2023[30]). Moreover, while India’s green securities eligibility categories are broad and do not specify specific thresholds or benchmarks, new disclosure rules (both before and after issuance) require issuers to provide details on the criteria applied and decision-making process followed to determine eligibility, as well as details on alignment with taxonomies (if any) and with India’s Nationally Determined Contribution (NDC) (SEBI, 2023[31]). After issuance, issuers are also required to provide qualitative and, where feasible, quantitative performance measures of the environmental impact of the financed projects (including methods and underlying assumptions made for such assessments). If they are not able to quantify the impact, they have to provide reasons why this is the case.

A further issue related to green bond issuances is the fact that they are generally used to raise finance for specific green projects so individual issuances do not necessarily signal that issuers have a credible and whole-of-entity transition plan in place to transform their business models and operations and drastically reduce their emissions. In addition, a significant share of green bonds is used to refinance existing debt, which raises questions for additionality and suitability to finance a credible transition (Bongaerts and Schoenmaker, 2020[32]). In light of this, ICMA’s Green Bond Principles recommend higher transparency on issuer-level sustainability strategies and commitments and better positioning of green bond eligible projects within the overarching strategy (ICMA, 2021[6]).

There remains scope for harmonisation of green bond frameworks across issuers, in terms of both structure and content, to facilitate investment and increase comparability of financed projects (OECD, forthcoming[5]). Such harmonisation could mean optional additional requirements to provide detailed taxonomies or eligibility lists, criteria for project evaluation and selection, and better reporting practices with respect to use-of-proceeds and impact. Specifically, where green bonds allow the financing of transition activities or projects involving natural gas-based energy production for a limited period (such as before switching to 100% renewable or low-emission fuels), credibility can be ensured through additional verification requirements and reporting on forward-looking indicators.

4.2. Transition bonds

According to CBI, transition bond issuances amounted to USD 3.4 billion in 2022 and represented 0.4% of the thematic bond market, with most bonds being issued in Japan (CBI, 2022[33]). As of 2023, a cumulative amount of USD 11.3 billion worth transition bonds have been issued (CBI, 2023[34]).

The growth of transition bonds has been spurred by the ICMA Climate Transition Finance Handbook published in 2020, and revised in 2023 (ICMA, 2023[35]). The Handbook encourages bond issuers to align with the elements contained therein to communicate their GHG emission reduction strategy. According to the Handbook, this is relevant to green, sustainability or sustainability-linked instruments designated as “climate transition” bonds, which in some jurisdictions may also take the form of an additional, separate label (ICMA, 2023[35]).

Lock-in risks are highly present in transition bond issuances, given the lack of definitions and eligibility criteria for what constitutes a transition bond. For example, in 2021, the Bank of China (BoC) issued its first transition bond in the offshore market. To facilitate the issuance, the BoC published its Transition Bond Management Statement, which explicitly refers to alignment with the principle of avoiding carbon lock-in by ensuring to evaluate projects according to local thresholds and selection criteria, referring to the decarbonisation pathway of the countries or regions where the relevant projects are located, and by phasing out ineligible or out-of-date transition projects (Bank of China, 2021[36]). Categories of eligible projects include production and co-generation of electricity, heating and cooling from gas, as well as manufacturing of cement, aluminum, iron, steel, fertilisers and nitrogen compounds. For example, the 2021 BoC issuance’s proceeds were used for natural gas co-generation projects (making up 92% of the proceeds), natural gas power generation, and cement plant waste (Bank of China, 2022[37]; CBI, 2021[21]).

In Japan, in 2021 the government published the Basic Guidelines on Climate Transition Finance, which put forward a set of (not legally-binding) considerations on key elements transition finance issuers should disclose about their strategies, actions, and plans, in line with ICMA’s Climate Transition Finance Handbook (FSA, METI and Ministry of Environment, Japan, 2021[38]). In 2023, the government also released a follow-up Guidance on Transition Finance for financiers (mainly bond issuers), with the aim of supporting effective dialogue between financiers and issuers on the execution and implementation of transition strategies and tracking progress towards decarbonisation targets (METI, 2023[39]). The government of Japan also published sector-specific roadmaps for shipping, aviation, iron and steel, chemicals, power, gas, oil, pulp and paper, cement, and automobiles. The guidelines and sectoral roadmaps have been used to develop several frameworks for transition bond issuances in Japan.

In India, SEBI’s regulation on “issue and listing of non-convertible securities” considers transition bonds as a “sub-category” of their recently redefined “green debt securities” (SEBI, 2023[40]). According to this regulation, transition bonds comprise “funds raised for transitioning to a more sustainable form of operations, in line with India’s Intended Nationally Determined Contributions”. To increase transparency, the regulation requires issuers of transition bonds to disclose transition plans and progress of their implementation, with details on the interim targets, project implementation strategy and related use of technologies as well as mechanisms to oversee the use of proceeds raised through the bonds. In case of a revision of the transition plan, the issuer should disclose the revised plan to the stock exchange, along with an explanation of any revision (SEBI, 2023[41]).

Transition bonds are issued by entities from a wide range of sectors, including high-emitting and hard-to-abate ones. For example, there have been issuances that funded construction of gas companies’ new LNG terminals and pipeline extensions (METI, 2022[42]), a high-efficiency gas-fired power generation project (DNV, 2022[43]), projects to gradually increase co-firing with hydrogen and ammonia in a coal-fired power plant (METI, 2022[44]), co-firing with black pellets in coal-fired power plants and energy saving activities in refineries (DNV, 2022[45]; METI, 2022[46]).

Hydrogen, ammonia, and hydrogen-based fuels play an important role in the net-zero transition, especially in hard-to-abate sectors, such as heavy industry and long-distance transport (IEA, 2023[47]). According to IEA’s updated net-zero emission by 2050 scenario, the use of low‐emissions hydrogen and ammonia in power plants and the use of carbon capture technologies can play an important role in cutting emissions from existing plants while maintaining electricity security (IEA, 2022[48]). At the same time, such activities could pose lock-in risks, based on the degree of environmental contribution of marginal or incremental efficiency improvements of fossil fuel investments. Hydrogen and ammonia production is currently mainly based on the use of unabated fossil fuels, with low-emission hydrogen having relatively high production costs, barriers to deployment and lack of infrastructure. It will require significant investment and policy measures to support its uptake and drive down costs for electrolysers and renewable energy (IEA, 2023[47]). Moreover, a number of studies have concluded that the use of ammonia as a fuel for co-firing in coal power plants has limited potential for emission reductions, cost competitiveness and technical feasibility for deployment at scale (Centre for Research on Energy and Clean Air, 2023[49]; E3G, 2023[50]). The amount of emissions associated with the production of hydrogen and ammonia varies considerably depending on the feedstock and processing route. According to one IEA report, the use of ammonia in the power sector has low overall efficiency and, even though ammonia consumption is considered to be low-emission, its production can lead to a level of emissions that could be significantly higher than that of the fossil fuels that ammonia would be replacing through co-firing (IEA, 2021[51]).

4.3. Sustainability-linked debt

Sustainability-linked loans (SLLs) and bonds (SLBs) are relatively new (first introduced in 2019) and innovative performance-based financial instruments that allow issuers to raise capital for general corporate purposes (thus their proceedings are not earmarked for specific green or sustainable activities, as is the case in use-of-proceeds bonds like green or sustainability bonds). SLLs’ and SLBs’ financial and structural characteristics (such as the interest rate of a loan or coupon of a bond) vary depending on whether the borrower or issuer achieves sustainability performance targets (SPTs) for a predefined set of Key Performance Indicators (KPIs), which can cover a range of environmental and/or social targets (see the Glossary in Annex A for definitions of the different thematic bond instruments). Box 4.2 below provides details on latest trends and existing principles on SLBs.

Box 4.2. Sustainability-linked bonds: latest trends, principles, and standards

SLBs are an increasingly widespread financial instrument, issued mainly by non-financial corporates, which mostly link their SLB issuances with emission reduction-related targets (Banque de France, 2022[52]). According to the Luxembourg Green Exchange (LGX) DataHub, in 2022 SLB issuances amounted to USD 66 billion and the cumulative issued amount over the 2020-2022 period was USD 171 billion, with a yearly average of USD 57 billion (ICMA and LGX, 2023[10]).1 SLBs are issued by non-financial corporates to a much greater extent than is the case for green bonds. 91% of SLBs were issued by non-financial corporates, especially in sectors such as utilities (24%), consumer goods (21%), industry (13%) and materials (12%), whereas the highest share of green bonds was issued by banking institutions (21%), followed by utilities (18%) and real estate companies (15%) (ICMA and LGX, 2023[10]). The ECB’s decision to accept SLBs as eligible collateral for Eurosystem credit operations and outright purchases for monetary policy purposes might have contributed to the development of this market, at least in the Eurozone (ECB, 2023[53]; National Treasury, 2022[54]). More recently sovereigns entered the SLB market with first Chile and then Uruguay issuing the first sovereign SLBs (Ministry of Finance, Chile, 2020[55]; Ministry of Finance, Uruguay, 2023[56]).

Some voluntary principles guiding the use of sustainability-linked loans and bonds have been developed by market actors, namely those by ICMA (2023[57]), the ASEAN Capital Markets Forum (ACMF, 2022[58]) and the Asia Pacific Loan Market Association (APLMA), Loan Market Association (LMA) and Loan Syndications & Trading Association (LSTA) (APLMA, LMA and LSTA, 2023[59]). However, most jurisdictions have not yet developed formal standards or frameworks for sustainability-linked financial instruments, except for the Ministry of Environment of Japan that has developed Sustainability Linked Loan Guidelines (Ministry of Environment of Japan, 2020[60]).

Most SLBs are linked to targets on emission reductions and other environmental objectives. According to Refinitiv data, in 2022, 87% of SLBs had at least one KPI related to an environmental objective. Among these, 61% had KPIs related to emission reductions, with most of them (47%) having targets on either just scope 1 or scope 1 and scope 2 emissions (Refinitiv, 2022[61]).

1. The issuance amounts are calculated including matured bonds.

The sustainability-linked debt market is still nascent and has been growing fast. In this context, a number of financial market actors, regulators and think tanks have raised concerns relating to greenwashing. First, concerns have been raised on the use of composite Environmental, Social and Governance (ESG) ratings as KPIs to link the financing with, as ESG scores are currently highly dependent on the assumptions used by ESG ratings and data providers (NGFS, 2022[62]; OECD, 2022[63]). For instance, the European Central Bank (ECB) does not consider improvements in ESG ratings or scores as acceptable SPTs for the purposes of determining the eligibility of assets as collateral in its credit operations or for its asset purchase programmes (ECB, 2023[53]). For this reason, issuing companies are increasingly asked to disclose and demonstrate that the emission reduction KPIs and targets they link the financing with are based on science-based pathways. However, according to Refinitiv data as of December 2022, only 1% of SLBs recorded have SBTi-verified targets (Refinitiv, 2022[61]).

Second, recent studies have found that existing SLB structures can allow for the possibility for issuers to take advantage of potentially lower costs of capital without undertaking the expected corresponding improvement in sustainability performance towards pre-set targets. Kölbel and Lambillon find that issuing an SLB yields an average premium of -9 basis points on the yield at issue compared to a conventional bond, although this premium decreases over time. The authors find that the average SLB premium exceeds the average penalty, suggesting that penalties are likely set too low (Kölbel and Lambillon, 2022[64]). A recent IFC paper empirically tests potential structural loopholes of SLBs and finds that SLBs with coupon step-up penalties, which represent the majority of SLB issuances, are more likely to have later target dates and call options embedded (World Bank Group, 2022[65]). Setting a late target date is a simple way for an issuer to reduce the total number of higher coupon penalty payments arising from a failure to achieve sustainability targets. Similarly, calling a bond before maturity relieves the issuer from the remaining coupon payments during the bond’s life, allowing to reduce or even completely avoid penalties. While it is early to assess the ambition, effectiveness, and credibility of SLBs, given the nascent stage of this market, such findings suggest the need for continued scrutiny of SLBs to address greenwashing concerns and realise their potential as a channel for environmentally credible transition finance.

SLBs are accessible for a wide range of issuers across sectors. This can be seen in issuances to date by high-emitting companies, such as those operating in the fossil fuel sector or in energy-intensive industries (namely steel, cement, and chemicals) – see the non-exhaustive list of examples in Table 4.1 below.

Table 4.1. Examples of SLBs issued by companies in high-emitting sectors

Company	Sub-sector	Country	Number of issuances	Year of issuance	Amount
Oil and gas production and exploration
Tamarack Valley Energy	Oil and gas exploration and production	Canada	1	2022	USD 300 mn
Eneos Holdings	Oil and gas exploration and production	Japan	2	2022 2022	JPY 85 bn JPY 15 bn
Eni	Oil and gas (exploration and production, power, refining, etc)	Italy	2	2023 2021	EUR 2 bn EUR 1 bn
Polski Koncern Naftowy Orlen	Oil refinery	Poland	2	2020 2021	PLN 1 bn PLN 1 bn
Repsol	Oil and gas (exploration and production, power, refining, etc)	Spain	1	2021	EUR 1.25 bn
Oil and gas infrastructure and transportation
Enbridge	Oil and gas pipelines	Canada	2	2021 2021	CAD 1.1 bn USD 1 bn
Kinetik Holdings	Oil and gas transportation and infrastructure	US	1	2022	USD 1 bn
Nederlandse Gasunie	Natural gas transport and infrastructure	Netherlands	2	2021 2022	EUR 300 mn EUR 500 mn
Snam	Natural gas transportation	Italy	2	2022 2022	EUR 850 mn EUR 650 mn
Worley	Oil and gas consulting and engineering	Australia	1	2021	EUR 500 mn
Utilities
ČEZ	Electric utility	Czech Republic	1	2022	EUR 600 mn
Enel Finance International	Financing company for Enel Group (Italian electric and gas utlility)	Netherlands	22	From 2019 to 2022	Approx. USD 1 bn (on average for each issuance)
NRG Energy	Electric utility	US	2	2020 2021	USD 1.1 bn USD 900 mn
Public Power Corporation	Electric utility	Greece	3	2021 2021 2021	EUR 775 mn EUR 125 mn EUR 500 mn
Empresa Generadora de Electricidad Haina	Electric utility	Dominican Repuiblic	1	2021	USD 300 mn
Chemicals
Braskem Idesa	Thermoplastic resins and other petrochemicals production	Mexico	1	2021	USD 1.2 bn
Henkel	Chemical and consumer goods	Germany	3	2022 2021 2021	EUR 650 mn EUR 500 mn USD 250 mn
Indorama Ventures	Intermediate petrochemicals production	Thailand	3	2021	THB 5 bn THB 3 bn THB 2 bn
Metals and mining
Newmont Corporation	Gold mining	US	1	2021	USD 1 bn
Constellium	Aluminium	France	2	2021 2021	USD 500 mn EUR 300 mn
Jsw Steel	Steel	India	1	2021	USD 500 mn
SSAB AB	Steel	Sweden	1	2021	SEK 2 bn
Norsk Hydro	Production of aluminium and energy	Norway	2	2022	NOK 1.5 bn NOK 1.5 bn

Note: This table includes a non-exhaustive list of examples, mainly for illustrative purposes. It will be complemented by further examples in the next phase of research and data collection, for further analysis. This list includes the five largest issuances from five different countries within each sub-sector, for which a Second Party Opinion (SPO) is publicly available in English, within a sample of issuances available on Refinitiv up until December 2022.

Note: “mn” = million; “bn” = billion

Source: Refinitiv data (until December 2022), complemented by desk-based research.

The uptake of sustainability-linked bonds and loans by a wide variety of issuers across sectors indicates that the instrument has potential to be used for a whole-of-economy, cross-sectoral transition. At the same time, evidence suggests that the KPIs and metrics used in SLB issuances in high-emitting sectors are not always consistent with an ambition to transform a company and adhere to a credible low-emission pathway. According to CBI, issuers in the oil and gas sector have set targets that do not envisage to halve emissions by 2030 (as called for by the IPCC) and may significantly rely on offsetting (CBI, 2021[66]). Analysis of second party opinions (SPOs) of the SLBs in Table 2.1 indicates insufficient details regarding the use of offsets (Vigeo Eiris, 2021[67]; ISS ESG, 2021[68]; ISS ESG, 2021[69]; Vigeo Eiris, 2020[70]; Sustainalytics, 2021[71]; ISS ESG, 2021[72]).

Moreover, it is important to monitor how a company intends to achieve its pre-defined targets and to verify the actions a company takes to reach them. The structure of a sustainability-linked instrument could potentially allow a company to achieve a pre-defined target and avoid triggering a coupon step-up by selling high-emitting assets to other financers while still retaining off balance sheet liabilities in such assets (Financial Times, 2022[73]). Ex-ante, interim, and post-issuance reporting, ideally externally verified, can provide evidence on the impact and credibility of results. The ICMA SLB Principles refer to the need for post-issuance reporting to include an “illustration of the positive sustainability impacts of the performance improvement” where feasible and possible (ICMA, 2023[57]). Such reporting should detail specific projects undertaken to achieve the predefined targets as well as inputs, outputs, and outcomes that have led to those impacts. Moreover, anchoring an SLB issuance in an entity-wide credible transition plan, specifying concrete actions the company intends to take to achieve its targets and related capital expenditure (CapEx), can help to address potential greenwashing risks and provide confidence to prospective investors (OECD, 2022[74]).

In some cases, SLB financing frameworks for oil and gas companies have depicted planned marginal efficiency improvements in natural gas facilities as positive steps towards achieving emission reduction targets (S&P Global, 2021[75]; Vigeo Eiris, 2021[67]; ISS ESG, 2021[76]). However, as noted above, such improvements could result in incremental emission reductions and risk locking in further emissions in the long run. In some instances, SLB financing frameworks of oil and gas companies do not provide sufficient information on the opportunities and limitations (e.g., costs and feasibility challenges) of the use of innovative technologies (for example, on the use of bio-fuels or renewable-based hydrogen (Vigeo Eiris, 2021[67]; ISS ESG, 2021[68]). In the industry sector, CICERO explicitly mentions lock-in risk in a SPO of an aluminum company’s SLB framework. It concerned some of the company’s planned investments to substitute fuel oil with natural gas in an alumina refinery. According to the company, the switch was due to the lack of infrastructure that would be needed to support short-term renewable energy projects in the area of the refinery. This fuel switch would entail investments in natural gas infrastructure that would increase access to natural gas for other industries and consumers in the area. CICERO recommended that the company continually reassess local conditions and report on its efforts to promote renewable energy development while reducing lock-in effects of the switch (CICERO, 2022[77]).

Some SPOs of oil and gas companies’ issuances indicated that it was not possible to assess the calibration and ambition of the emission reduction targets relative to a science-based transition pathway or to the Paris Agreement temperature goal. An often-cited reason was the lack of a sector-specific target-setting methodology for oil and gas companies by the Science Based Targets initiative (SBTi) or other methodology providers (ISS ESG, 2021[69]; ISS ESG, 2021[76]; ISS ESG, 2021[78]). SBTi is currently revising its guidance and methodologies on setting science-based targets for the oil and gas sector and has hence temporarily discontinued the validation of targets of companies in the fossil fuel sector. Some SPOs also indicated challenges in assessing and comparing the ambition of targets among industry peers, due to the use of proprietary measurement methodologies (ISS ESG, 2021[68]) or due to lack of peer data and targets (ISS ESG, 2021[69]; ISS ESG, 2022[79]).

Moreover, some SLB issuances in this sector are linked to targets related to emission reductions per unit of production (intensity targets), rather than total emissions (absolute targets), despite the issuer in some cases having set both absolute and intensity-based corporate emission reduction targets (Reuters, 2022[80]). Arnold and Toledano analysed the net zero pledges of 35 companies across seven sectors and found that oil and gas companies are the most heavily reliant on intensity targets, with all assessed oil and gas companies using either only an intensity target or a blend of absolute- and intensity-based targets (Arnold and Toledano, 2022[81]).6

Different approaches exist for corporates to measure their GHG emission performance, based on either absolute- or intensity-metrics. The three approaches are: (i) Absolute Emissions Contraction (AEC); (ii) the Sectoral Decarbonisation Approach (SDA); and (iii) Economic Intensity Contraction (EIC) (SBTi, 2022[82]) (see (Noels and Jachnik, 2022[83]) for further details on the three approaches). Intensity and absolute targets each have advantages and disadvantages. On the one hand, using intensity-based targets can be problematic as they are vulnerable to changes in production outputs and may hence not be good indicators of improvements in GHG emission reductions. Another issue with the use of intensity-based targets in SLB issuances is that companies might use different methodologies to calculate the denominator, even when choosing the same indicators. For example, production volume can be measured either considering sales productions, or raw production volumes. Differences in measurement practices and choice of indicators hinders comparability of intensity targets across companies and benchmarking comparisons to assess ambition. On the other hand, absolute metrics hinder comparability across firms of different sizes (Noels and Jachnik, 2022[83]). SBTi recommends that companies express targets in both absolute and intensity terms (SBTi, 2022[82]). The IIGCC Net Zero Standard for Oil and Gas stipulates that oil and gas companies can set targets based on absolute or intensity metrics but should indicate how an intensity target translates into absolute emissions and vice versa (IIGCC, 2021[84]). Based on existing guidance, both types of targets should be used as KPIs of SLB issuances to increase environmental integrity and reduce greenwashing risks.

A further methodological issue is that in SPOs of some SLB frameworks, the assessment of the ambition and calibration of SPTs is often backward-looking, based on peers’ past performance, rather than comparing it with a forward-looking, science-based pathway or long-term target specifying where the sector is supposed to be in the future. Assessments based on backward-looking performance risks creating lock-in as a marginal improvement with respect to past performance may not be sufficient to ensure that emissions are sufficiently reduced. Moreover, in some cases, SPOs of SLB issuances indicate challenges in comparing a given target with past performance due to the lack of verified historical emission data (ISS ESG, 2021[76]; ISS ESG, 2022[79]; ISS ESG, 2021[85]).

In addition, issuances of companies in hard-to-abate sectors often do not encompass scope 3 emission targets. According to CBI, 84% of SLB issuances by oil and gas companies do not include scope 3 targets (CBI, 2022[1]). This was confirmed by the analysis of SLBs’ SPOs in Table 2.1. However, scope 3 emissions, for instance from the use of sold products of oil and gas companies (wherever they operate in the value chain) can account for a high share of total emissions, often more than scope 1 and 2 combined (CDP, 2023[86]). Wood Mackenzie estimates that Scope 3 emissions account for 80-to-95% of total carbon emissions from oil and gas companies (Wood Mackenzie, 2022[87]).

In a broad sense, SLBs are a relatively new and fast-developing market segment, and it is still early to evaluate their impact. However, their KPI-linked feature brings in potentially promising avenues for environmental ambition and integrity. Moving forward, agencies that provide verification of issuers’ sustainability-linked financing frameworks and examine the relevance and ambition of their KPIs and targets could facilitate the transparency and growth of this market. At the same time, it is important that issuers continue to strengthen their capacity to set credible KPIs and SPTs and investors continue to build their expertise in assessing their ambition, relevance, and consistency. The environmental concerns laid out above have not prevented issuers from receiving a positive SPO on their framework. The role of verifiers and SPO providers is of critical importance since such verifications should provide assurance to investors, transparency to regulators, and efficiency in the market. Standards and oversight are needed to ensure that verification providers operate with environmental integrity.

Several jurisdictions have put forward related policies or proposals, mainly on a voluntary basis. In 2022, Japan’s Financial Services Agency (FSA) released a “Code of Conduct for ESG evaluation and data providers”, designed as a voluntary code on a “comply or explain” basis, to ensure the quality and transparency of ESG ratings, data and methodologies (Financial Services Agency, 2022[88]).7 Following its release, in July 2023, FSA published the list of 17 ESG evaluation and data providers who had notified the FSA of their intention to endorse the Code of Conduct by the end of June 2023, including global major players participating in Japanese financial markets. Similarly, in 2022 the UK Financial Conduct Authority (FCA) announced the establishment of an independent group to develop a Code of Conduct for ESG data and ratings providers, proposing to introduce regulatory oversight (Financial Conduct Authority, 2022[89]). In 2023, the European Commission made a proposal for a regulation on the transparency and integrity of ESG rating activities, which would require ESG rating providers offering services to investors and companies in the EU to be authorised and supervised by the European Securities and Markets Authority (ESMA) (European Commission, 2023[90]). In 2023, SEBI proposed to introduce an enforceable regulatory and supervisory regulatory framework for ESG rating providers (SEBI, 2023[91]).

4.4. Key findings and good practices for transition financial instruments

Clearly distinguishing between green and transition eligible activities will make frameworks for transition financial instruments more credible. Credibility can be enhanced by linking frameworks with corporate transition plans, using ambitious KPIs and SPTs that are linked with key milestones designed to prevent carbon lock-in.

• To reduce the risk of lock-in, it is important that green and transition bond frameworks and standards clearly distinguish between green and transition eligible activities, in line with applicable taxonomies or other relevant classifications. Where taxonomies do not exist, transparency on eligible projects can be achieved through additional issuer disclosure requirements.

• The credibility of SLB frameworks can be enhanced by anchoring them in and providing details about the corporate climate transition plan, in line with international best practice, such as the ten key elements of transition plans laid out in the OECD Guidance on Transition Finance. It will also follow regulatory guidance and frameworks for transition plans, where they exist.

• As per the OECD Guidance, emission reduction-related KPIs and SPTs that are meaningful, science-based and line with the global temperature goal of the Paris Agreement can enhance the credibility of SLB frameworks. It is important that they include all emission scopes, both absolute and intensity targets and not rely on offsets. In cases where offsets are used as a last resort option, sufficient details on their reliance and use will be provided.

• Frameworks of transition financial instruments used to raise finance for fossil fuel related investments, e.g., efficiency improvements of fossil fuel assets, ammonia co-firing in coal-fired power plants, or hydrogen blending in gas networks or power plants, can be enhanced by including explicit and detailed information on key milestones to achieve net zero and this should be reflected in KPI and SPT requirements, such as:

  • Timelines for achieving the planned level of co-firing, blending, or fuel switch and their dependencies on technology development and supply evolutions (see also relevant findings and good practices on future-proofing and sunset clauses in chapter 3 for more information);

  • Flanking measures to enable the desired level of blending, co-firing, or fuel switch, such as contracts of supply or additional investments, for example into hydrogen production (see also relevant findings and good practices on flanking measures in chapter 3 for more information);

  • Timelines for the retirement of high-emitting assets, if any, and relevant effects on the company’s financial strategy (see also relevant findings and good practices on early retirement of high-emitting assets in chapter 3 for more information);

  • Any other key dates or milestones that arise from the company’s decarbonisation strategy and transition plan, which may be necessary to prevent lock-in;

  • Any potential feasibility challenges;

  • Reasons for not choosing a lower-emission alternative.

The development of standards and frameworks for SLBs is necessary to strengthen the credibility of this instrument and address emerging loopholes that currently increase the risk of lock-in of related investments.

• Standards and frameworks for SLBs are important tools to address emerging loopholes and potential penalty-minimising behaviour in SLB structures, such as by ensuring issuers do not intentionally set late target dates and call options. It is important that penalties are set in a way that provides adequate incentives for the issuer to achieve its sustainability targets.

• Standards and oversight are needed to ensure that verification and SPO providers follow the highest quality standards available and ensure the credibility, integrity, and ambition of SLB frameworks and related KPIs and SPTs. In a credible SLB framework, standalone ESG metrics and scores will not be used as KPIs and SPTs.

Eligibility criteria of standards and frameworks for transition financial instruments should be regularly updated and reassessed as factors affecting feasibility evolve.

• Green and transition bond frameworks (whether of jurisdictions, entities, or other market actors) typically include a list of projects that are eligible to be financed through the bond proceeds. Wherever eligible projects include activities that are emission-intensive because of feasibility hurdles, feasibility should be regularly reassessed in case technological, economic, regulatory, or political and social conditions change.

• Wherever innovative and not fully tested and scalable net-zero technologies are used (in SLBs, transition or green bonds), details should be provided on the associated CapEx required, the feasibility of the technology used and any foreseen limitations, constraints, and uncertainties to their application.

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Notes

← 1.  Compliance with the EUGBS is not mandatory for green bond issuers within or outside the EU, but those choosing to issue under the “EUGBS” label will have to follow its requirements. For further details on the link between the EU Taxonomy and the EUGBS, please see (OECD, 2023[8]).

← 2.  Specifically, this includes the “construction and operation of natural gas transmission, storage and transportation peak shaving facilities such as long-distance natural gas pipelines, gas storage, branch pipelines, regional pipeline networks, and liquefied natural gas (LNG) receiving stations” (People's Bank of China, 2021[22]).

← 3.  Namely, electricity generation from fossil gaseous fuels, high-efficiency co-generation of heat/cool and power from fossil gaseous fuels and production of heat/cool from fossil gaseous fuels in an efficient district heating and cooling system.

← 4.  It should be noted that the European Commission’s 2021 “Hydrogen and gas markets decarbonisation package” proposes harmonised rules on gas quality, allowing for the blending with up to 5% hydrogen and access to LNG terminals and gas storage is ensured for low-carbon and renewable gases (European Commission, 2021[23]). In 2023, the Council’s position on this proposal was to keep the level of blending of hydrogen into the natural gas system limited to 2% by volume (instead of 5%) (Council of the EU, 2023[97]).

← 5.  The IEA estimated that to satisfy a given energy demand, a 5% blend of low-carbon hydrogen into gas networks would reduce CO₂ emissions by 2% (IEA, 2019[28]). According to IRENA, blending 20% hydrogen into gas networks could achieve, at best, only 7% CO₂ emissions reduction (IRENA, 2022[98]).

← 6.  It is worth noting that they analysed a relatively small sample of companies.

← 7.  It is worth noting that the regulation and supervision of rating providers does not authorise assessment of the quality of every SPO they provide and it is the responsibility of users of these ratings to ultimately assess them.